Financial Skeptic Bulletin, July 2008
Situation continued to deteriorate from June.
Bonds dropped considerably, essentially in sync with stocks on inflation fears.
For 401K investors one of the problems is extremely poor
performance of some Vanguard funds during the downturn . Especially dismal performance
of Windsor II probably can be explained by the fact that James P. Barrow has lost
his touch. In February, 2008 Vanguard dropped Grantham's Firm
as Co-Manager of Funds (Bloomberg.com)
which has a bear bias. If a value dropped more then S&P 500 during the downturn
this is not a value fund. With Windsor II this happened probably due to overexposure
to finance. Vanguard Windsor II holding in Bear Stears at end of 2007 was $694,324,525!
The "golden days" of this fund are probably over due to the amount of assets under
for growth’s sake is the ideology of the cancer cell.
|"Any fool can buy a company. You should be congratulated when you
do not lend themselves to innovation. What is recurrently so described
and celebrated is, without exception, a small variation on an established
design . . . The world of finance hails the invention of the wheel over
and over again, often in a slightly more unstable version.”
Galbraith, A Short History of Financial Euphoria
[Jun 29, 2008] An anti-stagflation strategy: move back home by By Tim Harford
June 27 2008 19:44 | FT.com
For us, the financial journalists, the credit squeeze is a lot of fun to
write about. For you, the honest newspaper subscriber, it may not be so much
fun to read about.
This stagflation business – inflation and low growth all at once – is so
depressing. You cannot look to the authorities for comfort. Your government
blew all the cash in the good times, unless you happen to live in the Gulf or
in China. Your central bank, desperately trying to sound both sympathetic and
hawkish, is changing position more frequently than a presidential election candidate.
No, you cannot rely on others. If you are going to survive – perhaps even
prosper – in a stagflationary world, you are going to have to be tough, resourceful
and self-reliant. You will have to cope with a boss looking for people to fire,
a tightwad bank manager and columnists who use words such as “stagflationary”.
It is not going to be easy.
If you are a homeowner in the UK, for example, you probably have half a million
pounds of mortgage debt, securely padlocking you to a house whose value is depreciating
by £10,000 ($20,000, €13,000) a month. This is the financial equivalent of taking
a swim while handcuffed to an anvil . What can be done? I suppose you could
always hold your breath and hope the tide goes out fast.
On the other hand, you may have some savings. If so, it is vital to invest
wisely. But where? Many pundits will have you believe that, in stagflationary
times, “cash is king”. That all depends what they mean by “king”. After tax,
a UK savings account will pay you less than the inflation rate, so the pundits
are presumably thinking of the one-eyed-man-in-the-kingdom-of-the-blind sort
It is true that cash has recently performed better than property and better
than shares, with the FTSE 100 down about 15 per cent over the past year. Still,
the savvy investor should be looking for inflation-beating returns. It is possible.
According to the UK Office for National Statistics, the price of spirits is
up nearly 10 per cent, milk, cheese and eggs are up more than 15 per cent, and
the price of edible oils and fats is up more than 20 per cent. Here, surely,
are the new investment classes. Had you sold shares last summer and stocked
up on Nido and Mazola, you could have beaten the stock market by up to a third.
Past performance is no guarantee of future performance, of course, so it
would be rash to jump headlong into a portfolio that is short on equities and
long on powdered milk. Still, an investment strategy that would also see you
through the collapse of western civilisation has something going for it.
Moving from investment tips to money-saving advice for consumers, there is
good news and bad news. The bad news is that most things are getting expensive
quickly. The good news is that the banks will not lend you the money to buy
any of them, so the problem is largely academic.
You could refer to the lists of money-saving tips provided in certain newspapers,
but I cannot personally recommend them. One “top 10” featured the following
eye-catching tip: roll a lemon around on a flat surface before squeezing it,
because this produces more juice. That is thought-provoking, but one thought
it provoked was that the money-saving gurus have failed to reveal either for
how long the lemon should be rolled, or how much extra juice would be harvested.
I strongly suspect that calculated as drops of juice per minute, lemon-rolling
does not pay the minimum wage. What is more, does anyone really look at a little
dish of lemon juice and ruefully reflect that there is nothing for it but to
squeeze another slice? As money-saving tips go, this is not much better than
taking the batteries out of your doorbell and checking every minute to see if
someone is on the doorstep.
Anyway, no amount of lemon juice is much help if you have been sacked by
your investment bank and your monthly mortgage payment is due on Tuesday.
No, the really frustrating thing about stagflation is that, while there are
people who are doing very nicely out of it all, emulating them is impossible.
Take members of the Saudi royal family, for example. I will warrant that they
are not rolling too many lemons at the moment, but the House of Saud is not
the kind of organisation you can join by submitting a peppy application letter.
Shell tanker drivers are not in the oil billionaire league just yet, but
should be pleased with a 14 per cent
pay rise over the next two years. Economic commentators should also be hot
property, but alas: no matter how great the supply of financial news, the supply
of talking heads seems to keep pace.
Then there are the teenagers and young adults living at home. Despite being
too young to know what stagflation is, they have perfectly positioned themselves
to take advantage of it. The rising cost of fuel, food and services does not
bother them: they do not pay for domestic heating or school fees, and they always
borrow the car and leave the tank empty.
On the other hand, clothes, trainers, computer games, iPods, DVDs and even
illegal drugs are all falling in price. Living at home is the perfect way to
ensure a negative inflation rate, and by the time the little blighters leave,
people will be giving houses away. It’s an ill wind, as they say.
The writer is an FT economics commentator
For months, economic Pollyannas have looked beyond the dismal headlines
and promised a quick recovery in the second half. They're dead wrong.
...this downturn is likely to last longer than the eight-month-long
recession of 2001. While the U.S. financial system processes popped stock bubbles
quickly, it has always taken longer to hack through the overhang of bad debt.
The head winds that drove the economy into this dead calm -- a housing and credit
crisis, and rising energy and food prices -- have strengthened rather than let
up in recent months. To aggravate matters, the twin crises that dominate the
financial news -- a credit crunch and the global commodity boom -- are blunting
the stimulus efforts. As a result, the consumer-driven economy may not bounce
back as rapidly as it did in the fraught months after 9/11
...The upshot: the Fed's adrenaline isn't really circulating through the
commercial bloodstream. According to mortgage-data firm HSH, rates on conforming
30-year mortgages (under $417,000) have only fallen marginally since the Fed
began cutting rates, from 6.4 percent on Sept. 21 to 6.17 on May 30, while jumbo
loan rates haven't budged at all.
...Economists say it generally takes nine to 12 months for Federal Reserve
interest-rate cuts to work their way into the system. By contrast, sending checks
to consumers tends to produce quick results. Some retailers have reported a
surge of business spurred by the tax rebates. But consumers are shopping for
necessities, not discretionary items. Sales at Wal-Mart and Costco were up in
May, while sales at Kohl's and Nordstrom were down. David Rosenberg, chief economist
at Merrill Lynch, argues that higher food and gas prices are eating the rebate.
Follow the math. The rebate checks will total about $120 billion. Studies suggest
that about 40 percent of that total, or about $48 billion, will be spent in
short order; the rest will be saved or spent later. Rosenberg reckons that higher
energy costs???crude-oil prices are up 40 percent so far in 2008???are draining
about $30 billion out of household cash flow per quarter, and that food inflation,
running at a 9 percent annualized rate, drains another $20 billion per quarter.
"So instead of the stimulus being filtered into real economic activity, it's
being diverted into the checkout counter at Albertson's and the gas station,"
May 23, 2008 | immobilienblasen
The following post from Bill Gross is worth reading every single sentence. While
i´m with Mish on what Inflation is ( see
Inflation: What the heck is it? ) it is very telling how the US is able
in depressing the symptoms of inflation. But as long as foreigners are willing
to destroy money in buying US treasuries and agency paper one has to congratulate
the US for their excellent PR ( no sarcasm! )...
I´m staying with gold......
This brings up a laughable "letter to the editor" of the Financial Times
from David Nowakowski of Atlas Management, who wrote, "For 25 years, the Fed
has kept inflation at an average of 3.2% a year - that should be applauded"!
Hahaha! You will go a Long, Long Time (LLT) long time before you hear something
so ridiculous! Hahahaha! Applauded! Hahahaha! <
But even 3.2% sounds good right now, as even food and energy, and everything
else we have to buy, are increasing at rates of inflation that are multiples
of the "official rate", which means that the horrifying 3.9% inflation is, unbelievably,
the residual inflation after the government ignores the things that went up
a lot in price, and then lies about the rest! Hahahaha! <
My laugh is nervous and dry, and for a little comic relief we go to this
week's Barron's and look in their "Indexes' P/Es & Yields" table to see that
the price-to-earnings ratio for the Dow Jones Industrial Average is now up to
87.07! This is, incredibly, up from last week's P/E ratio of 85.97! Hahahaha!
And while that is funny enough, get a load of this;
the dividends paid by the DJIA companies to their stockholders was $317.88,
while earnings were only $149.16! Hahahaha! <
Naturally, my stupid kids come running into the room with that very fact
in hand, and they want to know why it is that the 30 companies in the Dow Jones
Industrial Average can pay out three times as much as they earn, and yet I can't
let them have a tiny fraction of what I make with which to buy decent food,
or shoes that are not held together with duct tape. My eyes narrowing, I pointedly
ask them, "And who pays for the duct tape?" and they have to admit that I do.
Naturally, I think this closes the whole point of discussion, and so I provide
the denouement by saying, "So shut the hell up and go to hell!", but they, of
course, don't. <
So I ignore them, and since I am already in the "Indexes' P/Es & Yields",
I take a look at the S&P500, and see that the P/E ratio there is 22.89, which
is up from last week's P/E of 20.89, even though earnings dropped to $62.28
from last week's $66.28, which are both down from last year's earnings of $83.39!
The strategy the [neo-classical] economists used was as simple as it was
absurd—they substituted economic variables for physical ones.
Nadeau's article reminds me of the observation that the difference between
physics and economics is that physics has 3 laws that explain 97% of everything
while economics had 97 laws that explain 3% of everything.
The Big Picture
When financial companies feeling the need to
dilute their shareholders just to make ends meet can link up with the trusting
managers of other people's money, it's more than just the perfect match. It's
the perfect example of positive thinking at work in today's markets.
Remember the adage: "Be trustworthy to all and optimistic in all your dealings,
excepting those of a financial nature." ;-)
May 8, 2008 | Yahoo
How many times have you been witness to an event and then read about it in
the newspaper later? How many times would you say the newspaper reported the
event as you witnessed it?
If you're like me, truthful, accurate reportage is a rarity in your experience
when compared with, well, with your experience.
Reports of Recession Greatly Exaggerated
This is as true of giant national events as it is of neighborhood ones. I've
been involved in many of these big events, from
Watergate to the Drexel/Michael
junk bond scandal. The media simply never
gets it right. They give an impression, highly colored by the inexperience,
bias, and laziness of the reporter. Most of all, in national events, the reporting
is based upon the reporter's urgent need to magnify his or her own importance.
This is only human, but it's good to recognize it.
I've been thinking about this a lot because in the last few weeks, we've
seen a barrage of data buried in the back pages of major newspapers telling
us that the "recession" everyone said was a certainty, the "recession" that
the reporters assured us would be about as bad as the
Great Depression, is simply
The bond markets have rallied staggeringly. The stock markets had one of
their best months ever in April. The rate of defaults on corporate bonds remains
extremely low. And index securities that track mortgage defaults are saying
that the fear of a colossal national mortgage default epidemic was ill-founded.
Ignoring the Data
Just as I am writing this, new employment data has come out showing only
very small job losses in April -- 20,000 jobs out of a labor force of very roughly
160 million, meaning that 1 in 8,000 jobs has been lost. The actual rate of
unemployment is falling to a very modest level -- 5 percent.
Yet the national media is still selling us fear of a recession. One of the
major national newspapers has a reporter who's desperately trying to peddle
a story of national economic collapse even as the economy stays afloat.
And the beautiful part is that it's now crystal
clear that we're not in a recession (we could be later -- anything can happen).
There was just a report that showed first-quarter 2008 GDP growth was positive,
meaning that as a matter of arithmetic we can't be in a recession, any more
than a man who's gained weight can also be losing weight.
The Economy's Still Afloat
No, that's not the beautiful part: The beautiful part is that because we're
not meeting the definition of a recession -- two consecutive quarters of negative
economic growth -- the pundits are trying to rewrite the definition, to make
it just about anything they feel like making it. (Or, as I like to say, the
new rules allow liberals to call a conservative administration's tenure a recession
any time they have the urge.)
Ladies and gentlemen, the dogs may bark but the caravan moves on. Adroit
moves by the Federal Reserve
have saved the economy from a bad recession. The
housing crisis was never
anywhere near as bad as the media naysayers were trying to claim. The mortgage
foreclosure problem was never the disaster
hedge fund traders and their allies in the media were trying to say.
This big old leaky barge of an economy is still floating lazily down the
river. It's not as strong as it was two years ago, but it's still above the
water line. The big problem for most employers now (as
they tell me) is getting decent labor. Any halfway skilled, halfway
decent college grad can have her choice of jobs. Anyone with a real work ethic
and an education can make a fine living.
Get Real Now
I've come to feel that you, my readers, are my family. So I hope you haven't
been terrified by the media and didn't sell your stocks. I hope you've been
buying while the market was down. It may have some further air pockets, but
the direction sure looks like it'll be up for a while now. P/E's aren't at all
high, and foreign stocks are amazingly cheap.
And I'll add another suggestion. My evidence
is anecdotal at this point, but I'm hearing of an
uptick in home sales in
my beloved Southern California and my native Washington, D.C. I think the tide
is hitting full ebb, and while it may ebb for a while, it'll turn before long.
The nation is still rich.
Mortgage rates are low. Employment is high. Contrary to media reports,
loans are easily available to qualified buyers. Houses are still tax-subsidized.
Young families need homes. We old people need retirement homes. People are moving
for many reasons, and they need homes, too. Clearly it's a good time to dip
your toe in and see how you like the residential real estate water.
Bunk, More or Less
As for the financial journalists, take a cue
Henry Ford, who famously said, "History is more or less bunk."
I wouldn't say business journalism is all bunk.
But I would say it's about glorifying the reporters and selling newspapers.
And while fear sells papers, it doesn't make for good investors.
Milton Friedman’s misfortune
is that his economic policies
have been tried.”
- John Kenneth Galbraith
It looks like each class experience its own level of inflation. So there are
different inflation levels for low income, middle-class and rich. In no way
this is one nation under God.
Government statistics, particularly the CPI, have been in the news (e.g.,
up on my previous posts
I want to take a stab at the question posed in the title.
This post focuses on issue separate from the mathematics of the index forumulation,
and has to do with what the typical weights at any given instant in time
should pertain to. Should one use the expenditure weights that pertain to
all the households aggregated in the economy? Or should one use the expenditure
weights that pertain to the "typical" household?
Kokoski (2003) summarizes
the distinction thus:
In the democratic index, the expenditure pattern of each household counts
in equal measure in determining the population index; in essence, it is
a case of "one household--one vote". In the plutocratic case, the contribution
of each household's expenditure pattern is positively related to the total
expenditure of that household relative to other households--in essence,
"one dollar, one vote".
Clearly, there's no "right" answer to this question. Just like when
asking for the average household income, does one take the income earned
in a year, and divide by all the households in the US? Or does one identify
all the households in the US, rank them by income from top to bottom,
and pick the one in the middle. The former yields the mean, the latter
yields the median. Both are measures of central tendency.
that distinction can be helpful in understanding why any given observer
does not feel the CPI represents his or her experiences. Literally,
unless the income distribution is concentrated at one level, or
all households have the same expenditure patterns regardless of income
levels, then almost nobody will feel the CPI is representative of the
changing prices facing them. The more unequally income is distributed,
or the more expenditure shares vary by income level, the more strongly
this perception will held.
The gap between the CPI weighted by expenditures (so that higher
income households will naturally get a greater weight) and the CPI weighted
by the average over households, irrespective of each household's total
expenditures, is sometimes termed the "plutocratic gap". From Eduardo
Ley in a 2005 Oxford Economic Papers article. From the abstract:
Prais (1958) showed that the standard CPI computed by most statistical
agencies can be interpreted as a weighted average of household price
indexes, where the weight of each household is determined by its
total expenditures. In this paper, we decompose the CPI plutocratic
gap -- i.e. the difference between the standard CPI and a democratically-weighted
index, where each household has the same weight -- as the product
of expenditure inequality and the sample covariance between the
elementary individual price indexes and a term which is a function
of the expenditure elasticity of each good. This decomposition allows
us to interpret variations in the size and sign of the plutocratic
gap, and to discuss issues pertaining to group indexes.
Note that despite the tendency to associate "democratic" with good,
and "plutocratic" with bad (the terminology originates with Prais, I
believe), economic theory does not provide a basis for strongly preferring
the democratic over the plutocratic, in the absence of some strong conditions.
And indeed, it's not clear that either index can be justified under
Now, in the commentary on my two previous government statistics posts,
a recurring theme is that the CPI is not representative of the particular
writers' experiences. And it is true that if one's consumption bundle
does not match that of the average consumption bundle, then one will
either feel that the CPI understates or overstates the price level.
Another way of tackling this question is to ask what kind of household
has a consumption pattern that matches the CPI? The answer is as follows:
It is natural to ask then what is the household better represented
by the plutocratic CPI. Muellbauer (1974) searched for the household
whose budget shares were closest to the ... aggregate weights in
the UK CPI, and found it to be at the 71st percentile in the household
expenditures distribution. For the US in 1990, Deaton (1998) estimates
that this consumer occupies the 75th percentile. Thus, the 'representative'
consumer embedded ... is inclined towards upper-expenditure households.
Ley cites a 1987 study by Kokoski that estimates the plutocratic
gap at -0.1 to -0.3 percentage points per year over the 1972-80 period.
In words, this means that CPI using democratic weights experienced between
0.1 to 0.3 percentage points greater inflation than the reported CPI
More recently, Kokoski (2003) has updated her analysis (a related version published
in Monthly Labor Review in 2000, see
She summarizes her paper thus:
This paper provides an empirical analysis of the differences
between the plutocratic and democratic price indices, using data
from the Consumer Expenditure Survey and the CPI for the periods
1987-1997, and for simulated price change scenarios. The results
show that there is very little difference between the two types
of index, and that one index need not always exceed the other. In
the simulated scenarios, even the extreme cases where prices changed
only for expenditure-inelastic goods and services, the difference
between the democratic and plutocratic indices was only about one
point for every ten percent increase in the relative prices of these
Can we extend these results to the present time? It's not clear.
There is the conjecture that, with lower income households having a
basket skewed toward food and gasoline, the plutocratic gap would be
wide, particularly over the last couple years. While that conjecture
makes sense to me, I'd say that answer is actually not clear. The reason
I say that is because of a recent paper by Broda and Romalis, who note
that because of Chinese imports, lower income households have actually
benefitted from globalization to a much greater degree than typically
thought exactly because they have consumption patters skewed toward
goods that have decreased in price over the past decade. From
Broda and Romalis's paper:
â€¦ we find that inflation for households in the lowest tenth
percentile of income has been 6 percentage points smaller than inflation
for the upper tenth percentile over this period. The lower inflation
at low income levels can be explained by three factors: 1) The poor
consume a higher share of non-durable goods -- whose prices have
fallen relative to services over this period; 2) the prices of the
set of non-durable goods consumed by the poor has fallen relative
to that of the rich; and 3) a higher proportion of the new goods
are purchased by the poor. We examine the role played by Chinese
exports in explaining the lower inflation of the poor. Since Chinese
exports are concentrated in low-quality non-durable products that
are heavily purchased by poorer Americans, we find that about one
third of the relative price drops faced by the poor are associated
with rising Chinese imports.
Still, the Broda-Romalis paper does not directly address what has
happened in the very recent past (say the last two and half years),
as prices of goods imported from China have started to rise, and oil
and food prices have risen relative to other prices. Some ideas can
be gleaned from the data provided in Kokoski (2003), who provides 1987
expenditure shares for the various income quintiles. I present for illustration
the distributions for the bottom first and top fifth quintiles.
Figure 1: 1987 expenditure shares for bottom income quintile,
according to Consumer Expenditure Survey. Source: Kokoski (2003), Table
Figure 2: 1987 expenditure shares for top income quintile,
according to Consumer Expenditure Survey. Source: Kokoski (2003), Table
With this information, one can make a back of the envelope calculation
(and I stress this is only a back of the envelope calculation),
based upon these shares and the indices reported for the components.
This yields the following figure:
Figure 3: Year-on-year inflation calculated using annual CPI (not seasonally adjusted), (black), and guesstimated
CPI for first quantile (blue) and fifth quantile (red). Inflation calculated
as first log difference of annual CPI. Guesstimated CPIs calculated
as geometric averages of component indices. Source: BLS, and author's
calculations based on weights in Kokoski (2003), Table 5.
Here are several caveats. First, these are calculations that take
into account differential expenditures at a very high level of aggregation,
so they ignore differential shares at much finer levels of disaggregation.
Second, relative prices may have moved even more dramatically in 2008,
and the impact of that effect will be missed in this calculation. Third,
these are a calculation based upon annual data; calculation
of year to year changes will then allow for minimal influence of what
has happened to food prices in the last half of 2007.
Those caveats in mind, these guesstimates imply that the differential
between the actual CPI inflation and the inflation rate for the first
quintile is only about 0.3 ppts in 2007.
A final caveat to keep in mind (from Kokoski (2003)):
...For most a priori definitions of demographic groups, there
is generally more variation across households within each group
than there is across groups. Since the statistical significance
of any differences observed here between quintile indices is unknown,
one should not draw quantitative conclusions from these results.
So one's experience should deviate from that represented by
the CPI, even if one were at the 75 th quintile, exactly because of
the highly individual nature of consumption bundles. But it is not clear
that the income distributional aspects are driving people's differential
[Update, 2pm Tue 22 July]: Reader Andrew asks why I used geometric
averages. Upon inspecting BLS documentation, I learn that I should aggregate
the high level components (as opposed to the elementary prices) using
the arithmetic average. Iâ€™ve recalculated the indices using the arithmetic
averages, and present them in Figure 4. There is little visible difference
in the pattern of results.
Figure 4: Year-on-year inflation calculated using annual CPI (not seasonally adjusted) , (black), and guesstimated
CPI for first quintile (blue) and fifth quintile (red). Inflation calculated
as first log difference of annual CPI. Guesstimated CPIs calculated
as arithmetic averages of component indices. Source: BLS, and
authorâ€™s calculations based on weights in Kokoski (2003), Table 5.
Posted by Menzie Chinn at July 21, 2008 08:15 AM
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Another great post!
It is important to note that the issues considered here
are separate from the issues about substitution (Laspeyres vs. Paacshe indexes
and so on) discussed in the last post. And they are also separate from the many
other issues such as those in the Boskin report (such as quality changes, new
goods, price variation among retailers, how to treat housing, etc.)
Before people jump to criticize the CPI, I hope they take time to understand
these issues, and how inherently complicated calculating
a useful price index can be.
Posted by: ed at July
21, 2008 09:08 AM
Very nice post. Even though you show that everyone experiences inflation
differently, it doesn't explain widespread beliefs that inflation is understated
by 3 percentage points or more. I think the
explanation for that perception is more psychological in that people experience
inflation in their marginal spending. They really notice
paying an extra $30 a week at the gas pump, but don't consider that amount
in the context of their entire spending.
Posted by: Joseph at July
21, 2008 10:22 AM
As an interesting side note, what I found surprising from your figures 1
and 2 is that the affluent have so much more
discretionary spending available beyond basic food, housing and utilities
and they seem to squander it all on cars (private trans.) It seems to imply that in our society, when someone gets more money,
the first thing they do is buy more expensive cars.
Posted by: Joseph at July
21, 2008 10:24 AM
As an upper middle class parent hoping to buy a home, to pay college tuition,
and eventually to retire, the computed CPR is almost completely irrelevant.
Housing purchase price (which isn't even in
the CPR), tuition and medical costs together account for over 90% of my
Once I have a house purchased and tuition paid for, it will again be
irrelevant, but in some other direction.
Posted by: fg at July 21,
2008 10:57 AM
As mentioned by fg, above, ignoring the issue
of the difference between Owner's Equivalent Rent, and actual housing prices,
will mean that numbers for both your high and low quintiles don't really
match actual experience.
If you instead took the "housing"
component, and instead replaced it with rents for low income people (rents
have increased by 10% per annum for the the last five years where I live),
and housing prices (which have tripled in the last five years where I live),
I suspect you'll see a rather different picture.
Garbage in, garbage out, and OER is garbage, in terms of computing real
odograph at July 21, 2008 05:55 PM
I guess my take-away is that we should de-emphasize "the" CPI. As Menzie
chronicles, there are many CPIs.
I don't see the word "core" in this page.
There is one particularly poor CPI, beloved by glib politicians.
I think the (glib) claims that "inflation is low because the (glib) CPI
is low" should be viewed with real suspicion.
As to what's better, we probably need to tailor it to our audience. A
welfare recipient should have a CPI tailored to real rent. Perhaps retiree
CPI should be rent-based as well.
Those of us concerned with retirements decades off might need another
CPI to gauge our how well our savings are, or aren't, pacing buying power
in geriatric drugs and fishing cabins.
Posted by: Andrew
at July 21, 2008 07:29 PM
To people talking about owner's equivalent rent. If you want to track the
prices that people experience you need to track the payments that people
typically make. Housing is often paid for via a loan, so you need to use
housing loan repayments as a major part of the housing cost rather than
the raw cost of the house. The same for cars. This is how it is done in
many places. So housing costs are made up of loan repayments, real actual
rent, and a smaller portion for direct house prices since some housing is
purchased that way.
In the US, tax laws treat a house that you live in as an investment rather
than as a consumer item, so owner's equivalent rent is consistent with that
treatment - you buy your house as an investment and rent it to yourself.
In other places, your primary residence is treated for tax purposes as a
consumer item (no tax deduction, but also no capital gains tax on it). It's
a matter of classification. The house you live in is both an investment
and a consumed item. You might try to work out what portion of it is investment
and what portion consumed, and weight the loan repayments and owners equivalent
rent by those weights.
Posted by: Andrew
at July 21, 2008 07:49 PM
Anecdotal evidence suggests that people do not generally perceive
the official CPI to be characteristic of their own inflation experience.
Yale University professor Eduardo Engel reports that a popular newspaper
in Chile ran a series of interviews with two dozen celebrities who
were asked the same battery of questions, one of which was: "Do
you trust the official CPI?" It was the only question to which all
the respondents answered in agreement: "No." Government statistical
agencies, therefore, have a difficult task: How best to summarize
thousands of price movements in a single index.
(1) Why the CPI
may be inappropriate: escalating transfer payments by the usual
plutocratic CPI may result in over- or under-compensation relative
to a democratic index during different times. Although these deviations
may prove unimportant when averaged over time, there is an important
perversity, however, that should be emphasized. The plutocratic
gap in the CPI often accentuates the change in household welfare
rather than smooth it. In effect, lower-income households suffer
under-adjustments when inflation is more harmful to them (ie, when
they can least afford it). During periods in which the plutocratic
gap is negative, when prices behave in an anti-poor way, social
programs, which primarily benefit the poor, are revised less than
what would be the case with a democratic group index. Similarly,
when price movements ar (ie, when the plutocratic gap is positive)
indexed social transfers grow faster than proper cost-of-living
adjustments would dictate. Thus, plutocratic-CPI adjustments display
harmful procyclical features.
(2) On the other hand, plutocratic
weights would arise if we were to draw prices at random in
such a way that each dollar of expenditure had an equal chance of
being selected (Theil, 1967; Economics and Information
Theory p.136). So the standard CPI is quite useful as a macro indicator.
(3) Bottomline: different indexes could be easily computed for
Eduardo Ley at July 21, 2008 08:12 PM
Thank you very much for putting together such a picture of a discussion.
There are a number of things that come to mind including why governments
collect this data (cost of living indexed expenditures and stuff).
I wonder if something could be learned by not worrying too much
about the whole, or the individual or the average. Instead, use
the IRS data on household income by size and source (a series produced
with a delay)to develop a distribution curve for household income
by size, using a five-fold division, (too low, under, adequate,
comfortable, more than enough)by comparing with the BLS household
expenditure data by household income.
This approach would permit one to estimate the different effects
of food, energy, transport and debt service on lower income households,
the effects of health, energy, transport and education type expenditures
on the better off.
It could provide a corrective to "core" CPI which probably eliminates
the bottom half of households from the CPI estimates altogether
while providing a basis for working towards a representative household
defined in terms of the income which would support consumption expenditures
which would be a norm to aim for rather than a description of what
might appear to be.
The approach would also provide interesting critical insights
into the three-key government data series, employment, income and
consumption while offering the potential for an implied view of
July 31, 2008
Of Misnomers, Fallacies, and Lies
by Brady Willett
The top misnomer being perpetuated by personalities like Jim Cramer and
policy makers like Henry Paulson today is that financial problems are lingering
because there is a 'crisis of confidence' in the marketplace. This misnomer
continues that confidence can only be restored via radical bailout actions
by policy makers. To note: we are not being told that Bear Stearns, the
GSEs, and others necessarily deserve to exist, only that they must be bailed
out because there existence is essential to the system (how confident are
you in the 'system' after hearing this?)
To begin with, the contention that unprecedented bailout efforts are
required to restore investor confidence is patently wrong. If a company
is reliant upon the credit markets for its day-to-day survival and/or can
not function if its reckless trading book no longer fetches top dollar,
investors were wrong to have confidence in this enterprise in the first
place. In this regard confidence restoration in the U.S. is akin to trying
to bring back the grainy luster of a table made press board.
Next, if 'confidence' in the marketplace can only be generated by making
the populace share the financial burden of bad financial choices it would
be socialism, not capitalism, which engenders the greatest confidence in
financial markets. How many bailout efforts does it take before the supposed
confidence generating payoff from socialistic activities no longer outweighs
the growing burden on the U.S. government and its citizens? Current trends
suggest that we will eventually find out.
In short, the real story is not of investors being more or less 'confident',
but of investors no longer behaving stupidly.
The top fallacy making the rounds today is that inflation is the
serious threat. What few seem willing to acknowledge is that the rising
inflationary trend in 2008 has not been hurting the U.S. on a relative
basis. Rather, and after ending a multiyear stretch of sever underperformance
in 2007 (compared to other world markets), U.S. markets are holding up exceptionally
well in 2008. Moreover, spiking inflation rates have helped take the once
ominous threat of emerging market dominance off the radar.
Another positive (?) inflation story is seen in the debasing of the U.S.
dollar (or the primary cause of today's 'inflation'). With trillions in
U.S. assets being destroyed, bank stocks crashing, and policy makers reacting
frantically to this deflation, dollar debasement is not only generating
inflation but also helping smooth an otherwise rocky path for the financial
markets. Given that this statement may seem controversial, consider the
following: take away the debasing of the dollar and the bailouts still to
come do not get enacted, future stimulus checks do not get printed, and
wars do not get funded. In other words, it is a massive contradiction to
extol the benefits of a strong dollar to combat inflation in one breath
while calling for more unprecedented bailout efforts with the next.
To make a potentially long story short, a weakening dollar has and can
be in the best interests of America if this weakness does not spark a 'crisis
of confidence' in the dollar, or (remembering the above misnomer) so long
as investors continue to behave stupidly.
The biggest lie is that the Fed can always save the day. The reality
is that post-Volcker the Fed has done everything possible to avert periods
of creative destruction in the marketplace while at the same time doing
little to promote the longer-term health of the U.S. financial markets through
regulatory prudence. At the risk of sounding like a broken record, this
deadly dynamic is largely the result of Alan Greenspan, a man who eulogized
the supposed benefits of self-regulation at every opportunity. Today's crisis
is suggesting that the self-regulated beast requires larger and larger bailouts
in order to survive and a super-regulator to tame it - thanks for nothing
As the Fed slashes interest rates, accepts junk for treasuries, and applies
for the job of regulatory ringmaster, the recurring gravity of the situation
should be obvious: the Fed can only save the day by postponing necessary
periods of adjustment (i.e. today's 'deleveraging' is moving at a snails
pace largely because of Fed meddling!) It goes without saying that when
the adjustment obstacles become too large for even the Fed to handle the
U.S. dollar and financial system crumbles. Perhaps only then will the 'lie'
in question be fully exposed.
If the deflationary monsters can remain veiled behind advantageous amounts
of inflation, perhaps the U.S. bailouts can be effective over the short-term.
Perhaps also if the world feels that it has no choice but to continue along
the USD-hegemony-trail a little while longer, the system can avoid Armageddon.
Nevertheless, few trends tell us that longer-term a crisis of confidence
in the U.S. dollar can be avoided, and this suggests that one of the few
safe options for the investor remains gold.
But before arguing that gold is about to return to its safe haven throne,
remember that global policy makers, regulators, and money managers desperately
want to avoid this outcome. As for the average investor, so long as he or
she remains hooked on the misnomers, fallacies, and lies, they will continue
running down a paper dream while walking right by gold. To wit, amidst today's
financial blow-ups, foreclosures, and bank runs how many investors have
been hoarding gold because they fear holding fiat money? Not many.
In short, while gold is the answer if the explosion occurs, there
is reason to be optimistic that the paper chase can continue. Confidence
in paper money may indeed be shrinking as the inflation rate increases and
the Fed tries to throw its soothing cocoon over the financial world, but
this confidence - unlike the trillions in OTC derivatives and off-balance
sheet schemes - is nonetheless still observable.
Are we in a recession or are we not? The debate goes on. Take a look at the
year-over-year change in operating profits of the S&P 500 corporations (see
Chart 1). Profits have declined for three consecutive quarters through
the first quarter of this year. Given reports of second-quarter profits
to date and estimates of those corporate profits to be reported,
it is a good bet that year-over-year profits will
be down for four consecutive quarters.
... the current behavior of corporate profits is signaling a recession.
... ... ...
Now, the nice thing about corporate profit data
is that they do not get revised as do a lot of other data that go into the recession
decision. (I suppose that there might be an exception to this
when it comes to the profit data associated with Fannie and Freddie!) With the
S&P 500 profits data there is no debate as to whether the Commerce Department
is using a correct measure of prices to deflate nominal data.
If Ben Stein wants to continue arguing that the U.S. economy has not yet
slipped into a recession, as he did in Sunday's New York Times, so be it. In
the meantime, those who are paying attention to
the behavior of corporate profits continue to win Ben Stein's money.
The following is an excerpt from commentary that originally appeared
at Treasure Chests
for the benefit of subscribers on Tuesday, July 8th, 2008.
As discussed in previous commentary, despite the
dire realities affecting the global economy, it appears investors are not
heeding the warnings. Sure, some people are paralyzed like a deer in the headlights,
where you can't blame them if they are just waking up to the reality of what
lies before us. However, these still appear to be the few, with most still in
denial concerning future prospects for the economy and markets. This is evidenced
in gold and silver's sluggish performance of late. It should be doing far better
as an alternative, but again, the public does not see the need to buy it yet.
Can you blame them however, with the incessant cheerleading and gaming that
the media (CNBC in particular) pawns off as analysis? Exposed long enough to
this kind of thing it's bound to have an effect - that's just common sense.
What effect is this having on investors? The effect this is having is to
make the greater investing population, who get most of their analysis from television
believe it or not, complacent, where the conditioned response 'everything is
just fine' is predicated on the belief that as with all the other times it appeared
the sky was falling - it didn't. What's more, if you don't capitalize on other
people's weakness and buy every dip in the stock market, bubble-vision commentators
endeavor to make it appear you are an idiot, and will be left behind in the
dust. Combine this with the belief the bureaucracy would never let anything
happen to the economy / markets in an election year, and you have a recipe for
disaster in terms of sentiment, which is the primary reason(s) stocks are falling
- and could fall a great deal more.
Why would stocks fall a great deal more? On the surface, which is where most
minds operate on a perceptual basis, if the stock market were to 'crash', it
would be attributed to a disintegrating economy, which as you know from our
last meeting is the case with respect to
corporate earnings. The economy is falling off the preverbal cliff hypothecated
by so many for years now (which again, is why the public thinks it doesn't matter),
quality minds in the bureaucracy appear powerless to stop it this time because
they can't keep the stock market from falling. Of course the reason they can't
keep stocks from falling is not because of pessimism, but again, complacency.
Market participants are not
buying enough puts to keep the perpetual short squeeze alive - so the stock
market naturally falls.
Of course the real bad news is the stock market is an important source of
for many (the most important next to the housing market), as was the case with
home equity withdrawals. So, if this source of income
is lost, an unstoppable negative spiral could ensue, possibly ushering in the
unthinkable - a
The bureaucracy knows this of course, which is where the inflation thingy
comes into the picture. Here, as the economy gets progressively worse, central
monetary authorities find the justification to print ever-increasing quantities
of fiat currency to
combat the slowdown, with the end result being rising prices as this
inflation works its way
through the (global) system to the consumer.
With all this said, it's not difficult to understand why
stagflation appears to
be the word right now then, because macro-conditions are undoubtedly gripped
in a period of rising prices that appears to be having a visible impact on the
economy. Unlike the last time we had a prolonged stagflation episode back in
the 70's however, with
debt rates set against low
the ultimate outcome will likely be quite different this time around. This time,
with the US tapped on both a
domestic and international
basis, along with
considerations, regenerating the credit cycle will not be quite so easy,
if not impossible. This is of course what is not being talked about in the mainstream
media; the dire prospects
that lay ahead for the larger economy.
This is because that's what it's all about you know, keeping the credit cycle
growing. And this is how all economies mature through time. In the case of the
US, being the centerpiece of the current global boom, the bureaucracy decided
to export it's manufacturing sector(s) in favor of ever-increasing
deficits and debts to extend
the credit cycle, where since Nixon closed the gold window in 1971, the party
has been nonstop basically. Here, manufactured imports could be had on an increasing
basis in exchange for fiat currency so long as this inflation was not felt on
a wholesale basis by exporting nations. As with all things however, the global
nexus is maturing too now, where process has led to increasing input costs /
commodity prices as an enriched labor pool in these exporting nations adds to
So, let's take stock here. We have stagflation in Western (mature) economies,
who in turn export their inflation to a developing world that needs to print
money at break-neck speeds in order to cope with demand in their now booming
economies courtesy of globalization. What's more, these countries, with the
most notable example being China of course, are running huge foreign currency
reserves as a result off all this, meaning too much money is chasing too few
goods, which is why commodities are going through the roof. More recently however,
wage gains in these economies that are necessary to keep the global credit cycle
expanding have caused prices to rise too quickly - to the extent bureaucracies
are having to attempt walking the fine line of slowing their own booming economies
while not tipping mature economies into irreversible credit contractions. One
could hypothesize we have already arrived at the station in this regard, which
could permanently disrupt the entire global boom.
Most Americans do not question the existence of giant government sponsored
corporations that subsidize the real estate industry with discounted loans.
When I was interviewed by German Public Radio (See
Recorded at Wall Street) my interviewer, besides expressing surprise at
absurdly low prices in New York City where the interview took place, wondered
why Americans tolerated US government subsidies of the US real estate industry
via institutions and tax policies that the German constitution, as most European
constitutions including the French, forbid. Good question. In August 2007, French
President Nicolas Sarkozy proposed the mortgage interest deduction,
a cornerstone of US FIRE Economy policy passed as
part of the 1986 Tax Relief Act. The Constitutional Council,
the highest court in France, struck it down as unconstitutionally creating a
tax advantage for property owners. The development of a system of rent extraction
by one class of society over another worried the framers of the US constitution,
but in the end loopholes remained that left us open to the crisis of systemic
corruption that we face today.
In August 2007, French President Nicolas Sarkozy proposed the mortgage interest
deduction, a cornerstone of US FIRE Economy policy
passed as part of the 1986 Tax Relief Act. The Constitutional
Council, the highest court in France, struck it down as unconstitutionally creating
a tax advantage for property owners. The development of a system of rent
extraction by one class of society over another worried the framers of the US
constitution, but in the end loopholes remained that left us open to the crisis
of systemic corruption that we face today.
President Reagan was not. Addressing the National Association of Realtors
in 1984, he said, "I want you to know that we will preserve the part of the
American dream which the home-mortgage-interest deduction symbolizes." He didn't
mention that it also symbolized the American love affair with debt; after all,
it encourages people to pay for their homes with a mortgage instead of with
equity. Two years later, in the tax-reform act of 1986, Congress ended the deductibility
of interest on credit-card and other consumer loans; it left the mortgage deduction
But Congress did set a cap. Today, a taxpayer
can deduct the interest on mortgages worth up to a total of $1 million on his
or her first or second homes. Also, you can deduct up to $100,000
on a home-equity loan. (And what prevents you from using a home-equity line
to buy a flat-screen TV and then deducting the interest? Absolutely nothing;
go for it.)
At the beginning of 2005, flush from his election victory, President Bush
envisioned another major tax reform, somewhat similar to that of 1986. Simplifying
the tax code was a major goal, as was winnowing out the tax breaks that were
again eating a hole through the Treasury. Bush appointed a nine-member, bipartisan
panel to drum up a proposal. The president ordered the panel to "recognize the
importance of homeownership." People figured the interest deduction was off
But the panel, with former Senator Connie Mack III as chairman, asked the
taboo question of whether homeownership and the interest deduction were related.
It decided that they weren't.
I agree that the mortgage interest rate deduction should be eliminated. What
folks don’t understand is that it benefits banks. To avoid taxes people are
willing to pay a bank $1000 to save $700. How whacked it that?
Banking expert Martin Mayer, author of
The Bankers: The Next Generation The New Worlds Money Credit Banking Electronic
Age and a dozen other books on banking and frequent writer for Barron’s
Magazine, Institutional Investor, and others explains:
Exporters to America who keep the dollars and use them for American purchases
and investments create what economists call an autonomous flow of funds
back to the United States, financing the American trade deficit with an
American investment surplus.
This produces the argument most closely associated
with the new Federal Reserve chairman, Ben Bernanke (though Alan Greenspan
believed it, too), that our trade deficit is caused by a surplus of savings
that can't be profitably invested in the home countries of our trading partners.
Financing for our trade deficit comes before — and actually causes — the
If instead of investing their dollars in the United States, foreign exporters
want to take the proceeds of their sales in their own currency, their central
banks will in effect sell them that currency for their dollars. Back in
the late 1960's, when Great Society deficits and the Vietnam War prompted
the first serious sell-off of dollars (and forced the United States to abandon
the gold standard because too many holders of dollars, led by President
Charles de Gaulle of France, wanted gold), those central banks lent those
dollars into the new Eurodollar market, where they traded somewhat separately
from domestic dollars.
This created a nightmarish prospect of the United States losing control
of its own currency, and in 1971 the Fed chairman, Arthur Burns, negotiated
a deal with the European and Japanese central banks. The deal was that they
would return to America the dollars they acquired in their own economies,
and the Fed would invest the money on their behalf, in absolutely safe government
securities, without charge and at the best rates.
Today, the Fed continues as custodian of the "foreign official holdings"
of such government obligations. During the Clinton
administration, the Fed agreed to invest in federally guaranteed housing
securities for those foreign central banks that wanted a better yield on
their dollar reserves than they would get from government bonds, and now
half a trillion dollars* of the total official holdings are invested in
Foreign official holdings of government paper is a miner's canary number.
It tells you if there is big trouble ahead. The most common worry is that
the number will shrink suddenly, with foreign governments dumping their
dollar holdings, driving down the dollar's value and driving up American
interest rates, but that's not a real danger. If the price of our government
securities dived, the foreign central banks would have to bear the loss.
This would be a budget item for their governments, whose leaders would not
like it at all.
- Federal Reserve System: The Mark of the Bust, Martin Mayer, June 14,
* Half a trillion two years ago, almost a trillion today.
... ... ...
This marked the beginning of a period of political versus economic investment
by foreign governments in the US. One government does not support another
without purpose; compensation is expected in return, which compensation may
not accord with US domestic interests. The bailout of Fannie and Freddie is
the first example of a domestic economic policy decision made to satisfy short
term foreign and US interests to the detriment of long term US interests. As
we circle the whirlpool created by foreign debt and the folly of the FIRE Economy
that the debt has enabled, you can be certain it will not be the last. To make
matters worse, the maintenance of the FIRE Economy depends on foreign lending
from non-market oriented, unelected often repressive governments. More on that
and the implications later.
"In the U.S., the Standard & Poor's 500 Index will tumble another 10 percent
to 15 percent by 2010 as global growth slows and inflation accelerates, he said.
Until then, the outlook for commodities and equities in developed and emerging markets
looks poor, he said."
July 31 (Bloomberg)
Jeremy Grantham, chairman of Grantham, Mayo, Van Otterloo & Co., told investors
to cut holdings of
emerging-market stocks, reversing his recommendation earlier this year.
``Our advice until now was very simple: take as little risk as possible except
for emerging markets,'' Grantham, 69, whose Boston-based firm oversees $126
billion, wrote in his
quarterly letter to investors. ``Now it is even
simpler: take as little risk as possible.''
Grantham said he favors holding cash instead
of owning stocks because ``there
are likely to be much better investment opportunities in a year or two (or three)
than we have seen for 20 years.'' Dubbed a ``perma-bear'' for
his dour view on U.S. stocks for more than a decade, Grantham correctly predicted
a crash in
technology shares two months before the bubble burst in March 2000.
The money manager cut his weighting on emerging-market
stocks to ``neutral or
just below.'' In the U.S., the Standard
& Poor's 500 Index will tumble another 10 percent to 15 percent by 2010 as global
growth slows and inflation accelerates, he said. Until then, the outlook for
commodities and equities in developed and emerging markets looks poor, he said.
``I underestimated in almost every way how badly economic and financial fundamentals
would turn out,'' Grantham wrote in the letter. ``Events must now be disturbing
to everyone, and I for one am officially scared!''
Professor Roubini notes, there are a number of key countries now either in,
or flirting with, recession. If the global economy slows enough - causing U.S.
exports to decline - we might start to see significant job losses in manufacturing,
and then the current recession could be more severe than I currently expect.
As I noted in a prior thread - Japan mfg output is down 2% in the last Q.
Most found the speed/abrupt adjustment surprising.
Bob Dobbs writes:
Time to look at trasports and shipping. I suspect a huge adjustment in this
area. CA truck transport (commercial miles driven w/ paid loads) down 18% for
June, on a y/o/y basis. JIT deliveries means JIT adjustments.
"I take Roubini with a huge grain
of salt. He's been crying recession since late 2006.
I think he has overestimated the time span over which the events of late will
I suspect that Roubini, and those like him, underestimated the degree to which
the economy could could be hotwired to produce good numbers, long after the
fundamentals themselves went south.
Bob Dobbs |
Homepage | 07.30.08 - 7:11 pm |
He was a little early on his call, I agree. He underestimated
stupidity. That was just about the only thing he's got wrong.
He underestimated panicky short-sighted fixes that ramped
up the federal deficit, devalued the dollar, and fueled commodities inflation.
Tell the truckers, airline employees, hotel owners, car dealers, resort workers,
etc. that Roubini was wrong. They're all in a deep recession right now...and
for years to come.
|aleister perdurabo writes:
MH: I assume that by doom you mean that the dollar will continue to
sink against foreign currencies, while price inflation eats away at
what wages will buy. The idea that a worse economy will be self-curing
is IMF anti-labor ideology and Chicago School propaganda. This is indeed
what Nobel Economic Prizes are given for, I grant you. But it’s Junk
Economics. A falling dollar threatens to become self-reinforcing. For
starters, dollar-denominated stocks, bonds and real estate are worth
less and less in terms of euros, sterling or other harder and foreign
currencies. This doesn’t provide much incentive for foreigners to invest
here. And if we go into a recession (not to speak of depression), there
will be even fewer profitable opportunities to invest.
Meanwhile, U.S. import dependency will continue to rise as the economy
de-industrializes that is, as it is further financialized. U.S. overseas
military spending will throw yet more dollars onto the world’s foreign
exchange markets. So a weak economy here does NOT mean that the dollar
will strengthen; it means we have a bad investment climate! Austerity
will make us more dependent on foreign countries. For a foretaste, just
look at what has happened when the IMF has imposed austerity plans on
Third World debtors. And remember, last time when Robert Rubin was given
a free hand, in reforming Russia under Clinton, the result was industrial
collapse and bankruptcy.
aleister perdurabo | 07.30.08 - 7:19 pm |
Americans today spend almost as much on bandwidth — the capacity to move
information — as we do on energy. A family of four likely spends several hundred
dollars a month on cellphones, cable television and Internet connections, which
is about what we spend on gas and heating oil.
Just as the industrial revolution depended on oil and other energy sources,
the information revolution is fueled by bandwidth. If we aren’t careful, we’re
going to repeat the history of the oil industry by creating a bandwidth cartel.
From the Centex Investor Materials (from
8-K filed with SEC):
Market conditions worsened in the quarter
Foreclosures are rising
Employment is weakening
Consumer confidence is waning
Mortgage qualification standards are tightening
Traffic and sales have diminished
Expect to see more stories like
Macon Mall Faces Foreclosure.
Restaurants chains start feeling pain. "More empty space available. More bad
debt. More consumer ripples." Will Applebee's or TGI Friday's be next?
From the WSJ:
Bennigan's, Steak &Ale Close Doors, File for Bankruptcy Protection (hat tip
Long-time, national restaurant chains Bennigan's and Steak & Ale have closed
their doors and filed for Chapter 7 bankruptcy protection, shuttering more than
300 sites and letting go of thousand of employees.
More empty space available. More bad debt. More consumer ripples.
It is one of the country's largest restaurant bankruptcies ... The chains will
liquidate and are not likely to re-open.
Era of ‘buy now and pay later, and later’ is over
New York is the second state in five days to declare a fiscal emergency. See
Schwarzenegger Announced Intention To Slash State Workers' Pay Till Budget Passes
for more on the crisis in California.
The most stunning thing about Paterson's announcement is how rational it is.
He is not begging Washington for handouts, asking for higher taxes, or praying
This is pretty stunning too: In June 2007, the 16 banks that pay the most on
their business profits remitted $173 million to the state treasury. “This June,
just a month ago, they sent us $5 million — a 97 percent decrease.”
Unlike Schwarzenegger who has for years resorted to floating bond or proposing
various lottery schemes to "fix" the budget, Paterson has the correct solution.
Peter Schiff is not only brilliant, but brave and has the courage of his
convictions. I admire him.
Not only is Assmuss a patronizing fart... he was and IS an ASS! Peter's been
right for so long that in certain circles he is now hated. As Peter told us,
the bail out of Freddie and Fanny, Bear Sterns (via Fed/J.P. Morgan scam), and
the collapse of big banks and investment brokers will eventually send inflation
sky-high and our GREAT grandchildren will be left to pay for it all. The USA
was once loved. We are now HATED by many around the world for our GREED and
Military stance (for oil).
I would like to see that pompous ignorant asshole with the Ph.D Mr. Asmus,
speak at another one of these with Schiff. Shows you the true value of a Ph.D,
or being a part of a conservative think tank - reminds me of jumbo shrimp, an
Survival is a matter of teamwork. If people start to learn lessons from these
financial mistakes...if we use our brains... we can overcome a disaster. Survival
is your preparation NOW. But don't store food as if it is the end of the world.
As a good christian you KNOW that the LORD GOD will "bail you out" ;) I enjoyed
this Las Vegas conference on YouTube and I posted it on my personal website,
which will have a lot of "airplay" in the village that I leave, because I will
write a goodbye letter.
When CNBC or Fox needs a guest who can be counted on to deliver a thoroughly
gloomy outlook for the U.S. economy, they call on "Dr. Doom."
To say Peter Schiff is bearish is like saying Tiger Woods is an okay golfer,
or China has a small problem with air quality. The president of Connecticut-based
Euro Pacific Capital Inc. is so pessimistic about the U.S. economy that he lives
in a rented house and keeps the vast majority of his and his clients' money
outside the country, a healthy chunk of it in gold and energy stocks.
"America is finished. We are going to destroy this country. Our economy is
just going to unravel," he told me yesterday. "The question is how much money
is the world going to lose before it writes us off?"
Apocalyptic forecasts are a dime a dozen these days, so why should anyone
pay attention to Mr. Schiff? Because his past predictions have proved uncannily
When dot-com stocks with no earnings were shooting skyward in the late nineties,
he was advising clients to stay away and instead putting money into the unloved
energy sector, just in time for the great oil bull market.
A few years later, when the housing bubble was inflating, he was warning
about the dangers of reckless mortgage lending and the precarious state of Fannie
Mae and Freddie Mac. "If it looks like a bubble, walks like a bubble and quacks
like a bubble, it's a bubble," he wrote. That was in 2004, when speculators
were still lining up to buy investment properties in Las Vegas.
Ever the contrarian, Mr. Schiff made a bundle shorting the subprime mortgage
So, one year into the credit crunch and with more than $400-billion (U.S.)
of mortgage losses piling up on company books, where does Dr. Doom see the U.S.
economy heading now?
Unfortunately, into an even deeper hole, one from which it could take years
Far from rescuing the economy from the housing debacle, the government's
efforts to prop up Fannie and Freddie - which own or guarantee nearly half of
the $12-trillion in outstanding U.S. mortgage debt - will only compound the
problem by delaying the inevitable day of reckoning. The same goes for plans
to help hundreds of thousands of homeowners refinance into more affordable mortgages.
Apart from encouraging the very moral hazard that got the U.S. into this
mess in the first place, the government bailout will come with an enormous price
tag in the form of soaring inflation, Mr. Schiff argues. He believes government
figures vastly understate the true rate of inflation, which he estimates is
now running at 10 to 12 per cent. Before long, it could be north of 20 per cent.
"The government doesn't have the balls to raise taxes. It's going to print
the money. It's going to destroy the currency," he says.
During the Depression of the 1930s, at least people who held cash made out
okay. Because prices were falling, their money actually bought more. But if
Mr. Schiff is right and the U.S. is heading into a period of hyperinflation,
then even the most prudent savers will see their wealth eviscerated.
With the walls closing in on the U.S. economy, where is an investor to turn?
Apart from gold and energy producers, which benefit from a plunging U.S. dollar,
Mr. Schiff likes conservative, dividend-paying stocks such as pipelines and
utilities. He's especially fond of Europe, Asia, Australia and Canada, where
his holdings include Barrick Gold Corp., Goldcorp Inc., Crescent Point Energy
Trust, Baytex Energy Trust and Pembina Pipeline Income Fund.
He has two words for Canadian investors thinking now is a good time to shop
for bargain-priced U.S. stocks: "Stay away."
Wednesday, July 9, 2008
We have long warned that stagflation, or economic contraction accompanied
by inflation, would become so evident that even the most optimistic observers
could not deny its virulence.
Last week, Warren Buffet was the latest to describe his encounter with the beast.
The world’s most famous investor pronounced that the current economy is in the
middle stages of a stagflation episode. Although Mr. Buffet is not typically
associated with either bullish or bearish sentiment, he asserted that both the
“stag’” and “flation” aspects of the condition would intensify before they relent.
So if we can all recognize the wolf at the door, can we agree on the best course
Unfortunately for policy makers, different weaponry is called for to vanquish
the two heads of the stagflation dragon. Recession can be held at bay by lowering
interest rates, while inflation is usually tamed by raising interest rates.
Given the impossibility pursuing both courses of action simultaneously, priorities
come into play. Historically, inflation has been considered the greater long
term economic menace, and has therefore been dealt with first.
This was the plan of attack successfully mapped out by President Reagan and
Fed Chairman Paul Volcker in the 1980s. With the President’s political backing,
Volcker was able to kill stagflation with a short but heavy dose of double-digit
interest rates. With the stable currency and low inflation that resulted, the
stage was then set for a sustained and robust economic expansion.
By Daniel Pfaendler
Published: July 29 2008 15:06 | Last updated: July 29 2008 15:06
Developed market bond yields should move markedly
higher through the rest of this summer, but then fall sharply going into 2009,
says Daniel Pfaendler, head of G10 economics & strategy at Dresdner Kleinwort.
He believes the oil price shock and the unwinding of asset bubbles, over-leverage
and economic imbalances in general should keep growth
significantly below trend and real yields depressed for a protracted period
[Jul 29, 2008] Quote of the Day: Michael Belkin
Posted by Barry Ritholtz on Tuesday, | 01:15 PM
Technical Analysis |
“Most global stock indexes have decisively broken below their
200 week moving averages, which is a major trend reversal. The intermediate
term (3 month) and long term (12 month) model forecasts point down. We recommend
taking advantage of every minor rally to close long positions, go short and
shift out of tech and cyclicals into defensive groups. Stock indexes haven’t
yet had the big surge in volatility (5% daily NASDAQ moves down and up amidst
a declining market). That is probably approaching. Bear market trading is typically
more productive selling into those big percentage bounces, rather than selling
into big declines and then watching the market bounce back in your face.
Potential downside targets after a 200 week average breakdown
are 1) the 200 month average and 2) The previous 2002-2003 lows. Those levels
are 25%-47% below current levels for most stock indexes. U.S. financial indexes
are already there (BKX, XLF). So don’t think it can’t happen for the broader
market and other currently elevated indexes, stocks and groups.”
The Belkin Report
July 6, 2008
To say it's disconcerting to find that your
bank has been shut down by authorities is probably an understatement. We asked
David Barr, spokesman for the Federal Deposit Insurance Corp., or FDIC, about
the procedure. The FDIC is an independent agency of the federal government.
It is charged with insuring deposits in banks and thrift institutions up to
$100,000 per depositor in individual accounts and $250,000 in retirement accounts.
Deposits held in different
categories of ownership may be insured separately.
White House outlook turns dark grey. The sluggish economy and expensive
stimulus package will swell the U.S. budget deficit to $482B in 2009 - $75B
more than previous White House estimates. GDP is seen growing just 1.6% in 2008,
down from a previous projection of 2.7%. In 2009 it expects 2.2% growth, down
from 3%. (.pdf)
complicates the upcoming presidential skirmish: the ballooning could play
havoc with McCain's planned tax cuts, and Obama's promised health-care expansion.
IMF pessimistic on U.S. The IMF riled markets Monday after it said
there's no end to housing slump in sight. The fallout will continue to leak
outside of just housing: "With delinquencies and foreclosures... rising sharply,
and house prices continuing to fall, loan deterioration is becoming more widespread."
Mishkin's hard line. The Fed's Frederic Mishkin said once again
that regulators should set concrete inflation goals, instead of their current
use of comfort zones (or
shmumfort zones as he calls them). He also wants the Fed increase its outlook
to five years. Apparently, he's not too fond of their use of so-called core
inflation, which factors out volatile food and energy prices. "It should be
an inflation rate that actually affects people - people
care a hell of a lot about what they are paying for gas."
Even though the Fannie and Freddie near crisis, which produced a few days
of panic in the credit markets, now seems to have abated, money market investors
are still on edge. The Financial Times warns that various risk measures remain
at elevated levels:
Libor, the measure of inter-bank interest rates
that is a key barometer of the health of the credit markets, continues to
signal problems a year into the credit crunch and raises doubts about whether
the financials’ share prices are close to a bottom....
There is a growing realisation that the all-clear signal for the banking
sector will not sound until the difference between Libor and the overnight
rates set by central banks narrows from its current elevated levels.
There have been quite a few anecdotes about a new tough-mindedness among banks,
and it is finally showing up in the data. From the
New York Times:
Two vital forms of credit used by companies — commercial and industrial
loans from banks, and short-term “commercial paper” not backed by collateral
— collectively dropped almost 3 percent over the last year, to $3.27 trillion
from $3.36 trillion, according to Federal Reserve data. That is the largest
annual decline since the credit tightening that began with the last recession,
“The second half of the year is shot,” said Michael T. Darda, chief economist
at the trading firm MKM Partners in Greenwich, Conn., who was until recently
optimistic that the economy would continue expanding.
“Access to capital and credit is essential to
growth. If that access is restrained or blocked, the economic system takes
... ... ...
Some suggest that the banks, spooked by enormous losses,
have replaced a disastrously indiscriminate
willingness to hand out money with an equally arbitrary aversion to lend
— even on industries that continue to grow.
Stumbling and Mumbling
But there’s a nastier possibility. As Justin
this is about stigmatizing the unemployed, by lumping them in with criminals
doing community service.
In this respect, for all the New Labour drivel about “modernization” what’s
going on here is something centuries old - treating poverty as moral failure.
Here’s C.B.Macpherson describing 17th century attitudes to poverty relief:
Nothing much has changed in the last 350 years.
The Puritan doctrine of the poor, treating poverty as a mark of moral
shortcoming, added moral obloquy to the political disregard in which the
poor had always been held. The poor might deserve to be helped, but it must
be done from a superior moral footing. Objects of solicitude or pity or
scorn, and sometimes of fear, the poor were not full members of a moral
community. (The political theory of possessive individualism, p226-7)
Low transaction costs are definitely fueling speculation.
As Alex Tolley stated incomments: "The idea that that
there is "good" and "bad" speculation depending on how prices move is silly and,
I suspect, unfounded."
Ah, good - I've been meaning to do something like this myself, but never
got around to it. Jeff Frankel sorts speculation into three types and notes
that only one of the three types, "bandwagon behavior," is worrisome. However,
there's little evidence that this type of speculation is present in commodities
Commodity Prices, Again: Are Speculators to Blame, by Jeff Frankel:
...Many currently are trying to blame speculators for the high prices of
oil and other mineral and agricultural products. Is it their fault?
Sure, speculators are important in the commodities markets, more so than
they used to be. The spot prices of oil and other mineral and agricultural
products — especially on a day-to-day basis — are determined in markets
where participants typically base their supply and demand in part on their
expectations of future increases or decreases in the price. That is speculation.
But it need not imply bubbles or destabilizing behavior.
The evidence does not support the claim that speculation has been the
source of, or has exacerbated, the price increases. Indeed, expectations
of future prices on the part of typical speculators, if anything, lagged
behind contemporaneous spot prices in this episode. Speculators have often
been “net short” (sellers) on commodities rather than “long” (buyers). In
other words they may have delayed or moderated the price increases, rather
than initiating or adding to them. One revealing piece of evidence is that
commodities that feature no futures markets have experienced as much volatility
as those that have them. Clearly speculators are the conspicuous scapegoat
every time commodity prices go high. But, historically, efforts to ban speculative
futures markets have failed to reduce volatility.
One can distinguish three kinds of speculation in the face of rising
prices. First, there is the “bearer of bad tidings”... The news that, in
the future, increased demand will drive prices up is delivered by the speculator.
Not only would it be a miscarriage of justice to shoot the messenger,
but the speculator is actually performing a social service, by delivering
the right price signal that is needed to get real resources better in line
with the future balance between supply and demand. Without him, the subsequent
price rise would be even greater, because supply would be less. But it does
not appear that speculators played this role in the commodity boom that
started earlier this decade: as already mentioned they, if anything, lagged
behind the spot price.
Second, when the price is topping out, stabilizing speculators
can sell short in anticipation of a future decline to a lower equilibrium
price. This type of speculator again adds to the efficiency of the market,
and dampens natural volatility, rather than adding to it.
Third, in some case, when an upward trend has been going on for a few
years, speculators sometimes jump on the bandwagon.
Market participants begin simply to extrapolate
past trends and self-confirming expectations create a speculative bubble,
which carries the price well above its equilibrium. Examples
of previous bubble peaks include the dollar in 1985, the Japanese stock
and real estate markets in 1990, the yen in 1995, the NASDAQ in 2000, and
the housing market in 2005.
It is the third kind of speculation, the destabilizing kind (also called
bandwagon behavior or speculative bubbles) about which politicians, pundits,
and the public tends to worry. There is little evidence that this has played
a role in the run-up of commodity prices. So far, that is. Just because
the boom originated in fundamentals does not rule out that we could still
go into a speculative bubble phase. The aforementioned bubbles each followed
on trends that had originated in fundamentals (respectively: rising US real
interest rates, 1980-84; easy money and rapid growth in Japan, 1987-89;
US recession, 1990-91, and Japanese trade surpluses; the ICT boom in the
late 1990s; and easy US monetary policy after 2001). It could happen yet
in commodity markets.
Alex Tolley says...
"Speculators have often been “net short” (sellers) on commodities rather
than “long” (buyers). In other words they may have delayed or moderated
the price increases, rather than initiating or adding to them. "
No chance this is the physical owners hedging then?
The idea that that there is "good" and "bad"
speculation depending on how prices move is silly and, I suspect, unfounded.
Far better to recognize that speculative instruments like futures can represent
volume many times the underlying physical or money instrument and thus can
take on a life of its own, un-anchored. Currency markets have been chronically
like this for over 30 years at least, creating wild gyrations in forex rates.
Low transaction costs lubricate these markets.
I don't know if one can mitigate this trading without either incurring
regulations that limit the # of transactions or increasing transaction costs.
Alternatively we could go back to the bad old days of fixing prices by fiat.
None of these choices seem desirable to me.
Bridgewater Associates estimates in a recent report that marked to market, US
banking industry losses would constitute over $560 billion versus the $116 billion
they have raised today. I guarantee that if banks were to mark their books in
accordance with the levels indicated by Bridgewater, investors would collectively
have a heart attack, liquidity would evaporate, credit spreads of all kinds
would widen massively and the stock market would head south, pronto.
While a "good bank/bad bank" structure may be part of the eventual resolution
of this mess, pray tell how does a non-failed bank go about creating this sort
of vehicle? A restructuring of this sort would presumably require shareholder
approval, and an admission that a bank was in bad enough share to go this route
would not merely tank the stock price, but almost certainly make any kind of
debt funding, including routine money market operations, difficult to impossible.
An effort to implement this sort of program would likely lead to a bank failure
(if I were a depositor in excess of FDIC limits, I'd head for the hills). Thus
in the absence of a Federal program, I am at a loss to see how this could work
(even if the bank had a "pre-pack" negotiated with private equity investors,
you'd still need shareholder approval, and you'd be subject to adverse reactions
from funding sources).
Reader Steve e-mailed some observations about recent FDIC actions that bear
on this discussion. One of his lines of thought is how analogies to the S&L
crisis (which was considerably smaller than our current mess) can be misleading.
I've highlighted some key points:
Simple comparisons--the number of bank failures, or the total assets of
failed institutions--can be misleading. A more important measure is the
percentage of assets that remain under FDIC control vs. the percentage sold
either at the time of failure or immediately after. For example, in the
FNB/Nevada and First Heritage transactions, FDIC is keeping 94% of the assets.
FDIC has so far been unable to sell Indymac's servicing arm, and hasn't
announced any portfolio sales. FDIC holds 100% of the assets of the second
largest bank failure in US history.
Fewer banks are failing
(so far), but the number of healthy institutions able to absorb their performing
assets has shrunk as well.
There is also a significant difference in type of troubled assets between
the 80's and today. Construction and development financing caused the majority
of failures twenty years ago. Losses on household mortgages were not a big
factor, because underwriting standards were higher. Today the problem assets
are C&D, CRE and huge numbers of first and second home mortgages.
The law governing FDIC has changed since the last crisis. The FDICIA of
1991 makes it impossible for FDIC to create bridge banks at will. Twenty
years ago, Indymac would have been bridged, meaning that uninsured deposits
would have been covered. Today, the `too big to fail' test for creating
a bridge bank is codified, and very few institutions qualify.
The huge losses embedded in household mortgage portfolios make the current
banking crisis different, and the regulatory response is different as well.
The reason for the concern over foreclosures has more to do with bank accounting
than with bleeding heart concerns for mortgagors. When a property is foreclosed,
a bank must write off the difference between the loan balance and the appraised
value of the property (with a further downward adjustment for disposition
costs). A write-off is a reduction in capital, so the bank's capital primary
capital ratio is affected. Banks are prohibited from writing owned real
estate back up. On the other hand, if the bank only recognizes an impairment
on the loan, there is a reserve against capital but no write-off. So the
loss can be strung out over time, and regulators can allow banks a fair
amount of leeway in forming `opinions' about loss severities. In other words,
an insolvent bank can appear to be adequately or even well capitalized.
I believe an argument
could be made that many institutions would be stone insolvent if foreclosures
and write-offs were being done in accordance with traditional banking and
regulatory practices. In particular, I suspect that the vast majority
of foreclosed mortgages are investor owned rather than bank owned, and that
regulators have adopted `go-slow' oversight in anticipation of legislative
action on foreclosures.
I agree 100% with Steve's assessment. A lot of banks are no doubt insolvent
now. Critics can argue that Bridgewater's mark-to-market calculation doesn't
necessarily reflect true economics, since some markets are arguably short of
buyers, and hence the low prices reflect illiquidity as well as impairment of
the assets. But the flip side is that we are at best only halfway through the
housing price decline. Case Shiller has the housing market currently at a 19%
decline from peak. A number of metrics (mean reversion, traditional relationship
of housing prices to income and rentals, plus the likelihood of overshoot on
the downside) suggest the bottom will be at least 35% below peak, and 40% or
even lower is not out of the question. Bridgewater's $560ish billion measure
against roughly $1.3 trillion in banking system equity (if memory serves me
right) and the $116 billion in new equity raised so far.
Even if you use the current Bridgewater figures
as a proxy for ultimate losses (and that is likely to be light), there is a
very big hole in the balance sheet of the banking system. And the reason for
trying to fudge things is to prevent panic.
It's clear the Bush II 2008 tax stimulus was poorly though over. It would be
much better move to stimulate switch to more energy efficient cars in some way or
form -- it would help auto-industry and environment.
Alan Blinder in today's New York Times, argues for an
ostensible stimulus package (hey, since more stimulus packages are probably
in the offing, better register your preferences early) that will help the environment.
But what I like about it is that it would cost so little that it barely rates
in the "let's goose the economy" category.
The idea is that the government buys old cars of types that are just about certain
to be heavy polluters. This is the dirty secret of auto emissions: the vast
majority of the damage is done by a comparatively small percentage of cars.
The program is means tested, so only those of middle and lower incomes can participate.
Although this initiative would do nothing to remedy America's dependence on
the internal combustion, it's an interim measure that yields tangible benefits
at a comparatively low price.
From the New York Times:
Cash for Clunkers is a generic name for a variety of programs under which
the government buys up some of the oldest, most polluting vehicles and scraps
them. If done successfully, it holds the promise of performing a remarkable
public policy trifecta — stimulating the economy, improving the environment
and reducing income inequality all at the same time. Here’s how.
A CLEANER ENVIRONMENT The oldest cars, especially those in poor condition,
pollute far more per mile driven than newer cars with better emission controls.
A California study estimated that cars 13 years old and older accounted
for 25 percent of the miles driven but 75 percent of all pollution from
MORE EQUAL INCOME DISTRIBUTION It won’t surprise you to learn that the well-to-do
own relatively few clunkers...
AN EFFECTIVE ECONOMIC STIMULUS With almost all the income tax rebates paid
out, and the economy weakening, Cash for Clunkers would be a timely stimulus
Here’s an example of how a Cash for Clunkers program might work. The government
would post buying prices, perhaps set at a 20 percent premium over something
like Kelley Blue Book prices, for cars and trucks above a certain age (say,
15 years) and below a certain maximum value (perhaps $5,000). A special
premium might even be offered for the worst gas guzzlers and the worst polluters.
An income ceiling for sellers might also be imposed...
The US had much higher growth rates when taxes were more progressive
2. The "rebates" were rebates in name only. The idea of an economic stimulus
is to increase spending. The rebate proposal was widely derided as providing
something like 70% of the proceeds to middle income consumers who do not have
as high a propensity to spend as lower income people. Economists argued that
the best bang for the buck, stimulus wise, would be to increase food stamps
and extend unemployment coverage.
3. The rich have a hugely favorable tax regime thanks to low capital gains taxes
and no taxes on corporate dividends. And since stock issuance is a trivial source
of funding for businesses (less than 2%; retained earnings and debt are the
big sources) the idea that the stock market is vital to the funding of American
businesses is way overplayed. Big companies, the kind that fund in the stock
market, have if anything been saving (which means getting smaller) as opposed
to growing, in balance sheet terms, thanks to outsourcing and cost cutting.
This is the key idea behind
Economics, by Alan S. Blinder).. Government should play an active role. Keynesians
believe the short run lasts long enough to matter. They often quote Keynes's famous
statement "In the long run, we are all dead" to make the point.
[M]acroeconomics is not just the summation of microeconomic outcomes, but
rather the interaction of microeconomic outcomes. For me, a simple concept brought
this realization: the paradox of thrift... if we all individually cut our spending
in an attempt to increase individual savings, then our collective savings will
paradoxically fall because one person’s spending is another’s income... what
holds for the individual doesn’t necessarily hold for the community of individuals.
Understanding this paradox is absolutely vital to understanding macroeconomics
and even more so to understanding what is presently unfolding in global financial
markets. Once the double bubbles in housing valuation and housing
debt burst a little over a year ago, everybody, and in particular, every levered
financial institution – banks and shadow banks alike – decided individually
that it was time to delever their balance sheets. At the individual level, that
made perfect sense. At the collective level... when we all try to do it at the
same time, we actually do less of it, because we collectively create deflation
in the assets from which leverage is being removed....
[M]onetary easing is of limited value in breaking the paradox of deleveraging
if levered lenders are collectively destroying their collective net worth. What
is needed instead is for somebody to lever up and take on the assets being shed
by those deleveraging. It really is that simple.... [T]hat somebody is the same
somebody that needs to step up spending to break the paradox of thrift: the
By definition, levering Uncle Sam’s balance sheet to buy or guarantee assets
to temper asset deflation will put the taxpayer at risk – but will do so for
their own collective good! This was de facto what the Federal Reserve did when
it put up $29 billion on nonrecourse terms to buy assets so as to facilitate
the merger of Bear Stearns into JPMorgan... this was a fiscal policy operation....
At the end of the day, there are $29 billion more Treasuries on the open market
than otherwise would be the case, and the Treasury is, one small step removed,
on the hook for any losses the Fed experiences on the $29 billion of non-Treasury
assets it now de facto owns....
Which brings us to Mr. Paulson’s request to Congress to give him – and his
successor – the power to spend unlimited amounts of taxpayers’ funds to buy
the debt or equity of Fannie Mae and Freddie Mac. I confidently predict that
he’s not going to get unlimited authority; it will most likely be checked by
counting any such deficit-financed injections into Fannie and Freddie against
the Treasury’s statutory borrowing limit, which can be lifted only by Congress.
But Mr. Paulson is going to get most of what he wants, if only because legislators
are too fearful of the consequences if they stiff arm him.... This is the way
it should be: bailouts and backstops with taxpayer funds should be legislated
by Congress and placed on the Treasury’s, not the Fed’s, balance sheet....
Conventional wisdom holds that when an economy faces a paradox of private
thrift, it is appropriate for the sovereign to go the other way, borrowing money
to spend directly or to cut taxes, taking up the aggregate demand slack....
[C]onventional wisdom is struggling mightily with the notion that when the financial
system is suffering from a paradox of deleveraging, the sovereign should lever
up to buy or backstop deflating assets. But analytically, there is no difference:
both the paradox of thrift and the paradox of deleveraging can be broken only
by the sovereign going the other way. Fortunately, Congress is finally
grappling with this reality, as it moves towards passage of Mr. Paulson’s plan
for backstopping Fannie and Freddie with taxpayer funds. It’s not a fun thing
to do, particularly following the use of $29 billion of taxpayer funds to facilitate
the merger of Bear Stearns into JPMorgan. But it is the right thing to do. And
it is further the right thing that Congress is doing it, not the Fed under Section
13(3), except as a possible bridge to Treasury authority.
Comments from Brad Delong Blog
Maynard Handley |
July 26, 2008 at 08:33 PM
- "At the individual level, that made perfect sense. At the collective
Or to put it more simply, the whole
Invisible Hand concept is a crock.
Or, more specifically, it is a crock to claim that at all times, in
all places, it will solve all problems.
Why is it that even your smarter libertarians like Richard Epstein, the
ones who will admit that there might, in theory, be such a thing as externalities,
even though they'll never actually admit to one in practice, can't seem
to get this?
And why is it that econ 101, at the same time that it is going on about
the wonders of free trade, and the importance of not setting the minimum
wage too high, is not flogging this type of example with the same enthusiasm?
The primary reason that the country is populated by a large number of gullible
fools who believe everything the GOP feeds them about the importance of
removing regulation is because of what is taught in AP Economics and Econ
101. This sort of pattern is enough to make one a Chomskyan.
Now, with respect to the details of this plan. Once again we have a situation
where, sure it's for the taxpayers' benefit, but, once again, it turns out
that it will be the super-rich who benefit most. Once again, I have to ask:
if it's so essential that this sort of bill get passed, why not pass it
in tandem with legislation that lays the bill where it is due; for example
a surtax on incomes above a certain level, or on financial industries, or
a very small financial transactions tax (like the stamp tax of many countries)
that won't dissuade transactions of genuine financial merit but will dissuade
vast amounts of the meaningless sloshing of money back and forth that we
see these days?
- MattY |
July 26, 2008 at 11:31 PM
- By the way, the author makes the common economic mistake. The backstopping
done by the legislature only occurs when it is too late. Like the New Deal,
the legislature only hires labor when labor has already gotten very cheap.
In this case, the legislature is investing in mortgages because they are
very cheap right now.
PIMCO basically is going to want this government backstop so it can re-enter
the business. PIMCO had been very careful about not getting caught, now,
like wealthy do, this company wants the federal backstop, then PIMCO can
be the second investor and do well.
I would not be surprised if much of the gains possible in this backstop
will end up, not in taxpayer hands, but in PIMCO hands and their followers.
The real test here is to raise progressive
taxes by a few points, then see how the legislature handles this. I think
PIMCO would change their tune once they find their investors will have to
pay for the bulk of their government guaranteed winnings some two years
down the line.
Publication of such papers suggests that situation is closer to "light at the
end of tunnel" then one might think... Passing of Foreclosure Prevention Act
of 2008 points to the same direction.
Research by an IMF economist concludes that US residential real estate was
overvalued by 14% as of the first quarter of 2008. The paper seeks to define
an equilibrium price and also anticipates that the housing market will fall
markedly below that level.
Milton Freedman was really disingenuous promoter of 'free markets" (IMHO "Capitalism
and Freedom" was written really of CNBC level ;-). But people do a lot of stupid
things for good money and professors, especially former "undernourished" professors,
are no exception...
Chicago School Unwelcome at Chicago
University of Chicago academics
oppose naming a new research centre after Milton Friedman:
In a letter to U. of C. President Robert Zimmer, 101 professors—about
8 percent of the university’s full-time faculty—said they feared that having
a center named after the conservative, free-market economist could “reinforce
among the public a perception that the university’s faculty lacks intellectual
and ideological diversity.”
“It is a right-wing think tank being put in place,” said Bruce Lincoln,
a professor of the history of religions and one of the faculty members who
met with the administration Tuesday. “The long-term consequences will be
very severe. This will be a flagship entity and it will attract a lot of
money and a lot of attention, and I think work at the university and the
university’s reputation will take a serious rightward turn to the detriment
...faculty critics are concerned that it will be one-sided, attracting
scholars and donors who share a point of view.
The opposition probably tells us more about the lack of diversity and the
ideological biases at the rest of the university than at the new research centre.
Most commentary on the
2006q4 current account
balance release focused on the improvement in the overall balance. Little
noted is the fact that 2006 is the first year in which the net income category
has registered negative. From
... The 2006Q4 current account deficit shrank sharply to $195.8bln from
$229.4bln in Q3. It also shrank compared to its $223.1bln level in 2005-Q4.
And a shrinkage in the deficit over four quarters ago is unusual.
Such improvement generally was induced by recession (1990, 2001, 1981,198)
but also can be occasioned by significant slowdowns (1995) and the sharp
dollar depreciation from its pre-Plaza Accord peak was behind the persisting
improvement in the late 1980s ahead of the onset of recession. The current
account is simple to understand because it is the just the difference between
the value of the goods services we sell Vs the ones we buy plus a few transfer
items. The US has a small positive and essentially stable balance on its
services account. The trade account is the problem. Its deficit is large
and persistently growing larger.
The recession-trade balance link I've discussed
"We believe the current account has peaked" and will decline to $809
billion in 2007, said Nigel Gault, U.S. economist for Global Insight. "The
trends are becoming more favorable. Robust export growth, and some cooling
in import growth, should keep the deficit down this year."
Little remarked is that in calender year 2006, net income was -$7.6
billion, despite the surge in net income from -$5.5 billion in 2006q3 to +$3.0
billion in 2006q4 [late addition 12noon: and as
Brad Setser notes,
this q4 figure is likely to be revised downward]. Figure 1 portrays
the trend in the net income category.
ph 2007. Four quarter moving average (red) and 2006 average net income
(green). Source: BEA,
International Transactions release of 14 March, and author's calculations.
Obviously, in a $13 trillion economy, this is not an enormous number; it's
essentially zero. But the trend is interesting. I'm always wary of making predictions,
but I'm willing to venture that from here on out, positive entries in this category
will increasingly depend upon more dollar depreciation against the euro and
other major currencies (a regression of net income on the 4 quarter change in
the log Fed narrow dollar index over the last 17 years yields a statistically
Roubini and Setser pointed two years ago, even as the trade portion of the
current account balance improves, the deterioration in the net income component
will make overall current account deficit reduction harder over time -- unless
we have a persistently depreciating dollar.
The income and valuation effects (as well as expenditure switching effects)
arising from dollar depreciation may seem like an unalloyed good; but it's important
to realize that calculation of net assets and total returns in dollar terms
obscures the fact that dollar decline reduces the purchasing power of the dollar
against other currencies (i.e., as Ted Truman pointed
out, there's a "terms of trade" effect from dollar depreciation
significant deterioration in the US net foreign
asset position, there has not been a corresponding deterioration in the
net income balance.
In fact, there has generally been a net
income surplus. Two factors have been particularly
important for the positive net
income balance over the past 15 years or so.
The first is that the United States has a positive
net external equity balance and a negative
net external debt balance. This
contributes to a net
income surplus because the
income yield on equity has been higher than
the income yield on debt.
The second factor is that the United States earns
a persistently higher income yield on its foreign
direct investment (FDI) assets than foreigners earn on their direct investments
in the United States. This paper summarises the evidence from
firm-level studies and time-series data for the United States, as well as cross-country
comparisons, to weigh up alternative explanations for this outcome. The evidence
presented suggests that differences in income
yields on FDI are not explained by the presence of large stocks of unmeasured
assets. Moreover, they do not appear to be related to different characteristics
of the investment such as industry composition or riskiness. There is some evidence
that differences in the average maturity of investment have had some effect
on yield differentials, especially in the 1980s. There are also incentives to
minimise taxes that are consistent with the relatively low
income yields earned on FDI in the United States,
but no firm evidence that this is an important explanation.
net income balance,
dark matter, income yields, foreign direct investment
May 4, 2008 | NYT
PART of the New Deal was a new financial deal. The shameful
shenanigans leading up to the 1929 stock market crash and the frightening wave
of bank failures during the Depression led directly to the creation of the Securities
and Exchange Commission and the
Federal Deposit Insurance Corporation.
As we emerge from this, the worst financial crisis since the 1930s, a
New Financial Deal may follow. If so, what should some of the reforms be?
A warning to laissez-faire-minded readers: The following is mostly about
the dreaded “R” word — regulation. But I’m afraid that we need more of that,
starting in the mortgage market.
An inordinate share of the dodgiest mortgages granted in recent years
originated outside the banking system. They were marketed aggressively,
sometimes unscrupulously, by mortgage brokers who were effectively unregulated;
we have now lived to regret that arrangement. The need for a federal mortgage
regulator — including a suitability standard for mortgage brokers — is painfully
Next, we should resist calls to scrap the “originate to distribute” model,
wherein banks originate mortgages, which are then packaged into mortgage
pools and turned into mortgage-backed securities that are sold to investors
around the world. This seemingly convoluted model has given the United States
the world’s broadest, deepest, most liquid mortgage markets. And that, in
turn, has meant lower mortgage interest rates and more homeownership. These
are gains worth preserving.
But the model needs some nips and tucks. A far less radical, though still
regulatory, approach would require both originating banks and securitizers
to retain some fractional ownership of each mortgage pool. Keeping some
“skin in the game” should accomplish two things: make the banks and securitizers
more attentive to the creditworthiness of the underlying mortgages, and
reduce the tendency to play “hot potato” with mortgage-backed securities.
And while we’re on the subject of M.B.S., we must end the regulatory
fiction that off-balance-sheet entities like conduits and S.I.V.’s are unrelated
to their parent banks. (S.I.V. stands for structured investment vehicle,
if you must know, but please don’t ask me the difference between it and
a conduit.) Since last summer, we have seen one financial giant after another
brought to its knees by losses that originated off balance sheet.
What’s the solution? Take
Shakespeare’s advice and kill all the S.I.V.’s? Probably not, though
many will die of natural causes. These financial oddities were invented
to exploit the regulatory fiction just mentioned. If you buy the premise
that assets held off balance sheet pose no risks to their parent companies,
then banks should not be forced to hold capital against them. But if you
buy that, you may also be interested in a famous bridge connecting Brooklyn
to Manhattan. The remedy here is simple: Apply appropriate capital charges
to off-balance-sheet assets.
That brings us to leverage. After all, high leverage means owning a lot
of assets with only a little capital. This is where something fundamental
changed on March 16. Before that day, only banks had access to the Fed’s
discount window; broker-dealers took large risks without a safety net. But
everything changed when the
Federal Reserve became the lender of last resort to selected securities
dealers. Because securities firms are now under the Fed’s protective umbrella,
they must start operating as safely and soundly as banks. That means both
closer supervision and less leverage.
How much less? You may recall that
Bear Stearns ended its life with leverage of around 33 to 1, meaning
that just 3 cents of capital stood behind each dollar of assets. That won’t
do any longer. Leverage of 10 or 12 to 1 is more typical for a bank. We
should all take a deep breath here, because sharply reducing the leverage
of securities firms, to bring it close to that of banks, will be a major
change in the financial landscape. It will, for example, substantially reduce
the profitability of investment houses and, therefore, reduce their scale.
But that’s the price you pay for access to a publicly financed safety net.
Next come ratings agencies, whose recent performance has drawn criticism.
The good news is that they are making good-faith efforts at change. They
are improving their analytics, and guarding against conflicts of interest
by hiring ombudsmen and submitting to independent third-party reviews. We
should applaud and encourage all that. The bad news is that they face an
acute incentive problem when they get paid by the issuers of the very securities
What to do? The third-party reviews should help. My Princeton colleague
Dilip Abreu suggests paying ratings agencies with some of the securities
they rate, which they would then have to hold for a while. Robert Pozen,
head of MFS Investment Management, wants independent investors in the conduits
to hire the agencies instead. Another idea would have a public body, like
the S.E.C., hire the agencies, paying the bills with fees levied on issuers.
If you have a better idea, write your legislators.
LAST, but certainly not least, is something that the United States cannot
do on its own. Everyone knows we live in a world of giant multinational
financial institutions, huge cross-border flows of capital and increasingly
globalized markets. Such an environment demands ever closer international
cooperation and coordination among the world’s major financial regulators.
But today’s level of international cooperation is wholly inadequate to the
need. Perhaps the current worldwide financial crisis will finally persuade
the world’s financial regulators that lip service is not enough. At least
we can hope.
Finally, let’s be clear about the purposes of all these New Financial
Deal reforms. They would not banish speculative bubbles from the planet.
After all, there have been bubbles for as long as there have been speculative
markets. But with each bursting bubble, new flaws in the system are exposed.
Like a good roofer after a soaking rainstorm, we should patch the leaks
we see now, knowing full well that more leaks will spring up in the future.
Alan S. Blinder is a professor of economics and public affairs at
Princeton and former vice chairman of the Federal Reserve. He has advised
many Democratic politicians.
[July 25, 2008] Durable Goods, Beige Book
Posted by Barry Ritholtz on Friday, July 25, 2008 | 09:15 AM
Data Analysis |
The Big Picture[Durable Goods]
... rose 0.8% headline and 2% ex transports versus consensus estimates of a
decline of 0.3% and 0.2% ex transports. Leading the gains was an increase in
orders for electrical equipment, machinery, vehicles and parts, primary and
Miller Tabak's Peter Boockvar notes that "the Govt stimulus package has a
depreciation tax credit that expires by year end -- so companies have to now
use it or lose it. That could have had an impact on order rates but we need
more than one month's data to see by how much."
Regardless, as we have said many times, watch the overall trend, not a single
Let's see what sectors are expanding and contracting, via the Federal Reserve
Residential real estate
Office/Shopping Mall Real Estate
Job Placement Agencies
Tourism (local>far-away destination)
Fuel Efficient Cars/Hybrids
Electronics (boost from tax rebates)
Oil/Natural Gas Drilling
Wind Turbine Parts
Specialty Aircraft Parts
Sources: Federal Reserve, Merrill Lynch, Miller Tabak
Manufacturing and Construction Division, Commerce Department, JULY 25, 2008,
Mish's Global Economic
Ten Bear Market Phases
1. A huge buy the dip mentality sets in during the initial decline. Most party
goes cannot fathom that party has ended.
2. Moderate concern sets in when buy the dip stops working.
3. Initial panic.
4. Numerous bottom calls are made, all wrong.
5. Search for the guilty.
6. Punishment of the innocent.
7. More panic.
8. Lawsuits fly.
9. Regulatory power is given to those most responsible for spiking the punch
10. Congress gets in the act and makes things worse
Steps 4-10 are repetitive, may overlap, and may occur in any order during repetition.
Certainly there have been numerous bottom calls for months now, but each rally
Merrill Lynch has warned that the United States could face a foreign "financing
crisis" within months as the full consequences of the Fannie Mae and Freddie
Mac mortgage debacle spread through the world.
... ... ...
Fannie and Freddie - the world's two biggest financial institutions
- make up almost half the $12 trillion US mortgage industry. But that understates
their vital importance at this juncture. They are now serving as lender of last
resort to the housing market, providing 80pc of all new home loans.
Roughly $1.5 trillion of Fannie and Freddie AAA-rated debt
- as well as other US "government-sponsored enterprises" - is now in foreign
hands. The great unknown is whether foreign patience will snap as losses mount
and the dollar slides.
Hiroshi Watanabe, Japan's chief regulator, rattled the markets
yesterday when he urged Japanese banks and life insurance companies to treat
US agency debt with caution. The two sets of institutions hold an estimated
$56bn of these bonds. Mitsubishi UFJ holds $3bn. Nippon Life has $2.5bn.
Posted by David Jones on July 17, 2008 6:15 AM
Report this comment
I live in the USA, and I am British. Socialism is indeed what
is happening. Profits are private, but
loses are socialized. Very similar to pre war Germany. But here is the bad news.
Where are the riots? Where are the objectors? Where is the lash back? Where
is the outrage?
Four very sad reasons
1. The Patriot act will not allow for it, and to objecting
to this economy is seen as terrorism by
2. The media has no idea what is going on. Call it propaganda,
but it is less contrived than that, and is more to do with number 3. The
media fuels this "America is best" 24/7 and no-one actually can imagine this
grand scale theft taking place in the land of the free.
3. Education. There is such low levels of education in
this country that no-one knows or understands what is happening. The educational
system is very Patriotic and history is taught in those terms, and not in any
sphere of true critical thinking. Therefore, they don't know what to object
about. Not even the politicians.
4. There is a huge disconnect between politicians and voters.
McCain has admitted he knows nothing of the economy, and is currently trying
to teach himself how to use the "Interweb", (as my mother calls it). Everyone
feels powerless. No one feels represented.
Something very bad has happened here, and the people just can't
put their finger on it to do something about it. There was a man called Ron
Paul, but the media didn't endorse him. Sad.
I blame many things, but here is what I see. Public standards
have COMPLETELY disappeared. Really. First, Bill Clinton lied to the people
about a trivial matter. Whatever you think, you keep politics as an office of
integrity, and you leave. But he stayed on as an open liar. Then, the GWB
nightmare happened. Hanging chads, lies for war, VP's owning war machine stock,
Oil lobbyists, Enron, a fobbed 9/11 commission, AAA+ securities being poisoned
with trash, Scooter Libby.
No-one in public life either has integrity, or stands
down when caught. So why does this affect the current economic crisis? It is
all trickle down. No standards means it is a free for all. If you can't
get a president impeached for lying to take us to war, then surely he will stand
down on the incompetence of it alone? No? Well then lets lend with no
standards, lets rip the system with no standards, as there is no "standards
barometer" to measure anything against it. It is a free for all due to huge
and gross mismanagement.
You say impeach the president, and arrest these people,
but, believe it or not, there is no mechanism here left in this once great nation
for that to happen.
We've cribbed the title of a provocative post by Satyajit Das at Eurointelligence.
He argues that the US's days of continuing to borrow abroad with little worry
as to the consequences may be nearing an end.
Here is the beginning of the
Das post, which I recommend reading in its entirety:
... ... ...
In recent years, the United States has absorbed
around 85% of total global capital flows (about US$500 billion each year)
from Asia, Europe, Russia and the Middle East. Risk adverse
foreign investors preferred high quality debt – US Treasury and AAA rated
bonds (including asset-backed securities ("ABS"), including mortgage-backed
securities ("MBS")). A significant portion of
the money flowing into the US was used to finance government spending and
(sometimes speculative) property rather than more productive investments.
... ... ...
Foreign investors may not continue to finance the US. At a minimum, the
US will at some stage have to pay higher rates to finance its borrowing
requirements. Ultimately, the US may be forced
to finance itself in foreign currency. This would expose
the US to currency risk but most importantly it would not be able to service
its debt by printing money. The US, like all borrowers, would become subject
to the discipline of creditors.
For the moment, the US$ is hanging on – just.
... ... ...
Here is the money paragraph to me from elsewhere in Das' piece:
"Sovereign debt crisis, especially in
emerging markets, are characterised by high levels of debt, especially
foreign borrowings, poor fiscal policies, persistent trade deficits,
a fragile financial system, over-investment in unproductive assets and
a sclerotic political system.
Arturo Porzecanski (in Sovereign Debt at the Crossroads (2006)) noted
"Governments tend to default specifically when they must increase
spending quickly (for instance, to prosecute a war), experience a sudden
shortfall in revenues (because of a severe economic contraction), or
face an abrupt curtailment of access to bond and loan financing (e.g.
because of political instability). He further observed that: "governments
with large exposures to currency mismatches and interest rate or maturity
risks are, of course, particularly vulnerable."
_That_ picture by and summary well describes the US of A as of 2008.
Other comparable contexts ended in major social and political whackage.
Well, my fellow citizens, if the ass fits, wear it.
It is not 'different this time' even if the same good times are what those
in the midst of them mostly, selectively see. The best inference is that
for the US and it's currency, it is exactly the same this time as for others
other times, only moreso. Das makes another very relevant point also elsewhere
in his article, that debt service may be managed initially, but eventually
reaches a level where it is politically unsustainable even before it becomes
economically unsustainable. This is perhaps the most likely scenario for
the US, we spin the hampster wheels of debt service on our $10T, $12T, $15T
owed, while foreign currency holding shares for the $ drop to 50% and then
below . . . and then we skip on a bond, and the world is made new and strange.
This all may change not with a bang but a simper. What'll we do when our
creditors fail to applaud?
Corporate default rates set to soar in 2008. High yield bonds probably will
continue to fall. May be another 10-15%. A short version of the S&P report
is at http://tinyurl.com/5ecr97.
(It may have been updated since to include the Martinsa Fedesa bankruptcy.) The
full report is on S&P’s RatingsDirect website (subscription only). It’ll be interesting
in 12 months to look at what proportion of defaults come from companies subjected
to a private equity-backed LBO in recent years.
2008 is set to be the year of the corporate default. And it has been a while
The first seven months of 2008 - up to have seen 43 corporate defaults
around the world. Of those, 41 have been in the US, one in Canada and of course,
days ago, Martinsa Fadesa in Spain.
Compare that to the 22 recorded through the whole of 2007 and 30 in 2006,
and it’s clear that there’s a significant change in trend afoot.
The annual corporate default rate, according
to S&P, was around 0.97% at the end of 2007. A 25 year low.
In a report today, the rating agency said that on top of the 43 so far in 2008,
a further 145 corporates are “close to the default threshold”. And 118 of those
are in the US.
The fact is though, this uptick has been a while coming.
Analysts have been predicting a rise in default rates for nigh on eighteen
months. At the end of 2006, S&P and Moody’s were similarly both predicting a
rise in default rates to around the 4-5 per cent level.
There’s a growing sense - even from the rating agencies
themselves - that the default rate will likely easily exceed the base-case scenario
Senator Bruning is also the author of the famous quote "Fed is a systemic risk".
July 23, 2008 | Financial
Jim Bunning, the Hall-of-Fame pitcher and 76-year old Republican junior senator
from Kentucky, as "The Underperformer" because of his lackluster record on Capital
But consider the following (thanks to
Bunning was also the only member of the United
States Senate Committee on Banking, Housing and Urban Affairs to have opposed
Ben Bernanke for Chief of the Federal Reserve. He said it was because he
had doubts that he would be any different from Alan Greenspan....
On December 6, 2006, Bunning was one of only two senators...to vote against
the confirmation of Robert Gates as Secretary of Defense claiming that 'Mr.
Gates has repeatedly criticized our efforts in Iraq and Afghanistan without
providing any viable solutions to the problems our troops currently face.
We need a secretary of defense to think forward
with solutions and not backward on history we cannot change.'
Along with the comments he made today, as reported by Bloomberg
Freddie Rescue Plan May Cost $1 Trillion, Bunning Says," it might also be
said that Bunning will eventually be seen as some sort of visionary.
A government rescue of Fannie Mae and Freddie Mac would require taxpayers
to pay "way" more than the $25 billion estimated by the Congressional Budget
Office, potentially as much as $1 trillion, Senator Jim Bunning said.
Treasury Secretary Henry Paulson "hasn't told us the truth about this
bill," Bunning, a Republican from Kentucky, said in an interview with Bloomberg
Television today. "Why would you put in a backstop of unlimited amounts
of money if you weren't going to need it."
Paulson on July 13 asked Congress for authority to increase credit lines
to Washington-based Fannie Mae and McLean, Virginia- based Freddie Mac,
buy shares in the firms and give the Federal Reserve a "consultative role"
in overseeing their capital requirements. The proposals are meant to restore
confidence in the government-sponsored enterprises, which own or guarantee
almost half of the $12 trillion of U.S. home loans outstanding.
The House of Representatives is set to vote today on the rescue plan
for Fannie Mae and Freddie Mac as part of broader legislation aimed at alleviating
the worst housing slump since the Great Depression. Bunning called the plan
"What is good about this bill is the fact
that maybe it shores up Fannie and Freddie for a temporary basis,"
Bunning said. "What it does not do is change the model of Fannie
and Freddie. It does not give the regulators
the power to make the changes needed in Freddie and Fannie to make them
viable entities for the future. That is why I object."
Armageddon - I believe it is all but written into the screenplay
at this point. The recent rally of 50-100% in banks and builders is indicative
of the nonsensical days leading up to October 1929.
What I am seeing in the field, is a crumbling of the builders and the
banks, followed by retailers.
But on Wall Street, Paulson is passing out the Kool-Aid and telling us we
need protection from the short sellers. Let’s face it, if the short sellers
push the envelope too far, buyers have the right to step in and take advantage
of the bargains. But when the Federal Government, or should I say Goldman Sachs
(Paulson), take it upon themselves to change the rules, that’s when you can
bet Armageddon is in the cards. Over the next few weeks, we will all see just
how much more pain there is, and the bag of garbage we just threw up in the
air, will come back down harder and stinkier.
Crisis Investing - Please. If you are not considering it, you
need to start thinking about it. If you want to buy into the rally and continue
to sip the Kool-Aid, you will be devastated.
Delong evaluation of Greenspan's monetary policy reminds me Wash Post. The essence
of Greenspanism was blatant distortion of economic statistics to produce "feel good"
results (that's why he peddled core inflation). A honest assessment of Greenspan
monetary policy presuppose an objective evaluation of the level of distortion of
economic statistics during this period. And if the statistics was significantly
distorted, the monetary policy based on this statistics was as close to the theater
of absurd as we can get without referring to Soviet Politburo practices. If Delong
looks outside his hermetic campus office both real inflation and, especially,
unemployment are close or over 10%.
Tim Duy writes:
Economist's View: Tim Duy: Not So Bad?:
Brad DeLong is puzzled. Earlier this week, defending
Greenspan-era monetary policy,
Now we are not yet out of the woods.
If the tide of financial distress sweeps
the Fed and the Treasury away--if
we find ourselves in a financial-meltdown
world where unemployment or inflation kisses
10%--then I will unhappily concede, and
say that Greenspanism was a mistake.
But so far the real economy in which people
make stuff and other people buy it has been
remarkably well insulated from panic at
57th and Park and on Canary Wharf.
Today Delong adds:
I still do not understand why the real
side of the economy is doing so well in
relative terms. The worst financial distress
since the Great Depression ought to trigger
the worst downturn in demand, production,
and employment since the Great Depression.
It hasn't--at least not so far.
Good questions; I think economic activity
has surpassed most peoples’ expectations.
My answer to DeLong’s question comes in
(1) The nature of the expansion defines the
nature of the following contraction. The post-tech
bubble expansion was anemic by most measures....
The tepid upside suggests a tepid downside....
(2) The impact of the consumer slowdown is
partially offshored, a point which I think deserves
greater attention. This shifts job destruction
to an overseas producer.... Note too that exports
are not falling as they were in the 2001 recession
as the global economy has held up better than
(3) Perhaps most importantly, however, is
the massive liquidity
injections from the rest of the world, or what
Brad Setser calls “the quiet bailout.”
In the first half of this, global central banks
accumulated $283.5 billion of Treasuries and
Agencies, something around $1,000 per capita.
This is real money.... Foreign CBs are happily
financing the first US stimulus package; will
they be happy to finance a second? Do they have
a choice? Their
accumulation of Agency debt is also keeping
the US mortgage market afloat. Do not underestimate the impact of these
foreign capital inflows.
If the rest of
the world treated the US like we treated emerging
Asia in 1997-1998, the US economy would experience
a slowdown commensurate with the magnitude of
the financial market crisis....
In short: External dynamics play a significant
role in explaining the relatively mild US downturn.
As long as foreign CBs are willing to accumulate
US debt, the US government is willing to issue
debt, the Federal Reserve is willing to accommodate
the debt with low interest rates, we will avoid
the most dire deflationary predictions.
by Paul De Grauwe in the Financial Times, deserves more discussion that I can
provide at this juncture (I am about to do a face plant), but I trust readers
will find it a worthy offering.
De Grauwe focuses on sacred cows that have been gored in the credit crunch.
He has written before, in
more technical terms, on central bank reliance on models that deviate in
key ways from observable reality. Nevertheless, despite his view that these
constructs are taking a mortal blow, he also acknowledges that they still play
a central role due to lack of obvious replacements.
The financial crisis continues to create victims. Not only people but also
some of our most cherished ideas risk falling by the wayside. Take the hugely
influential idea that financial markets are efficient. Its proponents told
us that when financial markets were left free, they would work miracles.
Savings would be channelled to the most promising investment projects, thereby
boosting economic growth and welfare. In addition, these financial markets
would spread risk around over a large number of participants, thereby lowering
the risk of doing business, again boosting growth and welfare. In order
to achieve these wonders, financial markets had to be freed from the shackles
of government control.
The country that embodied these principles most was the US. Helped by the
missionary zeal of successive American administrations and pushed by international
financial institutions, country after country freed their financial markets
from pernicious government controls, hoping to share in these economic wonders.
The credit crisis has destroyed the idea that unregulated financial markets
always efficiently channel savings to the most promising investment projects.
Millions of US citizens took on unsustainable debts, pushed around by bankers
and other “debt merchants” who made a quick buck by disregarding risks.
While this happened, the US monetary authorities marvelled at the creativity
of financial capitalism. When the bust came, a large number of Americans
who had been promised a new life in their beautiful homes were told to move
out. This boom and bust cycle cannot have been an example of efficient channelling
of savings into the most promising investment projects.
The fact that unregulated financial markets fail to deliver the wonders
of efficiency does not mean that governments should take over. That would
be worse. What it does mean is that a new equilibrium must be found in which
tighter regulation is reintroduced, aimed at reducing the propensities of
too many in the markets to take on excessive risks. The need to re-regulate
financial markets is enhanced by the fact that central banks, backed by
governments, provide an insurance against liquidity risks. Such insurance
inevitably leads to moral hazard and excessive risk-taking. The insurer
cannot avoid monitoring and regulating the be haviour of those who obtain
There is a second idea that is likely to become the victim of the financial
crisis. This is the idea found in macro economic models, that individuals
are supremely well-informed creatures. In these models that are now being
used in central banks and universities, individuals understand the most
complex intricacies of the world in which they live and they have no disagreement
about this. All these individuals understand the same “truth”.
If we have learnt one thing from the credit crisis it is that individuals
did not understand the “truth” and, it must be admitted, neither did economists.
Individuals who sold the new financial instruments did not understand the
risk embedded in these instruments, nor did the buyers. When the bubble
started many interpreted the happy turn of affairs as permanent and took
on massive levels of debt that turned out to be unsustainable. When the
bubble burst, they did not understand what had happened and nor did most
experts. Our world is one of a fundamental lack of understanding of the
But that is not the world of the macro economic models that are now in use
in central banks. The world of these models is one of supernatural and God-like
creatures for which the world has few secrets. These creatures can perfectly
compute the risks they take and estimate with great precision how an oil
price shock will affect their present and future production and consumption
plans. They may not be able to predict each shock, but they know the probability
distribution of these shocks. Thus the risk involved in financial instruments
is correctly evaluated by individuals populating these models.
These superbly informed individuals want the central bank to keep prices
stable so that as consumers they can optimally set their consumption plans
with minimal uncertainty, and as producers they can set prices equal to
marginal costs (plus a mark-up). If the central banks keep prices stable,
these individuals, helped by well-functioning markets, will take care of
all the rest and ensure that the outcome is the best possible one. This
is a world in which free and unfettered markets are always efficient.
This is also a world where individual agents cannot make systematic mistakes.
Their consumption and production plans are optimal. They will never build
up unsustainable debts. In the world of these macroeconomic models financial
crises should not occur. And if they do, it cannot be because of malfunctioning
markets. Governments that impose silly constraints on rational individuals
are messing things up, and central banks that do not keep their promises
to maintain price stability are the source of macroeconomic instability.
This intellectual framework helps to explain the single-minded focus of
many central bankers on inflation. Clearly, inflation is important and maintaining
price stability is an important task of the central bank. It is not the
only task, though. Financial stability is equally important. But this dimension
is completely absent from the macroeconomic models now in use. In addition,
since financial stability these days also depends on avoiding deep recessions,
stabilising the business cycle should also be of the concern of the central
Inflation in the euro area stood at 4 per cent in June. That is a problem.
But is it an acute problem, compared with the disequilibria in the financial
markets and the banking sector? When the European Central Bank raised the
interest rate two weeks ago it took the view that inflation is the most
important problem we face. No wonder the intellectual frame imposed on one’s
mind by current macroeconomic models said that inflation is the number one
There is a danger that the macro economic models now in use in central banks
operate like a Maginot line. They have been constructed in the past as part
of the war against inflation. The central banks are prepared to fight the
last war. But are they prepared to fight the new one against financial upheavals
and recession? The macroeconomic models they have today certainly do not
provide them with the right tools to be successful.
They will have to use other intellectual constructs to succeed.
Jul 8, 2008 | MSN Money
You have another chance to devastate your beleaguered
portfolio -- by getting back into stocks too soon. The market and the economy
are likely to keep grinding lower for a while.
Bear markets in stocks give investors two chances to lose their shirts. Get
ready for your second shot at big losses.
... ... ...
Safer on the sidelines
So, no, I don't think the drop that, as of Monday, had taken the S&P 500 to
a loss of 20.6% from the Oct. 9 closing high -- a 20% decline that marks the
official definition of a bear market -- is a bottom. I don't think it was a
signal to buy -- unless you're a very nimble trader. And I'm still looking for
the kind of washout that sends an "all clear" signal after a market like this.
I wish I could give you a date for that all clear. I'm sitting on a 33% cash
position in Jubak's Picks (as of July 1), and frankly, I'd rather have the money
at work making money than sitting on the sidelines.
But at the moment I think the important rule is still "safety first."
The U.S. Treasury and the Federal Reserve recognize that taxpayers will have
to pay whatever it takes to keep these two players in the mortgage game. With
$5 trillion in financial paper in the markets tied to these two companies, a
failure at one or the other would panic the U.S. and every other financial market
in the world.
We wouldn't have to wonder about whether the U.S. economy would slip into
a recession because we'd be in one -- and looking a depression straight in the
Fannie Mae and Freddie Mac are also just plain too big. It's incredible that
two companies could be so large that their troubles could threaten the U.S.
and global economies.
Creditworthiness of the country at stake
It's their very size that has turned the current financial crisis into something
affecting much more than the mortgage market or even the U.S. banking sector.
What's at stake now is the credit of the United States itself.
Because of Fannie Mae and Freddie Mac, the overseas investors who hold $9
trillion in U.S. government debt and trillions more in U.S. dollars
are weeks away from losing faith in the government's
In the days since the crisis at Fannie and Freddie turned red-hot,
the council that advises Saudi Arabia's king has
recommended revaluing the Saudi currency, the riyal, which is pegged to the
U.S. dollar, by up to 30%. That could be a first step toward
switching the riyal from a price pegged to the dollar to one pegged to a basket
of world currencies.
A similar advisory body in Abu Dhabi has suggested abandoning that country's
dollar peg for its currency. A third oil-rich Middle Eastern country, Kuwait,
ended its currency link to the dollar last year.
More ominously, because the threat is more immediate, some of the world's
largest sovereign wealth funds, including that of China, are edging away from
the U.S. dollar at an increasing speed. China's State Administration of Foreign
Exchange, which holds the majority of China's $1.6 trillion in foreign currency
reserves (mostly in dollars), has been holding talks with European private-equity
companies about investing in their latest round of funds. That would shift dollars
You'd be absolutely right on the facts. And dead wrong in practice. You see,
when you're a debtor, it's what your creditors believe, not any fact, that is
important. If your creditor believes you might not be able to pay, it's that
belief that counts, no matter the facts, when the creditor cuts off your credit.
What a creditor believes is especially important when a debtor needs that creditor
to keep extending credit in the future to finance new bills. That's, of course,
exactly where the U.S. finds itself now.
What the US must do
What happens over the next few weeks or months is critical. If the U.S. government
comes up with a credible plan to recapitalize Fannie Mae and Freddie Mac using
government and private money -- even if the private money is mostly window dressing
-- then overseas investors will be reassured that the U.S. isn't simply going
to walk away from its financial obligations.
If that plan includes tougher regulations and stricter limits on leverage,
and especially if it replaces current management at the companies, overseas
investors will gain confidence. If the plan includes an equity element, so the
U.S. government (and taxpayers) have a chance to profit from a recovery at these
two companies, overseas investors will start to believe the U.S. has faith in
its own future. And if the plan includes a timetable for reducing the size of
or, better yet, eliminating Fannie Mae and Freddie Mac, overseas investors might
actually start to believe the U.S. government is in control of its own future.
Certainly, it makes no sense from any perspective to let two private but publicly
traded companies have as much power over the U.S. financial markets and the
credit rating of the U.S. government as Fannie Mae and Freddie Mac do. Especially
since the financial markets are so much deeper now than they were in 1938. The
big banks and other investors are perfectly able to provide the liquidity that
Fannie Mae was designed to provide in 1938.
And if the U.S. doesn't come up with a credible plan? To protect their own interests,
overseas investors will increase the rate at which they're moving away from
the U.S. dollar.
In the short run, that means a cheaper dollar -- good for
U.S. exports but bad for U.S. consumers who will have to pay more dollars for
everything this country imports, including oil. In the longer run it means underperformance
by U.S. stocks and bonds because overseas investors will want to h rates and
an increased cost of capital to U.S. companies that want to expand their businesses.
What's happening at Fannie Mae and Freddie Mac wouldn't matter so much, of
course, if the U.S. didn't owe so much to the rest of the world. But it does.
The sooner we realize that the two most important jobs a debtor has are successfully
managing creditors and getting out of debt, the better off the U.S. will be.
Why Fannie and Freddie matter overseas
So why is the crisis at Fannie Mae and Freddie Mac so important to overseas
investors? Three reasons:
The crisis at Fannie Mae and Freddie Mac wouldn't be so threatening to US financial
credibility if these mortgage giants hadn't fudged the truth to sell their bonds,
Jim Jubak says.
Size counts. The two companies own or guarantee $5 trillion
in home mortgages. That's a little less than half of the $12 trillion U.S.
mortgage market. In comparison, the total U.S. government public debt totals
just $9.5 trillion. (In addition, Fannie Mae and Freddie Mac have
$831 billion and $644 billion. respectively, in bonds outstanding.)
The companies have behaved like part of the U.S. government.
Despite a clear statement to the contrary in the legislation that set up
Fannie Mae and Freddie Mac, most investors believe the U.S. government stands
behind the two companies. This belief in some sort of implicit "guarantee"
is the major reason that Fannie Mae and Freddie Mac have long been able
to borrow money in the financial markets at a lower rate of interest than
other mortgage lenders. The edge created by the belief in an implicit guarantee
has been a key to the two companies' ability to grab an ever bigger share
of the mortgage market. The management teams at Fannie Mae and Freddie Mac
have behaved as if they believed in that implicit guarantee, too. They used
their access to cheap money to build up huge mortgage positions without
raising much actual capital from investors. The $5 trillion in owned or
guaranteed mortgages at the two companies is backed by less than $100 billion
in actual capital. That's leverage of 50-to-1.
The U.S. government is caught in a terrible bind. On the
one hand, if the government doesn't stand behind Fannie Mae and Freddie
Mac, many overseas investors will see it as equivalent to the U.S. government
defaulting on its debt. If the U.S. government walks away from Fannie and
Freddie, these overseas investors will worry that the U.S. government will
walk away from the other U.S. debt they own and from the dollar itself.
There's already a suspicion among overseas investors that the U.S. government
will try to solve its dual problems of a massive government debt and a massive
trade deficit by letting the dollar tank. On the other hand, if the U.S.
government does back Fannie Mae and Freddie Mac, it runs the danger that
overseas investors will simply add Fannie and Freddie's $5 trillion in mortgages
and guarantees to the $9.5 billion the U.S. government already owes. By
that calculation, a bailout would increase the debt level of the U.S. by
Now, you may object that overseas investors are simply wrong in their beliefs.
That Fannie and Freddie never had any government guarantee, explicit or implicit.
That no bailout would turn that $5 trillion in owned or guaranteed mortgages
at Fannie and Freddie into U.S. government debt.
You'd be absolutely right on the facts. And dead wrong in practice. You see,
when you're a debtor, it's what your creditors believe, not any fact, that is
important. If your creditor believes you might not be able to pay, it's that
belief that counts, no matter the facts, when the creditor cuts off your credit.
What a creditor believes is especially important when a debtor needs that creditor
to keep extending credit in the future to finance new bills. That's, of course,
exactly where the U.S. finds itself now.
What the US must do
What happens over the next few weeks or months is critical. If the U.S. government
comes up with a credible plan to recapitalize Fannie Mae and Freddie Mac using
government and private money -- even if the private money is mostly window dressing
-- then overseas investors will be reassured that the U.S. isn't simply going
to walk away from its financial obligations.
If that plan includes tougher regulations and stricter limits on leverage,
and especially if it replaces current management at the companies, overseas
investors will gain confidence. If the plan includes an equity element, so the
U.S. government (and taxpayers) have a chance to profit from a recovery at these
two companies, overseas investors will start to believe the U.S. has faith in
its own future. And if the plan includes a timetable for reducing the size of
or, better yet, eliminating Fannie Mae and Freddie Mac, overseas investors might
actually start to believe the U.S. government is in control of its own future.
Certainly, it makes no sense from any perspective to let two private but
publicly traded companies have as much power over the U.S. financial markets
and the credit rating of the U.S. government as Fannie Mae and Freddie Mac do.
Especially since the financial markets are so much deeper now than they were
in 1938. The big banks and other investors are perfectly able to provide the
liquidity that Fannie Mae was designed to provide in 1938.
And if the U.S. doesn't come up with a credible plan? To protect their own interests,
overseas investors will increase the rate at which they're moving away from
the U.S. dollar.
In the short run, that means a cheaper dollar -- good for
U.S. exports but bad for U.S. consumers who will have to pay more dollars for
everything this country imports, including oil. In the longer run it means underperformance
by U.S. stocks and bonds because overseas investors will want to hold fewer
of them. It means higher interest rates because the U.S. government will have
to pay more to get overseas investors to overcome their reluctance and buy our
debt. And it means slower economic growth from higher interest rates and an
increased cost of capital to U.S. companies that want to expand their businesses.
What's happening at Fannie Mae and Freddie Mac wouldn't matter so much, of
course, if the U.S. didn't owe so much to the rest of the world. But it does.
The sooner we realize that the two most important jobs a debtor has are successfully
managing creditors and getting out of debt, the better off the U.S. will be.
This story is from the UK but the same situation applies here:
Taxpayers can bear no more, admits Alistair Darling.
Taxpayers are at the limit of what they are willing to pay to fund public
services, the Chancellor has said in an interview with The Times. In his
gloomiest assessment yet of the state of the British economy, Alistair Darling
gave warning that the downturn was far more profound than he had thought
and could last for years rather than months.
He revealed that he told Cabinet ministers this week that there would be
no more money for schools, hospitals, defence, transport or policing.
He confirmed that the Treasury was considering revising its fiscal rules
to allow more borrowing to deal with the economic problems. He said that
he did not believe that voters, already struggling with higher food and
fuel bills, would be willing to pay more tax. “People will pay their fair
share but you can’t push that,” he said.
Mr Darling said of this week’s Cabinet meeting: “I’ve been very clear with
my colleagues that there is no point them writing in saying, ‘Can we have
some more money?’ because the reply is already on its way and it’s a very
short reply. I told them at the last meeting of Cabinet they’ve got to manage
within the money they’ve got.”
The Chancellor played down that the Government is reviewing the fiscal rules,
which say that borrowing must not go beyond 40 per cent of gross domestic
product. “This routine work has been going at the Treasury for several months,”
He made clear that he thought that the only politically viable option was
to increase borrowing, rather than to raise taxation.
Teddy Saturday, July 19, 2008 4:28:52 PM
Good report Mish, I follow the economic events in the UK very closely
as I am a frequent visitor there. You are quite right about the UK government
now following the USA playbook. For some reason, the UK has been on a decade
long USA style binge of borrow and spend, now this has spread to the public
sector. With predictable results I might add.
I first noticed the Bubble Economy in the UK back in the late 90s, by 2006
it was a white hot big bang of a bubble, a whole new universe, something
I had never seen in the UK before. Knowing that UK industry was hollowed
out years earlier, I questioned how this new found wealth could be. The
City Of London was the answer. Financial services and it's bastard child
"Housing Bubble" were the answers. Now it has burst. So many deep in debt
UK households are in for a back to the 50s look at cold dark houses and
small paychecks for long hours. Where are the jobs in the UK? Take away
financial services, housing bubble and public employment, and
there isn't any. All other jobs are just service jobs to the Big Three that
are going down.
Good article Mish, every post of yours is looked forward to by me and those
I tell about your blog.
Supply side economics or spending without taxation is what got us in
this mess with the biggest excesses being the Iraq war and war on terrorism.
When you decide to go to war, you're suppose to raise taxes to pay for it,
not cut taxes and then spend a trillion there so far with the rest of the
world picking up the tab. This country has suffered unconscionable
losses in manufacturing jobs, especially to China and India,
as a consequence of refusing to pay as you go, resulting in our
outrageous trade deficits. This war, and not social security which runs
a surplus, is bankrupting this country. We have copied Magaret
Thatcher's England into bankruptcy.
We now have almost no middle class since we have minimal manufacturing
and with the inflation of the last four years, the salaries for most people
in this country along with their debt levels provide nothing more than a
sustenance existance. And with foreigners buying up what is left of the
equity in our companies, we resemble Argentina more and more each day. If
you rely on the kindness of strangers, you become a "nation of sharecroppers".
The elite foxes are still in the hen house, but how much is there left to
Jul 17th, 2008 by
Someone this week asked me what I thought of policy-makers who ex ante profess
a free-market ideology and acute sensitivity to the dangers of moral hazard
from financial bailouts, but who toss that ideology overboard when faced with
a financial crisis. The reference was to Treasury Secretary Henry Paulson’s
lobbying this week in support of a rescue for Fannie Mae and Freddie Mac,
the two big home mortgage agencies, following on the
of Bear Stearns in March.
My reply was: “They say there are no atheists in foxholes.
Perhaps, then, there are also no libertarians in
There are more egregious cases
than Hank Paulson of inconsistencies between ex ante promises by policy-makers
not to bail out and ex post bailouts when disaster strikes.
(Indeed, some amount of change in position may even be rational for an office-holder,
though I would draw the line at false stateme="MsoNormal" style="MARGIN: 0in
An example I have in mind concerns
the members of the starting team in the Bush Administration who had lectured
the Clinton Administration on the evils of its allegedly excessive bailouts
of emerging markets in the 1990s, only to engage in worse when they themselves
were faced with the Argentine crisis that began in 2001. There was no
particular reason to rescue the Kirchner government. Argentina in
2003 would have been the perfect place to refrain from rolling over an IMF program,
thereby putting a limit on the moral hazard problem.
The Clinton Treasury had done this with Russia in
August 1998 despite high costs in terms of systemic contagion.
Yet the Bush White House continued to push the IMF to bail out Argentina.
Apparently the failing lay in simple inexperience and lack of awareness that
any such choices are always difficult. (See pages 9-11 of my article
Managing Financial Crises, in the Cato Journal, Summer 2007.)
The Administration was very much following in the footsteps of the Reagan Administration,
which talked tough at first when the international debt crisis hit in 1982 but
which then participated in comprehensive IMF-led bailouts of Latin American
debtors who had been pursuing far worse macroeconomic policies than the emerging
market governments of the 1990s crises.
Incidentally, before writing this blog post, I checked into the World War
II origins of the sentence “There are
no atheists in foxholes.”
I discovered to my surprise that this expression was intended, and is still
considered, as a put-down of atheists, and that their lobby
protests its use.
Of course the proposition is not literally true; indeed some soldiers lose
their pre-existing belief in God when confronted with the horror of war.
But let us stipulate that those who suddenly face death more often find religion
than lose it. What strikes me as odd is that the expression is apparently
normally interpreted as meaning that people who profess atheism don’t really
mean it, and that their
true colors come out under pressure. I had, apparently erroneously, thought
rather the reverse.(Indeed, Richard Dawkins
argues that vast numbers of people who would no more bet on the existence of
God than on the existence of the Easter Bunny, nonetheless call themselves “agnostics”
rather than atheists, to avoid rocking the boat.) I had always taken the expression
to mean that mankind’s hunger for religious beliefs comes from a desperate desire
for divine intervention – or, failing that, comfort – when confronting death.
Something more along the lines “There are no unsoiled underpants in foxholes.”
I am in sympathy with the character in a
who said “That maxim, ‘There are no atheists in foxholes,’ it’s not an argument
against atheism — it’s an argument against foxholes.”
So what’s my point? Not to argue that governments should
intervene always (nor that they should intervene never). The lesson
for government officials is that wherever they choose to draw the bailout line
– one hopes the line strikes an intelligent balance between the short-run advantages
of ameliorating a serious financial crisis and the longer-run disadvantages
of moral hazard — they should think through the system ahead of time.
They should take the appropriate regulatory precautions during the boom times,
which correspond to the bailouts that will inevitably come during the busts.
Long ago, the United States worked out the approximate right answer for banks:
there will always be rescue of small depositors ex post when banks run into
serious trouble, and so under our system, (i) deposit insurance provides formal
guarantees ex ante and (ii) banks must pay the price ex ante through reserve
requirements, capital requirements, and active regulatory oversight. What
we now need to do is design the analogous sort of system for non-banks.
It should not come as a surprise to high officials that there are such things
as financial crises anymore than it should come as a surprise to soldiers that
there are such things as bombs. Human nature must be accepted for
what it is. But in the case of high officials, it shouldn’t
be necessary for them to alter their fundamental beliefs when crisis strikes,
in the absence of truly unforeseeable developments.
American economic engine needs tuning and attempt to convert it into financial
speculation Mecca failed. " "We can't make any headway in my opinion, if we don't
understand what went wrong.
A more measured approach might be to acknowledge the errors and work to convince
the political class to move toward regulating and dealing with our situation based
on the understanding of what we have recently done so wrong."
Brad is not worried. Nouriel Roubini is:
In a series of recent writings on the RGE Monitor Nouriel Roubini – Chairman
of RGE Monitor and Professor of Economics at the NYU Stern School of Business
- has argued that the U.S. is experiencing its worst financial crisis since
the Great Depression and will undergo its worst recession in the last few decades.
His analysis leads to the following conclusions:
This is by far the worst financial crisis since the Great Depression. Hundreds
of small banks with massive exposure to real estate (the average small bank
has 67% of its assets in real estate) will go bust
Dozens of large regional/national banks (a’ la IndyMac) are also bankrupt
given their extreme exposure to real estate and will also go bust.
Some major money center banks are also semi-insolvent and while they are
deemed too big to fail their rescue with FDIC money will be extremely costly.
In a few years time there will be no major independent broker dealers as
their business model (securitization, slice & dice and transfer of toxic credit
risk and piling fees upon fees rather than earning income from holding credit
risk) is bust and the risk of a bank-like run on their very short term liquid
liabilities is a fundamental flaw in their structure (i.e. the four remaining
U.S. big brokers dealers will either go bust or will have to be merged with
traditional commercial banks). Firms that borrow liquid and short, highly leverage
themselves and lend in longer term and illiquid ways (i.e. most of the shadow
banking system) cannot survive without formal deposit insurance and formal permanent
lender of last resort support from the central bank.
The FDIC that has already depleted 10% of its
funds in the rescue of IndyMac alone will run out of funds and will have to
be recapitalized by Congress as its insurance premia were woefully insufficient
to cover the hole from the biggest banking crisis since the Great Depression
Fannie and Freddie are insolvent and the Treasury bailout plan (the mother
of all moral hazard bailout) is socialism for the rich, the well connected and
Wall Street; it is the continuation of a corrupt system where profits are privatized
and losses are socialized. Instead of wiping out shareholders of the two GSEs,
replacing corrupt and incompetent managers and forcing a haircut on the claims
of the creditors/bondholders such a plan bails out shareholders, managers and
creditors at a massive cost to U.S. taxpayers.
This financial crisis will imply credit losses of at least $1 trillion and
more likely $2 trillion.
This is not just a subprime mortgage crisis; this is the crisis of an entire
subprime financial system: losses are spreading from subprime to near prime
and prime mortgages; to commercial real estate; to unsecured consumer credit
(credit cards, student loans, auto loans); to leveraged loans that financed
reckless debt-laden LBOs; to muni bonds that will go bust as hundred of municipalities
will go bust; to industrial and commercial loans; to corporate bonds whose default
rate will jump from close to 0% to over 10%; to CDSs where $62 trillion of nominal
protection sits on top an outstanding stock of only $6 trillion of bonds and
where counterparty risk – and the collapse of many counterparties – will lead
to a systemic collapse of this market.
This will be the most severe U.S. recession in decades with the U.S. consumer
being on the ropes and faltering big time as soon as the temporary effect of
the tax rebates will fade out by mid-summer (July).
This U.S. consumer is shopped out, saving less, debt burdened and being hammered
by falling home prices, falling equity prices, falling jobs and incomes, rising
inflation and rising oil and energy prices. This will be a long, ugly and nasty
U-shaped recession lasting 12 to 18 months, not the mild 6 month V-shaped recession
that the delusional consensus expects.
Equity prices in the US and abroad will go much deeper in bear territory.
In a typical US recession equity prices fall by an average of 28% relative to
the peak. But this is not a typical US recession; it is rather a severe one
associated with a severe financial crisis. Thus, equity prices will fall by
about 40% relative to their peak. So, we are only barely mid-way in the meltdown
of stock markets.
The rest of the world will not decouple from the US recession and from the
US financial meltdown; it will re-couple big time. Already 12 major economies
are on the way to a recessionary hard landing; while the rest of the world will
experience a severe growth slowdown only one step removed from a global recession.
Given this sharp global economic slowdown oil, energy and commodity prices will
fall 20 to 30% from their recent bubbly peaks.
The current U.S recession and sharp global economic slowdown is combining
the worst of the oil shocks of the 1970s with the worst of the asset/credit
bust shocks (and ensuing credit crunch and investment busts) of 1990-91 and
2001: like in 1973 and 1979 we are facing a stagflationary shock to oil, energy
and other commodity prices that by itself may tip many oil importing countries
into a sharp slowdown or an outright recession. Also, like 1990-91 and 2001
we are now facing another asset bubble and credit bubble gone bust big time:
the housing and overall household credit boom of the last seven years has now
gone bust in the same way as the 1980s housing bubble and 1990s tech bubble
went bust in 1990 and in 2000 triggering recessions. And a similar housing/asset/credit
bubble is going bust in other countries – U.K., Spain, Ireland, Italy, Portugal,
etc. – leading to a risk of a hard landing in these economies.
But over time inflation will be the last problem that the Fed will have to face
as a severe US recession and global slowdown will lead to a sharp reduction
in inflationary pressures in the U.S.: slack in goods markets with demand falling
below supply will reduce pricing power of firms; slack in labor markets with
unemployment rising will reduce wage pressures and labor costs pressures; a
fall in commodity prices of the order of 20-30% will further reduce inflationary
pressure. The Fed will have to cut the Fed Funds rate much more – as severe
downside risks to growth and to financial stability will dominate any short-term
upward inflationary pressures. Leaving aside the risk of a collapse of the US
dollar given this easier monetary policy the Fed Funds rate may end up being
closer to 0% than 1% by the end of this financial disaster and severe recession
The Bretton Woods 2 regime of fixed exchange rates to the US dollar and/or
heavily managed exchange will unravel – as the first Bretton Woods regimes did
in the early 1970s – as US twin deficits, recession, financial crisis and rising
commodity and goods inflation in emerging market economies will destroy the
basis for it existence.
Thus, the scenario of 12 steps to a financial disaster that I outlined in
my February 2008 paper is unfolding as predicted. If anything financial conditions
are now much worse than they were at the previous peak of this financial crisis,
i.e. in mid-march of 2008.
I half agree with Brad's post, while the other half is made seriously ill. The
part I agree with is that monetary policy is not the tool for dealing with asset
bubbles, so Greenspan's policies were probably basically right. What makes me
ill is the attitude of smug complacency towards asset bubbles, and the interests
of the middle-class savings and investing class. "...the people doing the buying
and investing were relatively well-off, and were grownups..." Brad's mental
map of the economy seems to belong to a Depression-era world made up of a minority
of plutocrats and a mass of impoverished factory workers, where unemployment
is the only problem. Does he not know how many people own stocks these days
and are hurt by the volatility of the financial markets? As for the "grownups"
part, I know from personal acquaintance how many intelligent and well-educated
people are frightfully naive about investing, and these are people who do most
of what little savings we as a nation do.
"...investors are supposed to take care of themselves." Tell that to the employees
of Enron, or for that matter, the employees of sound companies who nevertheless
saw their 401Ks melt away, and then maybe lost their jobs on top of that. I'd
better stop there, before I fall into what Phil Gramm would call "whining".
I just want to make the point that smugness and complacency is not necessarily
a monopoly of the right.
Posted by: Phil P |
July 17, 2008 at 06:40 AM
My view is that it is not given that the extra real estate built is a definite
One problem that I see is energy efficiency, and we invested a lot in exurban
homes and large cars. Now we have hard time decreasing the demand for fuel to
maintain the stuff. A temporary excess of fiber was not a constant drain on
resources, and in time, one could find uses for it. A pool of monster houses
or houses in monster locations, and monster vehicles is not as benign.
The other annoying thing is that it is OK for the invisible hand of the market
to misallocate a trillion, but politically impossible to spend a trillion is
a genuinely useful fashion, like more rational health care or energy production.
A survey of nearly 4,000 Americans across four generations found that most
adults believe responsibility for a secure financial future is rapidly shifting
People can typically borrow $50,000 or half the vested balance of their 401(k)
accounts with extremely favorable interest rates. Failing to repay loans on
time typically incurs a 10% excise tax and borrowers must also pay income tax.
Dipping into retirement money wouldn't be a problem if other sources of retirement
income -- such as Social Security and pensions -- weren't drying up, Weller
said. More people today are counting on 401(k) accounts to be their primary
income source in retirement.
Yet a study by Hewitt Associates this month found four out five workers aren't
socking away enough money into their 401(k) accounts to keep up their standard
of living after retirement.
On average, employees are projected to replace just 85% of their income in
retirement, compared with the 126% they would need when factoring in inflation,
longer life spans and medical costs, the study by Hewitt found.
The study found workers in 2004 had $31 billion in outstanding 401(k) loans,
a fivefold increase from $6 billion in 1989. Between 1998 and 2004, an average
of 12% of families with 401(k) plans borrowed from them.
"They don't necessarily pay penalties. But the penalty is that they have
fewer retirement savings," said Christian Weller, an author of the study.
As economic conditions grow bleaker, the number
of people dipping into retirement money will only rise, he added.
A $5,000 loan, for example, could cut retirement savings by 22% even if the
loan is repaid without penalty, according to the study. That's assuming the
person has a $40,000 salary and is five years into a 35-year career.
Inconsistency in regulation and popularity of "free market" fundamentalism prepared
the current trap.
July 18 | Bloomberg
``It turns out socialism is alive and well in America,'' Bunning said in
opening statement at a July 15 Senate Banking Committee hearing.
... ... ...
The securities industry regulator introduced new requirements for anyone
looking to sell short the stock of 19 financial companies. The new measures
will expire in 30 days if not extended. (Everyone who thinks they won't be extended,
raise your hand. Good. We can move on.)
... ... ...
``We want free-market mechanisms as long as everything is doing fine,'' says
Jim Glassman, senior U.S. economist at JPMorgan Chase & Co. ``In times of
crisis, we want to keep market mechanisms in check. If shorting a company is
a bad idea, reality will prove it wrong.''
How do we know the market failed if we don't allow it to work? Capitalism
without failure is like religion without sin.
The U.S. has spent the last 30 years dismantling some of the onerous regulations
enacted during the Great Depression. Entire industries have been deregulated.
The Glass-Steagall Act separating commercial and investment banking was repealed.
Where rules still existed, financial innovation -- the Eurodollar and Eurobond
markets -- found a way around them.
It's a foregone conclusion that the country is headed back in the other direction.
The only question is how far. The Nasdaq bubble gave us Sarbanes-Oxley. Now
housing collapse has devastated
construction and finance industries, government can take up some of the
slack. (Who better to staff new regulatory agencies than out-of-work Wall Street
types, who know the ins and outs of the rules?)
Foreclosure Prevention Act of 2008, which is now in a House-Senate conference
committee, establishes ``a new independent regulator'' for the GSEs that would
set capital standards and beef up risk management.
Conflict of Interest
What if said regulator finds the GSEs inadequately capitalized? One alternative
would be to shrink their huge balance sheets.
But wait! Congress needs Fannie and Freddie to gobble up all the mortgages
banks are willing to make to prevent a complete implosion in the housing market.
(That new regulator is being unnecessarily tough on poor Fan and Fred.)
Maybe Treasury should start a taxpayer-funded sovereign wealth fund and buy
all the bad loans -- even foreclosed homes -- no one wants. In retrospect, the
Resolution Trust Corp., created in 1989 to dispose of savings and loans'
bad assets, looks like a model of efficiency compared with some of the proposals
being bandied about today.
And no, none of them are solutions for a market failure. You can't whine
about the death of capitalism when government is putting a gun to its head.
Baum, author of ``Just What I Said,'' is a Bloomberg News columnist. The
opinions expressed are her own.)
Social Safety Nets, Inflation Fighting, and Market Discipline
Here is another important consideration for future Fed policy...
I've had some differences with Barney Frank in the past over Fed policy, but
here he makes an interesting point. Why do European central banks respond more
aggressively to inflation than the US central bank? Could it be the difference
in social safety nets?:
Frank Says Stronger Social Safety Net Would Free Fed, by –Michael
S. Derby, Real Time Economics: There are many reasons why the Federal
Reserve is boxed in on monetary policy, but Rep. Barney Frank Wednesday
found a new dimension to the central bank’s dilemma. ...
Ben Bernanke and his fellow policy makers are facing a worrisome mix
of tepid growth, troubled financial conditions and rising price pressures...
The weak economy and market tumult call for rate cuts. But the energy-driven
price gains and deteriorating expectations for future prices call for rate
That’s left the Fed stuck at its current rate of 2%, very likely for
an extended period. But according to Frank, if the U.S. social safety net
weren’t so miserly, the Fed might actually have more room to take on inflation.
... “The relative insufficiency of our social safety net vis-a-vis what
you have in Western Europe constrains monetary policy,” Frank said.
If the U.S. offered more support for the unemployed and displaced, “the
Federal Reserve would then be freer…to slow down the economy in the knowledge
this would not have a disproportionately negative effect” on the working
population. That part of the population is already losing notable ground
in economic terms, he said. ...
And, contrary to what you might hear -
sometimes based upon the argument that we are not in a technical recession
- "families are facing hardship":
Bernanke: Recession or Not, Families Are Hurting, by Sudeep Reddy: ...At
a House hearing, Mr. Bernanke — responding to a lawmaker’s question about
Americans’ economic pain ...[and] whether a recession is underway. ...
“Whether it’s a technical recession or not is not all that relevant,”
Mr. Bernanke said. “It’s clearly the case that for a variety of reasons
families are facing hardship.” ...Mr. Bernanke recounted the “numerous difficulties”
facing the economy: “ongoing strains in financial markets, declining house
prices, a softening labor market, and rising prices of oil, food, and some
other commodities.” ...
As to whether this is a technical recession, “I don’t see why that makes
a great deal of difference,” Mr. Bernanke said, adding that the terminology
doesn’t play into the Fed’s policy decisions.
In other what are you whining about
news, prices are up, and the ability of workers to buy goods and services
U.S. consumer prices soared at their fastest annual pace in nearly two
decades last month... Even more worrisome for policymakers than the headline
inflation jump may be signs that food and energy prices are starting to
filter through the broader economy, as evidenced by sharp price gains last
month in housing, transportation and services. ...
The consumer price index jumped 1.1% in June..., the second-highest increase
since 1982 and the highest since 2005. Excluding food and energy, it advanced
Consumer prices swelled 5% on a year-over-year basis, the highest rate
since May 1991. The core CPI grew a more modest 2.4% compared to June 2007,
though that's still well above the Fed's long-term goal of 1.5% to 2%. Over
the past three months, core inflation rose at a 2.5% annual rate. ...
In a separate report, the Labor Department said the average weekly earnings
of U.S. workers, adjusted for inflation, fell 0.9% in June, suggesting incomes
aren't keeping pace with prices...
JP Morgan’s no-nonsense CEO Jamie Dimon was clearly trying to temper investors’
newfound enthusiasm with a dose of market reality.
“Our expectation is for the economic environment
to continue to be weak – and to likely get weaker – and for the capital markets
to remain under stress,” he said in a press statement. “We remain
conscious that since substantial risks still remain on our balance sheet, these
factors will likely affect our business for the
remainder of the year or longer.”
Even though Greg Mankiw
claims in the New York Times today that " Economists are nearly unanimous
in their support of an unfettered system of world trade," another Harvard economics
professor begs to differ.
Dani Rodrik, writing for Project Syndicate, finds that some prominent former
staunch advocates of liberalized trade regimes are having serious doubts to
the point that they are actually airing them in public. The big issue appears
to be – surprise – that trade is not delivering the benefits in practice that
it is alleged to produce in theory.
And worse, as Rodrik has noted at his blog, the benefits in theory are often
exaggerated. We wrote about
one such discussion:
The debate among Serious Economists about the benefits of free trade continues,
and Dani Rodrik continues to take a dispassionate look at the data and the
There may be another cause for pause as far as unqualified support for more
open trade is concerned.
Research into financial crises by Kenneth Rogoff and
Carmen Reinhart has found that:
This post, although a bit geeky, is intriguing because Rodrik dissects an
analysis cited by Bernanke in a recent speech, which found that the benefits
of free trade per US household since World War II are roughly $10,000, and
full liberalization would generate another $4,000 to $12,000 per HH. Rodrik
finds those numbers to be "grossly inflated" and explains why in "The
Globalization Numbers Game."
At the end of the post, Rodrik chides his peers for goosing numbers to make
What puzzles me is not that papers of this kind exist, but that there
are so many professional economists who are willing to buy into them
without the critical scrutiny we readily deploy when we confront globalization's
critics. It should have taken Ben Bernanke no longer than a few minutes
to see through Bradford et al. and to understand that it is a crude
piece of advocacy rather than serious analysis. I bet he would not have
assigned it to his students at Princeton. Why are we so ready to lower
our standards when we think it is in the service of a good cause?
There is a simple answer: because with honest numbers, the case may not
be compelling. These models (as I understand them, which admittedly may
not be perfectly) rest on certain
assumptions, many of which do not operate in practice. Thus, there is
the real possibility that adjusting any model's results to more closely
approximate real world conditions may reduce (or improve) the theoretical
benefits to open trade. Give that many observers believe that America's
free trade deals tend to
favor its corporations rather than the population as a whole, it seems
more likely than not that any rectification of theory to reality would lower
the level of benefits.
Periods of high international capital mobility have repeatedly produced
international banking crises, not only famously as they did in the 1990s,
High levels of international trade is a necessary, although perhaps not a sufficient
condition for high international capital mobility (reader views on this point
in particular would be of interest).
Now, from Rodrik's
article at Project Syndicate:
The world economy has seen
globalisation collapse once already. The gold standard era – with its
free capital mobility and open trade – came to an abrupt end in 1914 and
could not be resuscitated after the First World War. Are we about to witness
a similar global economic breakdown?
The question is not fanciful. Although economic globalisation has enabled
unprecedented levels of prosperity in advanced countries and has been a
boon to hundreds of millions of poor workers in China and elsewhere in Asia,
it rests on shaky pillars.
Unlike national markets, which tend to be supported by domestic regulatory
and political institutions, global markets are only "weakly embedded".
There is no global anti-trust authority, no global lender of last resort,
no global regulator, no global safety nets, and, of course, no global democracy.
In other words, global markets suffer from weak governance, and therefore
from weak popular legitimacy.
Recent events have heightened the urgency with which these issues are discussed.
The presidential electoral campaign in the United States has highlighted
the frailty of the support for open trade in the world's most powerful nation.
The sub-prime mortgage crisis has shown how lack of international coordination
and regulation can exacerbate the inherent fragility of financial markets.
The rise in food prices has exposed the downside of economic interdependence
without global transfer and compensation schemes.
Meanwhile, rising oil prices have increased transport costs, leading analysts
to wonder whether the outsourcing era is coming to an end. And there is
always the looming disaster of climate change, which may well be the most
serious threat the world has ever faced.
So if globalisation is in danger, who are its real enemies? There was a
time when global elites could comfort themselves with the thought that opposition
to the world trading regime consisted of violent anarchists, self-serving
protectionists, trade unionists, and ignorant, if idealistic youth. Meanwhile,
they regarded themselves as the true progressives, because they understood
that safeguarding and advancing globalization was the best remedy against
poverty and insecurity.
But that self-assured attitude has all but disappeared, replaced by doubts,
questions, and scepticism. Gone also are the violent street protests and
mass movements against globalisation. What makes news nowadays is the growing
list of mainstream economists who are questioning globalisation's supposedly
So we have Paul Samuelson, the author of the post-war era's landmark economics
textbook, reminding his fellow economists that China's gains in globalisation
may well come at the expense of the US; Paul Krugman, today's foremost international
trade theorist, arguing that trade with low-income countries is no longer
too small to have an effect on inequality; Alan Blinder, a former US
Federal Reserve vice-chairman, worrying that international outsourcing
will cause unprecedented dislocations for the US labour force; Martin Wolf,
the Financial Times columnist and one of the most articulate advocates of
globalisation, writing of his disappointment with how financial globalisation
has turned out; and Larry Summers, the US Treasury chief and the Clinton
administration's "Mr Globalisation", musing about the dangers of a race
to the bottom in national regulations and the need for international labour
While these worries hardly amount to the full frontal attack mounted by
the likes of Joseph Stiglitz, the Nobel-prize winning economist, they still
constitute a remarkable turnaround in the intellectual climate. Moreover,
even those who have not lost heart often disagree vehemently about the direction
in which they would like to see globalisation go.
For example, Jagdish Bhagwati, the distinguished free trader, and Fred Bergsten,
the director of the pro-globalisation Peterson Institute for International
Economics, have both been on the frontlines arguing that critics vastly
exaggerate globalisation's ills and under-appreciate its benefits. But their
debates on the merits of regional trade agreements – Bergsten for, Bhagwati
against – are as heated as each one's disagreements with the authors mentioned
None of these intellectuals is against globalisation, of course. What they
want is not to turn back globalisation, but to create new institutions and
compensation mechanisms – at home or internationally – that will render
globalisation more effective, fairer, and more sustainable.
Their policy proposals are often vague (when specified at all), and command
little consensus. But confrontation over globalisation has clearly moved
well beyond the streets to the columns of the financial press and the rostrums
of mainstream think tanks.
That is an important point for globalisation's cheerleaders to understand,
as they often behave as if the "other side" still consists of protectionists
Today, the question is no longer: "Are you for
or against globalisation?" The question is: "What should the rules of globalisation
be?" The cheerleaders' true sparring partners today are not rock-throwing
youths but their fellow intellectuals.
The first three decades after 1945 were governed by the Bretton Woods consensus
– a shallow multi-lateralism that permitted policy-makers to focus on domestic
social and employment needs, while enabling global trade to recover and
flourish. This regime was superseded in the 1980's and 1990's by an agenda
of deeper liberalisation and economic integration. That model, we have learned,
is unsustainable. If globalisation is to survive, it will need a new intellectual
consensus to underpin it. The world economy
desperately awaits its new Keynes.
401K investors will be royally fleeced again. And in compasion with this period
2001-2003 recession will look like a walk in the park. Stock promotion jerks
like Ben Stein or Cramer did a good job in this area :-(.
Traders are betting that the credit crunch will still be hurting banks at
the end of
2010 with financial institutions expected to be scrambling for cash
to shore up their end-of-year balance sheets.
A popular so-called butterfly
trade in the money markets is showing expectations of three to four times
the stress at the end of 2010 as before the credit crisis started to bite
last summer, although it implies the situation will have improved sharply
compared with today.
... ... ...
Laurence Mutkin, head of European rates strategy at
Morgan Stanley, said money markets were pointing to long-running financial
strains. “The market expects that these stresses will persist,” he said.
“It is saying the system survives but individual institutions will have
to fight hard to be among the survivors.”....
Judging by the events of last week, equity markets are entering a full-blown
valuation crisis. Strategists have warned that earnings forecasts for individual
companies are much too high proved to be right.
By Tony Jackson
Published: July 13 2008 17:12 | Last updated: July 13 2008 17:12
You can always count on America to give the world a lead. Just as it kicked
off the credit crisis, so it stays at the cutting edge as the crisis unfolds.
So much the worse for the rest of us.
Phase I – the writedown of dodgy securities – is by no means over, but is
no longer the big story. Phase II – the travails of ordinary commercial banks
– is now well under way. And this, of course, is the mechanism whereby the credit
crunch transmits itself to the real economy.
In the UK we may feel we know about this stuff already. After all, shares
in the mortgage lender Bradford & Bingley are down some 90 per cent on a year
But shares in IndyMac Bancorp, a lender of comparable ranking in the US,
were down 99 per cent before the bank finally went under last Friday. As for
the drama of Fannie Mae and Freddie Mac, that is in part a US speciality. But
it also illustrates a wider issue.
To do their job of propping up the US mortgage market, the two agencies must
borrow heavily from the capital markets. If – as looks to be the case – those
markets become shut to them, they must instead sell assets, such as mortgage-backed
In today’s markets, that would mean a fire sale. Other banks would then be
obliged to mark to market and take further writedowns. And so the spiral winds
More generally, Lombard Street Research reports that total US bank credit
in the 13 weeks to mid-June fell by an annualised 9 per cent. That is the worst
since records began in 1973 – or, in effect, since the Great Depression – and
compares with a 15 per cent rise as recently as March. So much for the Bear
The pressure is therefore on the banks to recapitalise further. But providers
of capital seem to be getting scarcer.
Part of the problem lies with US rules, whereby if you hold over 9.9 per
cent of a bank you risk having to top up its capital should it fall below a
The rules also hamper you from appointing directors – not an appealing prospect
for an activist investor or private equity house. Hence recent moves to relax
those rules – but how soon?
Similarly, the US Treasury is urging commercial banks to issue covered bonds,
like their European counterparts. But there are snags. In the UK, for instance,
analysts have argued that Bradford & Bingley will have difficulty maintaining
its lending because of the extra capital needed to guarantee its covered bonds.
Despite all the alarm bells, though, the effects on the real economy are
only just starting to show, even in the US. According to Morgan Stanley, US
issuance of home equity loans actually accelerated in the 13 weeks to June 4.
That, combined with the tax rebates to US households, presumably accounts for
US consumer spending holding up so far.
But the latter factor is of course a one-off. And with consumer confidence
at a 28-year low, the real downturn surely cannot be long postponed. After all,
for lending to be sustained it is not enough for banks to advance the money.
Ultimately, borrowers need to be confident in their ability to repay.
Granted, Morgan Stanley also estimates that real capital spending by US corporations
rose by 5.7 per cent in the second quarter versus only 0.1 per cent in the first.
That is frankly puzzling, and gives comfort to those hardy souls who argue the
US downturn is the product of fevered Wall Street imaginations.
But corporate cash flows are under pressure,
bonds markets are unaccommodating and bank lending is down. So how is this spending
to be financed henceforth?
In the UK, the same sense of trouble postponed is if anything stronger. According
to Leigh Goodwin of Fox-Pitt Kelton, UK defaults on both mortgages and commercial
loans are still at the bottom of the cycle.
In mortgages, for instance, the default figure in this year’s first half
was a negligible 1-2 basis points of book value. He expects this to rise to
around 50bp – which, in the context of margins of 70-80bp, would wipe out most
of the banks’ profit on mortgage business.
On the narrow question of bank valuations, one could argue all this is mainly
in the price. Up to a point, no doubt.
But according to Absolute Strategy Research,
the analysts’ consensus forecast is for a 10 per cent fall in European bank
earnings next year, but a 23 per cent bounce the year after. For Europe, excluding
the UK, the latter figure is 33 per cent.
Given the experience of past downturns, that is frankly unrealistic. We are
in this for the long haul, and the US is showing the way.
As I noted
yesterday, the difference between a moderate and severe recession might
be what happens with oil prices:
One of the keys to the base case is that oil prices decline in the 2nd half
of 2008 (something I've been predicting for some time). This prediction
is based on demand destruction, lower subsidies in certain Asian countries,
weaker demand growth in China, and a few other reasons. The fundamentals
of supply and demand for oil suggests a small decrease in demand could led
to a fairly large decrease in price. If this happens, then that will hopefully
lead to Kasriel's "sharp deceleration in inflation".
A rate cut is now more likely (in their view) than a rate
hike by the September meeting.
"The base case includes a sharp deceleration in
inflation in the not-too-distant future as energy prices stabilize and then retreat
due to a slowdown in the growth of global demand for energy. The
Federal Reserve will maintain the federal funds rate at 2% through the first half
of 2009. In the second half of 2009, when economic growth picks up enough to stop
the upward trend in the unemployment rate, the Fed will start raising the funds
Note: the Northern Trust link doesn't seem to work. Here is the
Northern Trust chief economist Paul Kasriel writes for July:
Base Case vs. Checkmate
Our base case economic scenario is that the U.S. economy entered a recession
in early 2008, will remain in a mild recession throughout 2008 and will
begin to experience an anemic recovery in the first half of 2009.
The base case includes a sharp deceleration
in inflation in the not-too-distant future as energy prices stabilize and
then retreat due to a slowdown in the growth of global demand for energy.
The Federal Reserve will maintain the federal funds rate
at 2% through the first half of 2009. In the second half of 2009, when economic
growth picks up enough to stop the upward trend in the unemployment rate,
the Fed will start raising the funds rate.
Kasriel's "base case" is very close to my view; a mild to moderate recession
that lingers for some time with a prolonged period of elevated unemployment.
However I don't expect unemployment to reach 8%.
Our risk case scenario is that the U.S. dollar begins to fall precipitously
coinciding with a rise in Treasury bond yields. U.S. inflation does not
moderate because of the depreciation in the dollar. As a result, the Federal
Reserve is forced to raise the funds rate even in the face of a rising U.S.
unemployment rate. This would be “checkmate” for the U.S. economy, turning
a relatively mild recession into a severe one.
One of the keys to the base case is that oil prices decline in the 2nd half
of 2008 (something I've been predicting for some time). This prediction is based
lower subsidies in certain Asian countries, weaker demand growth in China,
and a few other reasons. The fundamentals of supply and demand for oil suggests
a small decrease in demand could led to a fairly large decrease in price. If
this happens, then that will hopefully lead to Kasriel's "sharp deceleration
However, if oil prices increase or stay elevated, then the Checkmate case becomes
somewhat more likely (although I still think it is highly unlikely). See Kasriel's
piece for much more.
It's hard to believe that oil will continue at these elevated prices with all
of the demand destruction occurring right now. So I concur with both you and
I believe that oil prices may retreat more quickly than many expect and begin
to better reflect the demand/supply situation rather than serve as a dollar/inflation
hedge with significant speculation. If the oil hedgers/speculators begin to
unwind their positions, it could fall pretty quickly. It's perhaps the only
good economic news in the near-term horizon.
So, the folks over at iTulip swear the oil price increase is mostly (80%) due
to dollar depreciation, rather than increased demand. That suggests to me that
demand destruction won't do the trick. If this is the case, it seems that the
only way to tame oil prices is to bolster the dollar by raising rates - significantly.
Which puts us right back into the checkmate scenario.
I gather that CR and iTulip disagree on the fundamental reason for very high
oil prices? The very high oil prices are creeping into everything - that has
to be what's driving that insane jump in the CPI.
Calculated Risk writes:
wally, oil might not be the only path to Kasriel's "Checkmate", but I think
it's the most likely. If you read his piece (the link wasn't working the last
time I tried), Kasriel suggests a huge bailout of the GSEs could be another
"Why might the dollar dive? Because the U.S. Treasury is forced to issue
more debt in order to recapitalize either Fannie/Freddie/ the Federal Home Loan
Bank System/FDIC, and the rest of the world balks at being the buyer of last
resort for U.S. government debt. As this is being written on Friday, July 11,
a hint of this is happening. Rumors are swirling that the U.S. Treasury will
have to recapitalize Fannie Mae and Freddie Mac. Rather than resulting in the
usual flight-to-quality bid for U.S. Treasury securities, yields on Treasury
coupon securities are rising and the dollar is falling. Another factor that
could precipitate a further sharp decline in the dollar might be the severing
of the pegs that foreign monetary authorities have maintained between their
currencies and the U.S. dollar. The byproduct of these pegs has been upward
pressure on the inflation rates in these foreign economies. If these monetary
authorities can no longer tolerate this imported inflation and sever their currency
pegs to the dollar, the dollar would likely go into a tailspin."
Best to all.
It seems like a strong dollar with massive asset deflation is the only way out
Kasriel's "base case" is very close to my view; a mild to moderate recession
that lingers for some time with a prolonged period of elevated unemployment.
However I don't expect unemployment to reach 8%.
FWIW Gary Shilling recently predicted unemployment topping out at 7.2% in a
"major recession" lasting until Q2 2009.
He says something to the effect that he's not going to predict the coming depression,
and otherwise alludes to the possibility that his forecast may be overly optimistic.
CR - it may amuse you to know that your outlook and Kasriel's base case are
nearly identical to the Fed's outlook as well...thru '10. In fact they even
bumped up the "central tendency" for growth a tad this year because of the slowmotion
of the slowdown. And FWIW my own assessment and analysis agrees.
Three other obs:
1) we've not really seen a "severe" recession since circa 1980 and even that
hardly qualifies since YoY real GDP growth was -2%. Severe would be more like
2) Downturns in GDP are always coincidently accompanied by almost equal downturns
in Employment - so not only is the definition a downturn in both it reflects
the underlying realities.
3) We're on such a tight S/D marginal balance with supply constrained by two
decades of rational under-investment the demand destruction for oil WILL see
serious prices drops. Particularly when you consider the feedback loop from
being on the margin to rational speculation. To which one ought to add Prof.
Hamilton's excellent work on the oil reserve exhaustion premium you pointed
to. That too has a feedback link. The $20-30/barrel impact of these factors
could see us back in the $90-110 range toward the end of the year, barring geo-political
For a analysis of a mild verse severe recession we must first look at the argument
that the expansion of credit is what kept the economy going.. we garnered real
products and sent paper promises... to the tune of 9 trillion dollars... to
the extent that the destruction of the credit making ability of banks is impaired
is the severity of the recession/depression..
How likely is it that CDO,MBS, and other securitization of loans will come back?
If so who would be the buyers?
The capital destruction going on as we speak is going to cause a long and severe
depression not to even go into the social aspects of it..
My grandpa lived through the worst of the depression and one thing he told me
was that he never stole one thing in his life but if he was facing the depression
again he would turn into a thief.
No one who travels outside this country can help but notice the difference in
20 years of how the ROW feels about us. Will they lend their hard earned money
to us based on faith based currency. Not... if that were only true.. no the
genie is out of the bottle and no three wishes for us...
I think many consumer are so stradled with debt, they are easily tipped into
BK if they lose their job, HELOCs, or have health issues. As employment increases
and/or remains for these people and inflation beats them senseless, the reprecussions
will cause a severe dislocation in the economy, prompting a severe recession.
You can only pull a rubber band so far until it snaps. I think that rubber band
will snap relatively soon.
Aleister Perdurabo writes:
The price of coal has gone up from around $30 per short ton in 2000 to around
$123.50 per short ton as of June 25th, 2008. This would seem to parallel the
rise in oil. All energy is getting expensive. I don't see oil coming down any
CR My Friend,
Re: "sharp deceleration in inflation"
How (old boy) can you have a sharp decrease as a future factor, when the sharp
increase that has been parabolic, continues to be factored out of things like
CPI or inflation metrics? The powers that be who exclude energy, food and housing
remain in denial, so what will they do in the second leg of the year, supercharge
that bias by lowering interest rates and then flood the economy with a tsunami
of easy liquidity...... it worked about six years ago and maybe a lot of the
retarded people out there that just burned up that easy cash, will be ready
for more, and then buy into the next instant bubble?
Talking about the VIX on haloscan breeds the same behavior that got us into
this mess in the first place.
I'm inclined to agree. And this really is just a rephrasing of the 1929 saw
about shoe-shine boys talking about stocks.
But this is not a phenomenon unique to the U.S. It's global.
ipodius - nice take.
Here is mine (by year end):
1. Inflation to 4.5%
2. Unemployment (national) to 6.7%
3. Oil moving to sub $125
4. Continued house price declines - maybe another 10 - 12%
5. Large price declines in CR (next wave of liquidation) maybe 30%
6. Foreign ownership rules for banks changed
7. Business capacity contraction and asset destruction
8. GDP finishes off the year at .1%
9. A Democratic Whitehouse
Barley | 07.15.08 - 3:35 pm |
tj & the bear writes:
C'mon... I have yet to see anyone (including CR) state where the new jobs and/or
new spending is going to originate. These things just don't happen -- there
has to be a driver.
There are NO FUNDAMENTALS to support job growth, period, end of story. Even
the so-called return of manufacturing can't stem the losses in that sector.
There are also NO FUNDAMENTALS to support spending growth, period, end of story.
Consumers are tapped, businesses are strapped, and don't even talk about the
tj & the bear writes:
The whole "oil" argument is a catch-22, too.
The only way you'll have true demand destruction is through a wrecked economy.
Furthermore (as Darth Toll often points out) all those oil dollars are being
recycled into the U.S., so if oil declines precipitously so does support for
Treasuries & Agencies.
Circumstances are much too complicated and nuanced for such simplistic "answers".
tj & the bear | 07.15.08 - 3:54 pm |
Brian J. writes:
The problem with the oil arguments is that American demand isn't the only, or
even the primary, driver in global demand. There's China, with its economy still
growing at 9-10% a year. India is growing nearly as fast. And many of the oil
producing state themselves, from Russia to Brazil to Saudi Arabia, are increasing
their consumption, leaving less for export.
So even tremendous American demand destruction will barely dent global oil demand-
and hence won't do much to oil prices.
Brian J. | 07.15.08 - 3:57 pm |
Time will tell on the prediction, but FWIW:
1. Demand Destruction - perhaps an argument that suffers too much from a US-centric
view. China is #2 global oil consumer after US, yet per capita they consume
approx 1/15 of US oil consumption. So just a small per capita bump could propel
consumption significantly. And of course there are all the other countries to
consider. US is not the only game in town but it seems too many theories revolve
around US being the center of the universe. There's plenty of other demand out
there that will likely continue to grow; regardless of subsidies being reduced
2. I don't see how these events are going to play out "business as usual", little
dip and then everything's fine - the evidence is substantial that America is
BROKE. Too many for too long buying too much shit they don't need with $$ they
don't have. The bill has come due and... we can't pay.
3. So many of these economists/analysts/pundits are wrong over and over and
over again, yet still proclaim from the media pulpit - why are we even still
paying attention to most of 'em?
Time will tell, but seems tough(er) times for some time are likely just ahead.
3rdbillygoat | 07.15.08 - 3:58 pm
Oil has been firm to higher because exports from the oil exporters is down 2.2%,
or nearly 1Mb/d, from 36Mb/d to 35Mb/d. The US, goaded by high price, is using
less, maybe as much as 4% less gasoline and jet fuel probably down 10% pretty
soon. In sum, US use might go down 1Mb/d, pretty much compensating for exporters
decline... for 2008. More reductions likely next year, and really significant
availability of oil after 2010. Note that in every recession in the past century,
including the thirties, we had cheap energy to help pull us out. This time we
will have continuous shortages.
Yes, subsidies in Chindia are ending, but this will not necessarily cut usage...
China suppliers have been supplying the local market at a loss, so have been
limiting sales causing long lines. With subsidies ending buyers can get all
they really want, albeit at a higher price. Accordingly, consumption may go
higher... of course, this can only happen in command economies.
BTW, the same thing happened in russia following their blowup, price, availability
and consumption of many things all rising in tandem.
jkiss | 07.15.08 - 3:59 pm
joe shmoe writes:
hmmm, what's the relation between deflation and recession?
Post-boom Japan had big deflation, but not a huge recession. right? Slow but
postive growth over the 1990s.
The Great Depression had deflation and big-time recession.
If we go Japan's way, then CR's forecast could be close to right.
Whether CR is right or wrong (we will find out) we shouldn't mock his proposal
if we disagree. A joke is one thing, mocking is another. Plus "LOL" and "You've
got to be kidding" are only persuasive arguments among people like those who
call their chief strategist "turd blossom."
We can do better than that.
joe shmoe | 07.15.08 - 4:05 pm
badger boy writes:
If you are from Washington d.c. I agree completely. If you are a software engineer
with a top secret clearance, it is still "Name your salary" in DC.
For the rest of those who are not among the blessed few, please name these mythical
comanies which are hiring.
I suspect ipodius bases his economic analysis on the now hiring signs in the
window of his local mcdonalds
badger boy | 07.15.08 - 4:09 pm
This is a very informative post with excellent, insightful comments...
... what if the resolution of the credit crisis and global imbalances isn't
a nasty recession or punishing inflation but Japan-like protracted low growth,
with stagnant to deteriorating living standards?
This idea may not be as much of a stretch as it sounds. Policy makers, in trying
to avoid the depression/entrenched inflation extremes, may steer themselves
into the Japan solution.
In the US, despite the brave talk of free markets, we have been socializing
losses right and left and trying to shore up plummeting asset values. Although
inflation is running at high rates in many countries, it is the product mainly
of commodities price increases due to developing economy demand. If the banking
system in the US, UK and Europe are in as bad shape as I think they are, demand
for imports will slacken further, which will reduce growth, and in some cases,
reduce consumption. Reader DownSouth reminded us that from 1979 to 1983, oil
consumption fell from 67 million barrels per day to 58 million bpd. And high
fuel price act as a tariff, again hurting exporters. We have already discussed
that factories near Hong Kong are being shuttered at a rapid pace, and this
is before the expected post-Olympics slowdown.
Similarly, the strain on food prices is due to biofuels, increased consumption
of meat in third world, and poor harvests in Australia, have put pressure on
foodstuffs. Biofuels subsidies may get undone (one can only hope) and similarly,
higher food costs will have us all, not just people in developing countries,
being more sparing of our meat consumption. A near-global slowdown will intensify
And there is the bigger question of whether we really have reached a crisis
of capitalism, whether a system whose raison d'etre is growth and increasing
standards, can adapt to a world of resource constraints. The optimists at the
Milken Institute Global Conference felt that technology would provide and answer.
But new technologies take time to be developed and implemented, particularly
on a broad scale, while the needs appear urgent.
Count Hong Kong real-estate mogul Ronnie Chan firmly among those who think
Japan's 1990s experience is highly instructive. The reason: Lost decades
may become the rule, not the exception.
Yves here. That is not a trivial point. My Communist college roommates would
remind me that Russia and China were the only economies to industrialize in
the 20th century (for the record, I was apolitical then and previously had a
someone who appeared in the Ivy League Playboy issue and later a brilliant but
highly wound poet as roommies).
``What if the lost decade in Japan becomes the global norm?'' Chan, chairman
of Hang Lung Properties Ltd., said at the Asia Innovation Initiative conference
in Fukuoka, Japan, on July 8. ``Can you imagine that? Perhaps we should.
Perhaps people should get used to slower growth, or no growth.''
It's not that Chan, who runs Hong Kong's fourth-largest real-estate development
company by market value, is a pessimist. Property developers don't often
relish 10 years of lost growth here and 10 years of declining asset values
there. Chan sees a rare confluence of economic and demographic trends that
bode poorly for a global rebound.
No one should be surprised by the rapid pace of economic expansion after
World War II.... It began from a low base, following the devastation of
economies in Europe and parts of Asia. Next came rapid population growth
and a boom in innovation. Then there were new social and institutional paradigms
as democracy spread and organizations such as the United Nations and the
World Bank offered support.
Today, the picture looks vastly different. As everyone tries to stabilize
growth, things are hardly at a low base. Population growth is fueling demand
for commodities, driving up inflation and increasing poverty rates. Innovation
may slow as investment dries up. And institutions such as the International
Monetary Fund hardly seem up to today's challenges.
Oddly, one of Asia's potential failures is democracy, Chan says. It simply
isn't proving to be the panacea that leaders in the U.S. and Europe promised.
Poverty rates remain stubbornly high in many Asian democracies, and so does
corruption. The former is often a result of the latter.
It's certainly not that democracy is bad. Yet there's something to be said
about what Chan calls ``premature democratization'' in Asia.
Elections matter only when nations build strong
institutions such as independent courts, ministries, a free press, credible
central banks and ample systems of checks and balances. Their
absence means many governments don't operate as transparently or successfully
Similarly, Japan with its one party system is not exactly a Western-style democracy.
Singapore, an island with just about nothing going for it, and some serious
disadvantages at the time of its independence, prospered under a far sighted
nation-builder who bordered on being a benevolent dictator, Lee Kwan Yew. Yew
in particular was concerned about corruption, and early on created tough watchdog
agencies and implemented the policy that top bureaucrats would earn the same
level of pay as top private sector professionals, both to make sure the government
would attract good people and reduce the incentives to cheat.
Back to Pesek:
All this may be a problem for the region as it tries to avoid the worst
of the credit-market crisis. Chan wonders if the type of prosperity during
the decade before the 1997 Asian crisis will be more unusual in the future.
``Those 10 golden years of rapid growth and high returns may well have been
an aberration,'' Chan says.
The combination of surging energy and food prices will challenge economies
with political rifts, such as Thailand and Malaysia. Nor does it bode well
for high-poverty ones such as Indonesia and the Philippines, or those trying
to compete amid China's boom -- South Korea, Singapore and Taiwan, for example.
Slower growth is absolutely necessary, of course. Economists, including
Kenneth Rogoff of Harvard University, argue that accelerating inflation
is a clear sign the global economy needs to cool to let commodity supplies
and fuel alternatives catch up. Yet a sharp slowdown in Asia may be devastating.
Take China, which needs to expand about 10 percent annually to raise the
living standards of 1.3 billion people. Slowing growth will place dangerous
pressure on Asia's second-biggest economy. For a nation at China's level
of development, 5 percent growth is essentially a recession...
Policy makers are merely putting off the inevitable and treating the symptoms
of what ails the global economy. If they aren't careful, Japan's experience
during the 1990s will become a familiar one.
``It's not a scenario many expect for the West or for Asia,'' Chan says.
``But I'm not sure it can be ruled out.''
- Anonymous said...
- I think people confuse Capitalism and Democracy....they are supposed
to be two very different things. In America, we have seen democracy
effectively vanish. We now operate mostly as capitalists in both economics
and politics, and thus have the monied special interests at the top
functioning like benevolent dictator without enough benevolence. Ultimately,
though, capitalists are nationless (they economic nations unto themselves)
and reduce countries to demographic zones.
- Richard Kline said...
- With regard to the US, I don't think the original question is an
either-or. From my perspective of considering long-trend historical
analysis, I think it's highly likely that
the US will have a 'lost decade' of stagnation and minimal growth that
feels more like a decline. Through a generation, we have
put off multiple, crucial macro-economic initiatives; now, we will have
to implement and pay for them all at once. A real health care system,
and it's funding. Affordable higher education that hasn't been for ten
years. A complete reconfiguation of public mortgage subsidies. A tax
system which supports public expenditure even at the current rates.
A prodigiously expensive, unproductive, and unsuccessful military establishment
experiencing continuous mission creep at the behest of peabrain politicos
of all flavors. A great deal of infrastructure work which has been shriked
by deadbeat governments, local and federal. Urban sprawl which will
be tremendously costly to either sustain or abandon with permanently
doubled or trebled oil prices from the time of their masterplan approval.
Failure to meet any of these initiatives only precipitates more stagnation;
successfully meeting them requires long-term revenue commitments for
which we have neither consensus nor planning. The dollar is not going
to recover to its former levels, so our long term costs for imports
finished and raw will take a bigger chunk of our discretionary income
than we have been accustomed to hitherto. Oh, and we have a colossal
amount of existing public debt to fund if not retire. Inflation takes
everyone of these problems, inverts it, and makes the ass-end balloon
(not pretty). Yadda, yadda, yadda, but look, these things take time
to work through, and most of them simply can't be put off another ten
years like they have been for thirty.
The question is whether ten years of stagnation begins with three-five
really bad years of implosion. If the powers that be do _really rapid
triage_ cutting out the infected capital in the financial system but
keeping the banking system as a whole solvent, we may get only three-five
crummy years and long and featureless financial plain. If those said
powers throw huge public commitments at stupendous private paper losses,
we'll blow our powder early and have nothing left to fund the necessary
parts of the re-build. Or if the authorities kill our currency, there
will be Hell to pay, but the Devil will have to get in line behind all
our senior creditors overseas. To this point, it's a near run thing
as the public authorities seem so mesmerized on the need to coax bankrupt
speculators back in from their window ledges with great wads of public
cash that they are leaning toward blowing this thing, badly (when they
should slam down and bolt the frickin' window instead and pray for a
high wind). Nor can they conceivably save individual mortgage holders
from asset price declines; faith based economics just won't serve: those
losses are in the pipeline and inevitable, so effort would be better
spent on political mitigation. Our present 'leadership' is 1930 level,
sold to the system and paralyzed in the headlights, so I think implosion
is the more likely experience, if not the certain one.
However, as the US goes so _does not go_ the rest of the world. I'm
going to steer clear of the EU in this monologue. That said, what typically
produces growth is demand, and there is tremendous demand starting from
a very low base in many, indeed most, 'emerging economies.' Domestic
demand in India, China, Vietnam for a few will produce growth if the
public authorities there choose to use that ratchet. Whether that growth
is 'emergent high' or 'emergent low' it is likely to be positive and
substantial because the bar is set lower in these realms. In this respect,
the article prompting Yves' post here seems to me off base, and their
musings regarding the 'inefficacy of democracy' not at all cogent to
the issue of growth (despite what neo-liberals would have us think,
but remember Think for Yourself). Taiwan and HK may not see the kind
of growth they have through the last twenty years, but China will continue
to grow barring massive macrofinancial mismanagement, which doesn't
seem in the cards.
I will add here that in my view _no one_ does genuinely good economic
forecasting even five years out, including myself; good in the sense
of both substantively accurate, comparable in scale to outcome, and
following from anticipated causes. Even though in a rather complex way
I have tools for this that others don't which make appropriate historical
comparisons possible, I still don't see prediction as readily achievable:
too much changes, and too much expected not to change proves ephemeral.
Even which is which are very hard to discern from their midst, so hard
that efforts to do so are more dependent on luck then perspicacity for
their accuracy. So too, then, with this 'ten flat years' suggestion:
we do not see the technological innovation, political dislocation, or
military provocation which banks a moving trend into a deflection point
only potential rather than probable at this instant of observation.
. . We'll get ten flat years unless we blow a hole in them or build an autogyro
for and ascension by another azimuth. Sez I.
- Richard Kline said...
- A Polish commentator quoted in the media (who and where I cannot
recall) several years after 89: "What we wanted was democracy. What
we got was capitalism." So as well could seven generations in Western
Europe and the United States declaim. I'd have warned the Poles and
their neighbors, but I didn't have a soapbox, and they wouldn't have
listened anyway . . . .
- Sometimes I wonder how we got where we are now, and then I read
comments like the first two, and, to some extent, Richard's, and it
all makes sense. Who ever thought democracy would be a good idea?
"Slower growth (i.e. less environmental degradation) and lower living
standards in the developed world are to be welcomed but will inevitably
hamper our ability to make the transition to a low-carbon economy."
So, you would rather have humans living in lesser conditions so that
the Earth is cleaner? Last time I checked, when civilizations advance,
they become wealthy enough to care about the environment, and the cost/benefit
analysis of accumulating more wealth versus living in a clean place
becomes weighted more and more in favor of clean than in wealth. Green
buildings cost more to build, so it takes more wealth to buy or rent
a 'green' unit than it does so random rat hole with lead in the paint
that is less energy efficient. You should be cheering increasing wealth,
especially in places like China, as they are beginning to actually care
about the crappy air, because as they become wealthier, they can care
about the environment, because putting food on the table isn't the primary
Back to the whole issue of democracy. We act like democracy wasn't tried
before modern times. That it has been the reason why we are all prosperous.
That is utter and total nonsense. Anyone who has really gotten into
political philosophy knows that the Greeks realized how unstable democracy
was, and that it would always lead to its own collapse. Our founding
fathers knew this, John Adams even said, "Democracy never lasts long.
It soon wastes, exhausts and murders itself. There was never a democracy
that did not commit suicide." There are many great books on this subject,
but Hoppe has one in particular, 'Democracy: The God that Failed'.
Those of us who understand political philosophy are watching with amusement
as democracy murders itself. The crazy democratic 'solutions' that are
going to be proposed and put into place will hasten the self mutilation.
At the same time, it is disheartening knowing what the end result will
be, lots of pain for the masses, who don't really know any better.
- b said...
- It's always seemed to me that one obvious factor in Japan's predicament
is demographics. Their population is falling, ipso facto demand for
housing and many other assets will also fall. This is already occurring
in Europe, and even China's population will peak in the next 50 years.
Sometime this century, world population will begin declining.
If population falls 1%, and real growth is flat, people are 1% richer
on average. How is that worse than population growth of 1% and real
growth of 2% like we have averaged in the US?
All the navel convoluted analysis about political systems seems fairly
The big problem I foresee is that our whole economic system can't deal
with positive deflation. That's where the Fed made it's mistake in the
early 2000s. That deflation was good. If they had raised rates, house
prices would have flattened and cars and TVs would have cost less.
The housing market has fallen hard but it's not time to buy, no matter what
you hear. Depending on where you live it's either time to decide if you can
afford not to sell before prices go lower, or grin and bear it as prices fall
farther. The choice depends on your likely future employment prospects and where
... ... ...
Professional traders use the term "catch a falling
knife" to refer to the misguided over-eager trader who jumps into a crashing
market to buy what he or she believes are distressed assets only to find that
the descent was only starting. Just like the tech stock trader
who bought stocks in December 2000 after the NASDAQ plunged nearly 50% from
its apex, but before the market collapsed the rest of the way down to 1172 in
2002, if you buy a home today you can expect significant additional price declines.
But you would not know it by reading Ben Stein.
The 10-year note
yielded 3.81 percent at 4:25 p.m. in New York, according to BGCantor Market
Data. It touched 3.78 percent, the lowest since May 21. The price of the 3.875
percent security due in May 2018 was little changed at 100 17/32. The two-year
note's yield increased 3 basis points to 2.42 percent.
The Treasury Department's quarterly sale of 10-year TIPS drew a yield of
1.485 percent, above the average forecast of 1.4498 percent of nine bond-trading
firms in a
Bloomberg News survey. Ten-year TIPS yielded 2.47 percentage points less
than regular Treasuries, the narrowest gap in almost three weeks.
The gap, known as the breakeven rate, indicates
the inflation rate traders expect over the life of the securities.
Peak Oil is real, and it isn't going away. Already trans-ocean transportation
costs became prohibitive and in many cases they reversed or close to reserved the
benefits of outsourcing. Rise in oil prices has gutted the profitability of the
Asian trade model for everything but high-value goods (solar panels, semiconductors,
etc.) But the transformation of world economy to "post peak oil" situation
justp with growing demand and long term price will probably increase from current
level. In any case there is no viable substitute for oil... Solar energy is
too tiny and biofuels are both tiny and affect fool production (with possible exception
of Brazil ethanol).
The great oil shock of 2008 is bad enough for us. It poses a mortal threat
to the whole economic strategy of emerging Asia.
The manufacturing revolution of China and her satellites has been built on
cheap transport over the past decade. At a stroke, the trade model looks obsolete.
No surprise that Shanghai's bourse is down 56pc since October, one of the
world's most spectacular bear markets in half a century.
Asia's intra-trade model is a Ricardian network where goods are shipped in
a criss-cross pattern to exploit comparative advantage. Profit margins are wafer-thin.
Products are sent to China for final assembly, then shipped again to Western
markets. The snag is obvious. The cost of a 40ft container from Shanghai to
Rotterdam has risen threefold since the price of oil exploded.
"The monumental energy price increases will be a 'game-changer' for Asia,"
said Stephen Jen, currency chief at Morgan Stanley. The region's trade model
is about to be "stress-tested".
Energy subsidies have disguised the damage. China has held down electricity
prices, though global coal costs have tripled since early 2007. Loss-making
industries are being propped up. This merely delays trouble.
"The true impact of the shock will only be revealed over time, as subsidies
are gradually rolled back," he said. Last week, China raised internal rail freight
rates by 17pc.
BP 's Statistical Review says China's use of energy per unit of gross domestic
product is three times that of the US, five times Japan's, and eight times Britain's.
China's factories "were not built with current energy levels in mind", said
Mr Jen. The outcome will be "non-linear". My translation: China is at risk of
Any low-tech product shipped in bulk - furniture, say, or shoes - is facing
the ever-rising tariff of high freight costs. The Asian outsourcing game is
over, says CIBC World Markets. "It's not just about labour costs any more: distance
costs money," says chief economist Jeff Rubin.
[Jul 9, 2008] 'Inflationistas' Coming Around
Based on the following post,
"Confessions of a Former Inflationist," by
Global Economic Trend
Analysis publisher Mike "Mish" Shedlock (who is also in the deflationist
camp), it looks like at least a few of the "inflationistas" are starting to
I recently received an Email from "RS", a long time member of the hyperinflation
is coming crowd now but now sees things in a different light. Let's tune
in and see what "RS" has to say.
Mish, I was a true believer in the "hyperinflation is coming" theory
for quite some time. However, I have since changed my mind. Here’s why:
I own a computer business and I used to pay techs $15-20/hr. I now have
people willing to work for $8-$10/hr. While the nice guy inside is saying
“pay people well” the businessman is saying “market conditions demand
paying people what the market will support.”
Recently I have had to offer price discounts to obtain new business.
Some contracts I picked up were for around 1/3 of my standard fees.
I have cut costs to the point where they can be cut no further if I
am to maintain my debt obligations. I am now at the point where my options
are to work more hours for less money or “exploit” the labor market.
Considering that I am already working 80-90 hour, there was no choice.
I just interviewed a single man nearing retirement age with a young
daughter a couple years older than mine. He is not only willing, but
trying to hide the fact that he’s DESPERATE to work for $8-10/hr. I
might be able to afford to pay him $12/hr today, but with what’s coming
over the horizon, wisdom dictates paying him $8 and using the difference
to lessen debt obligations as quickly as possible. That would lower
my costs for when the available business gets even tighter, leaving
me in a stronger position to bid and win, and helping make sure he’ll
still have a job in 12+ months.
As it seems to me, high debt load, plus rising product prices, plus
deflation’s hit is painfully powerful. I’m confident from reading your
articles that it’s only going to get worse.
There might be no such thing as 'capitulation'. It look like an artificial concept
that is somewhat reflect change of psychology and investor sentiment that are visible
only in retrospect.
The selloff that sent major indexes into bear-market territory has some investors
awaiting the "capitulation" moment that signals it's time to dive back into
It often seems like investors are looking for a road sign emblazoned
"Capitulation: Three Miles." But capitulation is one of those market paradoxes
-- it can't really be quantified until those most eagerly awaiting it are themselves
frightened out of the market.
"You have to picture someone on the deck of a battleship handing
over a sword to an enemy, not this 'Hey, the market's a little tough, but I
think we can get a trade on the long side' stuff," says Barry Ritholtz, director
of equity research at Fusion IQ.
Not all signs of this vaunted event are anecdotal or ephemeral.
Analysts say there are a few hard numbers that would indicate a selloff has
reached a crescendo."
More and more, the evidence
suggests that this is not just a temporary crisis. It is the beginning of the
end of the Petroleum Age.
How do we know that the
Petroleum Age is drawing to a close? Two key indicators tell us that this is
so. First, many of the giant fields that have satisfied our massive thirst over
so many years are experiencing diminished output. Second, although the major
oil producers are spending more money each year to discover new reserves, they
are finding less and less oil. Either of these factors by itself is cause for
significant worry; the combination is deadly.
...new discoveries may
add one or two million barrels of oil per day to existing output in 2015 and
beyond, but by that point output from existing fields is likely to be considerably
lower than it is today. Nobody can predict exactly where combined worldwide
production will stand at that time. But more and more analysts are coming to
the conclusion that the output of conventional (i.e., liquid) petroleum will
peak at about 95 million barrels per day in the 2010-2012 time-frame and then
begin an irreversible decline. The addition of a few million added barrels from
Kashagan or Tupi will not alter this trend.
...none of this can stop
the inevitable closing of the Petroleum Age.
Some say that any palliative is worth the expense as we head toward
certain disaster. But this is not a logical response. Knowing that the age of
petroleum is drawing to a close, it is far better to devote our talents and
investment dollars on hastening the arrival of its successor, rather than prolonging
the agony of oil’s decline.
At this point, we cannot be absolute certain of the dominant energy source
of the post-petroleum era. Will it be the Solar Age or the Biofuels Age or the
Hydrogen Age? But we do know that it will revolve around some constellation
of renewable, climate-friendly, domestically-produced supplies. From now on,
America’s top priority in the energy field must be to explore all potential
components of this new energy future and move swiftly to develop those with
the greatest promise.
Jul 9, 2008 | atimes.com (originally at Foreign
Policy in Focus - A Think Tank Without Walls)
Soaring food prices reflect the transformation of agriculture from a primarily
local activity to a global business. When agricultural policy is made by international
financial institutions with market fundamentalist policies and by big agribusiness
whose primary concern is their own bottom line, it is a recipe for disaster
... ... ...
...As Chuck Prince, head of Citigroup at the time, famously stated, "When
the music stops, in terms of liquidity, things will be complicated. But as long
as the music is playing, you've got to get up and dance."
That's a deeply troubling attitude. The willingness of investors and companies
to go along with speculative bubbles and the prevalence of a huge amount of
speculative capital in the global economy generally may have grave implications.
These conditions suggest that the bubbles may not be the disease in themselves,
but the symptoms of something much deeper. The market may be so based on speculation,
and speculative investors have such a tendency to herd together, that we are
in a chronic bubble economy. The economic bubble of the day may change - "emerging
markets" bonds one day, tech stocks the next, and home mortgages the day after
that - but the presence of a bubble may be ubiquitous.
Using this hypothesis, the food crisis becomes a little easier to understand.
Commodities, including food, are seen as relatively safe investments. One can
imagine situations where most of the world's population stop buying houses or
computers, but it's hard to stop buying food. The World Bank and the International
Monetary Fund (IMF) have pushed for the deregulation of trade in agriculture,
and therefore it is much easier today for the private sector to invest in a
global food market. Once big investors and analysts
begin to act as though food commodities are a safe bet, the herd mentality kicks
in, more and more investors join the fray and eventually you have an over-inflated
food market in the same way as you had an over-inflated mortgage market.
Creditors through the ages haven’t liked to take policy advice from debtors.
They generally tend to think that borrowers should listen to the advice offered
by those lending them money. And they often think debtors fail to pay sufficient
attention to the concerns of their creditors when formulating economic policies.
China believes that the US hasn’t paid enough attention to the dollar’s value.
That isn’t exactly news.
or less said as much in November. Nor should any American be surprised that
China no longer the US financial sector offers the best model for the future
development of China’s own financial sector. Securitizing risky mortgages loans
into complicated financial structures no longer looks like the highest stage
of financial evolution.
But I was still struck by
Edward Wong’s front page New York Times article several weeks ago. It highlighted
China’s new assertiveness — and China’s increased willingness to criticize US
Steven Weisman’s C section article that followed the completion of the Strategic
Economic Dialogue wasn’t that different than Edward Wong’s big front page story.
The governor of China’s central bank now argues that China needs to learn from
the United States’ mistakes as well as its successes. Clever rhetoric. Those
who think that the United States needs to learn from its own recent mistakes
would have trouble disagreeing with Mr. Zhou.
These articles raise some fundamental issues about how China’s economic and
financial relationship with the US will evolve. Right now China has lent — according
to the US data — about $1.1 trillion of its savings to the US. Realistically,
it has lent a bit more — let’s say $1.3 trillion. The US data tends to undercount
Chinese holdings of US assets.
That is a large sum by any measure — it is roughly 10% of US GDP, and it
is more like 30% of China’s GDP. given the extraordinary pace of growth in China’s
foreign assets — and its large current account surplus — China’s financial exposure
to the US is set to increase rapidly.
Many — see
Gideon Rachman as well as the
FT’s Alphaville — have argued that the growth in financial interdependence
between the US and China will reduce political tension between the two. China
has a large and growing financial stake in the US economy; the US relies on
Chinese financing. Their economic interests consequently largely converge.
I was never fully convinced by this line of argument. The United States and
Latin America were financially intertwined for much of the twentieth century.
That didn’t mean that the US and Latin American countries always saw eye to
eye. Latin debtors and their American creditors often had different interests.
That created conflict, or at least tension, in the United States’ relationship
with Latin America.
This is true more generally: creditors and debtors often have conflicting
For example, China would like to see the US place more of a priority on maintaining
the dollar’s external value — and thus the value of China’s large dollar holdings.
That is code for higher US rates. Higher US rates would also make the PBoC’s
life easier by reducing the incentive to sell dollars and buy RMB. Falling US
rates have combined with the RMB’s appreciation against the dollar to pull huge
sums of hot money into China.
The US would prefer to direct US monetary policy at stabilizing the domestic
US economy rather than stabilizing the dollar’s external value.
Other areas of potential conflict also aren’t hard to see. The US may believe
that China’s institutions for managing its governments external investments
should converge with US norms for managing public money (think the norms governing
state pension funds or Alaska’s permanent fund). China may prefer to develop
its own institutions for managing its external investments — institutions that,
for example, may be more inclined to support state firms as national champions
than comparable pools of public money in the US.
The US might change its domestic financial regulations in ways that reduce
the value of Chinese investments in US financial institutions. Or it could refuse
to bailout a bank or broker dealer that China has invested in. CITIC, remember,
came close to buying a small stake in Bear Stearns.
Or China may simply want to buy assets that the US doesn’t believe China’s
government should own.
China’s policy makers face a particularly difficult challenge. They have
invested an enormous share of China’s savings in low-yielding, fairly long-term,
dollar-denominated bonds. The value of those bonds — expressed in RMB — is likely
to fall over time. Those losses are the cost of subsidizing China’s exports.
They were baked in, so to speak, when China decided to hold its currency down
and thus overpay for US financial assets.
Dean Baker noted a while back, Chinese policy makers knew full well that
they were taking on the risk of huge (paper) losses when they bought so many
dollars. They effectively choose to take large financial losses rather than
allow the RMB to appreciate to its market value.
But it isn’t at all clear that China’s public expects to get hit with the
(deferred) bill for the last six years or so of export subsidies — and is willing
to swallow the huge losses that will be revealed as China lets its currency
appreciate relative to the dollar and euro. We can debate whether or not these
losses are real or not some other time. Central banks can operate with negative
capital, so China doesn’t need to issue bonds to recapitalize its central banks
and “realize” the loss any time soon. But it seems clear — at least to me —
that there is an opportunity cost associated with using the funds raised by
issuing RMB bonds to buy depreciating dollars rather than make domestic investments.
And for that matter an opportunity cost associated with holding large government
deposits at the central bank (rather than spending those funds at home) to help
sterilize rapid reserve growth.
When those losses are realized, there will be a strong temptation for China’s
policy makers to argue that the losses reflect bad US economic policy — not
bad Chinese currency policy. That worries me.
There are many ironies in the current situation.
The US still acts more like a typical creditor than a typical debtor.* It
believes other countries should adopt its economic model to succeed. But if
China adopted the US practice of allowing its currency to float, the US might
lose access to the financing that allows it to sustain large deficits at low
cost. Even analysts — like me — who believe adjustment is essential don’t want
it to happen over night.
China increasingly argues that other countries should emulate its own economic
policy mix. Yet it isn’t clear that it really wants the rest of the world to
model all their policies on China’s own policies. If the US adopted China’s
restrictive policies toward foreign portfolio investment or China’s policy of
limiting foreign firms ability to take over existing Chinese firms (as opposed
to making greenfield investments), China’s government would face serious limits
on the kind of US assets it could buy …
* In some ways, the US is a creditor. It has a large accumulated stock of
foreign assets - and many Americans want the opportunity to trade some of their
stock of existing US assets for assets abroad. In that way, it has much different
interests than many other big debtors. But it unquestionably is a big global
[Jul 9, 2008] A Disgrace? by Dean Baker
Jul 9, 2008 | Economist's
For folks not familiar with Social Security, it is the country's biggest
social program. It costs over $600 billion a year (20 percent of the federal
budget) and has 50 million beneficiaries.
At a forum on Monday, after wrongly claiming that Social Security won't
be there when young workers retire, McCain went on to say:
"Americans have got to understand that we are paying present-day retirees
with the taxes paid by young workers in America today. And that's a disgrace.
It's an absolute disgrace, and it's got to be fixed." [Transcript available
from Congressional Quarterly]
Of course present-day retirees have always been paid their benefits from
the taxes paid by current workers. That has been true from Social Security's
Some folks might have thought Senator McCain's description of Social
Security as a "disgrace" was worth a mention somewhere in the media, but
the NYT, Washington Post, WSJ, and USA Today don't seem to have noticed.
It's not like he said "bitter."
I was watching CSPAN yesterday, while I was eating dinner, and who should
I see but John McCain. And he said the most extraordinary thing. It's the
second paragraph of the excerpt that follows; I've included the rest so
that you can see that there was no context that made it seem more reasonable...
Let me repeat the astonishing bit: "Americans have got to understand
that we are paying present-day retirees with the taxes paid by young workers
in America today. And that's a disgrace. It's an absolute disgrace, and
it's got to be fixed."
The fact that we are paying present-day retirees with the taxes paid
by workers, young or otherwise, is not a disgrace, or a scandal, or a new
development. Social Security has been funded this way since its inception.
... This is not a disgrace; it's the way the system operates. And it's certainly
not a sign that we've mortgaged our children's futures, or that something
has to be fixed.
One interpretation of this statement would be that McCain is being deceptive:
trying to make a straightforward feature of Social Security seem like a
scary new problem, in order to gin up support for his
nonexistent plans to fix it. I tend to think that he just doesn't know
how Social Security works. (This would explain why he doesn't see the
problem with privatizing the system: the need to pay a generation's
worth of transition costs.) However, it doesn't really matter which explanation
is right: either one ought to be close to disqualifying. ...
Just one day after releasing an economic plan (pdf) that said that "John
McCain supports supplementing the current Social Security system with personal
accounts" (p. 5), McCain repeated his earlier claim that "I want young workers
to be able to, if they choose, to take part of their own money, which is
their taxes, and put it in an account which has their name on it."
Supplementing Social Security with private accounts is one thing. Allowing
workers to divert their FICA taxes into private accounts is another. The
first just gives workers more options; the second guts Social Security's
funding. These are very, very different proposals. Unfortunately, McCain
doesn't seem to understand the difference, perhaps because he
doesn't understand how Social Security works.
Now, before you think, "Wow, that must be a slip of the tongue, he can't
possibly mean that," please note that McCain said essentially the same thing
to John Roberts on CNN this morning. ...
This is not the first time that McCain has hinted that he will follow
in Bush's Social-Security-dismantling footsteps. In a Wall Street Journal
interview published in March, he made his intentions explicit:
"I'm totally in favor of personal savings accounts," [McCain] says.
When reminded that his Web site says something different, he says he
will change the Web site. (As of Sunday night, he hadn't.) "As part
of Social Security reform, I believe that private savings accounts are
a part of it—along the lines that President Bush proposed.
(Months later, McCain still hasn't changed his website.)
Does McCain really think he can get away with having two different Social
Security plans? Well, as ThinkProgress has pointed out, McCain was denying
his history of supporting private accounts
just last month. It seems he just can't make up his mind. But perhaps
having two different positions makes political sense—especially if one of
them has already failed.
It's becoming clear that McCain simply reads what's on the cards (and
not very well), but he really doesn't get the finer details of policy and
is thus susceptible to confusion, misdiagnosis, and to bad suggestions from
those around him. Haven't we had enough of that over the last seven and a half
Meanwhile, full-time jobs are vanishing. More companies are contracting out
their work. As a result, more people are doing several part-time jobs, or are
self employed. They’re also more likely to be part of a couple whose family
depends on two sets of paychecks.
So when times get tough, as they are now -- and people lose a job after having
it for only a few years or lose their part-time job or lose their client, or
one member of a couple loses earnings -- a family can be in real trouble. And
there are no unemployment benefits, not even partial benefits based on the proportional
loss of income from a part-time job, to help them. Or to help counter-balance
the economy as a whole.
It’s a disgrace that most Americans who lose their jobs don’t qualify for unemployment
insurance. It's also bad for the economy because unemployment insurance is less
effective as a counter-cyclical device. Congress should expand coverage (condition
federal UI funding of states) so a majority of American families have some security
in these perilous times.
We’re seeing formerly powerful financial institutions destroyed by even these
first stages of deflation. That’s because their only power came from franchise
- from being able to take out high-risk spreads. So they actually had very little
capital to support vast amounts of debt when things began to sour.
High risk has been rewarded in the past by government (easy monetary policy),
legislation (the repeal of Glass-Steagall, now clearly a mistake), and the markets
(the Wall Street marketing machine). Those rewards fall away quickly when you
see that you have built your house built on sand.
For decades, but especially over the last seven years, central banks have
“solved” any and all market dips, slowing economies, and financial problems
by creating debt. If the stock market declines, just make it easy to borrow,
so people can buy stocks. If the economy slows, just make it easy to borrow,
so people can consume more. This methodology may work on occasion, but doing
it systematically leads to crisis.
Central banks can’t fix this problem: They can only create more banking debt
or transfer its risks onto taxpayers via TAF auctions or nationalization - which
will only stabilize the banking system long enough for banks to dilute themselves
massively by suckering investors into buying stock. More debt isn’t the solution.
So stay the course. Stay out of the way. Bottom feeders keep coming up empty.
There will be rallies in stocks. Some will be quite vicious, but that doesn’t
mean we’re in a bull market. The GDP’s going to go way down, but will eventually
come back when debt is wiped out to a point where those with savings want to
lend or invest again.
We have a long way to go, though - and risk is high.
It is nice to know that there is at least one other person out there that
recognizes how foolish policy makers were to repeal the Glass-Steagall Act.
I noted how it was contributing to earlier scandals (e.g., Enron) in talks I
gave at that time. I really didn't think anyone else would recognize the importance
of keeping investment banking and commercial banking regulatorily separate.
Oh, to have not had the "free market" fools run monetary and microeconomic policy
these past twenty-five years!
Seems to me pessimism is high. This can feed on itself and create the
situation by which deflation and long term suffering become widespread.
This isn't to say optimism itself will save the day. However, while there
is massive debt that needs to be washed out of the system, a great portion
already has been washed out. Is there more to go?
Of course. Debt is the engine that drives every economy...debt is what we
borrow against the belief that this borrowing will yield a greater return
in the long run.
If that debt becomes too great, the yield won't materialize. That is the
situation some of these individuals/firms led themselves to reach.
But, at some point, that yield WILL materialize for many who have longer
views and/or took out debt earlier (or have been good at paying it off).
At that point, other distressed properties begin to look very, very good
The Fed is not an evil conspirator in a game of beggaring the population.
That is not its goal, whether you choose to believe it or not. It certainly
does not have unlimited tools to prevent all manner of crises, either (neither
does a gold-based currency, either, by the way).
However, the REAL problem that leads to deflation is expectations. It is
the guy next to you who sees the market decline 10% in a week and he feels
that he has to get out before it goes further. If he's the only one who
does so, then he more than likely will lose out on the rally that follows.
If there are 20 of him, and they have alot invested, then they create further
declines because their expectations fell.
If, on the other hand, most of these investors choose to hold, or at least
leave slowly in bits and pieces, then the declines will be less severe and
eventually things will even out.
Markets move on the back of many different bits of information and inputs.
Lowering interest rates tends to drive up stock prices, but the opposited
occurred in the 90's, when raising interest rates coincided with a rising
market....so sometimes other factors come into play.
Right now, there are many factors in play. But the largest, and most distressing,
is the doom and gloom factor of expectations.
I have had conversations with many friends who are absolutely in fear of
the "bad times ahead". I have pointed out to them that times are only bad
if you choose to let them be, and are unprepared. Just saying they are going
to be bad will make them bad, it doesn't prepare you.
I, on the other hand, remain cautiously optimistic. I am not going to be
investing, but I'm not selling either. I will take my lumps if a downturn
arrives, because the upside that follows will be significant and wonderful,
and I won't have to worry about timing it.
I am prepared for bad times, but being prepared for them doesn't mean I
have to expect them or even act like they will be bad.
It's all about attitude. I've survived before, I'll do it again. Any of
you who, like me, lived through the 70's know what I'm talking about. Will
this be worse? I doubt it. Could be if the doom and gloomers take over,
I choose not to let them. In the end, pessimists lose, pollyannas lose,
but optimists win.
I may be wrong, but I think there is an increasing, inchoate sense that we
are on the verge of a tipping point (I see (Duy's urgent need to post on vacation
as an indicator). I probably can't speak for other gloomsters, but even though
I have long thought It Would All End Badly, I still get a sinking feeling when
I look over the cliff and see how far down down might be. While I see lots of
reasons to expect terrible outcomes, part of me reminds myself that we have
muddled through disasters somehow and typically managed to avoid the worst.
But can we assume this time won't be different?
And when we have triggers, like big declines in the stock market, that sense
of peril is worse (and mind you, I am positioned to profit from that sort of
day!). But as more people start to look over that cliff into the chasm that
I have studied from time to time, I think more and more of the public at large
is getting a sense of how far the fall might be. And most people are constitutional
optimists, so that line of thinking is probably more upsetting to them than
to folk like me.
I may be placing too much faith in that collective barormeter of animal spirits,
the stock market. Normally, after a month as bad as June, you'd expect some
sort of reversion (indeed,
Barry Ritholtz has called for one). And last week may have been distorted
by the July 4 holiday. But looking at the trading in the US, several attempts
to rally (admittedly some on dubious pretenses, but what's new about that?)
I am wondering whether investors are too shell-shocked to get out at current
levels and are looking for a rally either to sell into or to validate a decision
to stand pat. If an upward move looked to have any sign of conviction, some
would revert to form and start bottom fishing. But I wonder what happens if
another bear market bounce is not forthcoming.
- Anonymous said...
- I realize that the price of oil has been increasing,
but then, so has the price of wheat, soybeans, and corn, major American
While oil pricing plays a major role in American import deficits, the increase
in exports due to rising grain prices is simply glossed over.
The trade numbers are likely to be really, really bad - reflecting the reality
of a transformation over a generation in which Americans have proudly turned
themselves into a nation of consumers.
- I will be interested to see if US exports changed
meaningful, particularly exports ex grains and distillates. The only reason
for meager optimism in the last year has been the economic prop of increased
exports; if that falters there's . . . nothing. Well, except _prayer_, but
that's a given. : )
I fully expect to see a DOW 7000 in the present cycle. More likely in 09,
but I'm no expert caller or pretend to be. I've wondered whether we would
have a crash scenario, but my sense looking at the declines over the last
eight months or so is more that we will have a steady grind down to November,
100 points here, 250 there. Equity holders just don't _want_ to get out,
they can't believe that the stock market wealth machine is running seriously
in reverse, so there is no incentive for them to sell; instead they hold
on to hope. That's the story of the last six months, and for reasons of
my own I consider it yesterday's chart as of 1 July. There is nowhere to
go but down, really.
William W. Wexler said...
- It seems to me that there are many conflicting forces working against
each other to create chaos and shear. These forces will release on the weakest
part of the container, which is the bottom 80% of the population.
I agree with the assertion that as energy costs increase, companies will
cut back on jobs and equipment purchases. Pressure from low price imports
on the one hand, increased manufacturing costs on the other... who gets
the squeeze? Always the bottom, never the top.
Vehicle fuel costs are so high now that consumers are having to choose what
to let go of next. In far too many cases it's been solvency, as people leverage
themselves into precarious debt loads with credit cards and second mortgages
hoping and assuming that something's got to give. The standard of living
down here in the streets is diving like a Kamikaze. Unemployed on COBRA
are sitting on a ticking time bomb waiting for their health insurance to
expire and their already absurd premiums to explode. The steady effort to
cut away the social safety nets and bankruptcy protection since Reagan are
about to become front page news.
Even as politicians heatedly debate opening new regions to drilling, corralling
energy speculators, or starting an Apollo-like effort to find renewable energy
supplies, analysts say the real source of the problem is closer to home. In
fact, it’s parked in our driveways.
percent of the 21 million barrels of oil the United States consumes every day
goes for transportation, with the bulk of that burned by individual drivers,
according to the National Commission on Energy Policy, a bipartisan research
group that advises Congress.
SO despite the fierce debate over what’s behind the recent spike in prices,
no one differs on what’s really responsible for all that underlying demand here
for black gold: the automobile, fueled not only by gasoline but also by Americans’
famous propensity for voracious consumption.
To be sure, the American appetite for crude oil is only one reason for the
recent price surge. But the country’s dependence on imported oil has only kept
growing in recent years, undermining the trade balance and putting an added
strain on global supplies.
Although the road to $4 gasoline and increased oil dependence has been paved
in places like Detroit, Houston and Riyadh, it runs through Washington as well,
where policy makers have let the problem make lengthy pit stops.
“Much of what we’re seeing today could have been
prevented or ameliorated had we chosen to act differently,” says
Pete V. Domenici, the
ranking Republican member of the Senate Energy and Natural Resources Committee
and a 36-year veteran of the Senate. “It was a bipartisan failure to act.”
Mike Jackson, the chief executive of
AutoNation, the country’s biggest automobile retailer, is even more blunt.
“It was totally preventable,” he says, anger creeping into his affable car-salesman’s
The speed at which gas prices are climbing is forcing a seismic change in
long-held American habits, from car-buying to commuting. Last week,
Ford Motor reported that S.U.V. sales were down 55 percent from a year ago,
while demand for its full-size F-series pickup, a gas guzzler that was the country’s
best-selling vehicle for 26 consecutive years, is off 40 percent. The only
Ford model to show a sales increase was the midsized Fusion. A Ford spokeswoman
says the market shift is “totally unprecedented and faster than anything we’ve
If the latest rise in oil prices isn’t just another spike — like those of
the 1970s and 1980s — but is instead a fundamental
repricing of the commodity responsible for much of modern American life, the
impact of that change will affect everyone from home builders and homeowners
in exurbs to corporate leaders, landlords and commuters in cities.
... ... ...
A much more effective approach would be to simply raise taxes on gasoline,
Mr. Dingell says, because higher prices are the easiest way to change buying
habits. Some Europeans agree with this, noting that policy changes engineered
through taxation can alter consumer choices without impeding economic growth.
Consumers overseas might not like higher taxes on gasoline, but they’ve adapted,
says Jeroen van der Veer, chief executive of
Royal Dutch Shell, the European energy giant. “A society can work, can function
and can grow even at higher fuel prices,” he says. “It’s a way of life — you
get used to it.”
Jun 30, 2008 | ml-implode.com
As far as I am concerned, the
"inflation vs. deflation" debate is over: we are already at hyperinflation --
even though certain markets and measures of credit exhibit deflation. If you
want to quibble about the definition (how "hyper" the inflation actually is),
go somewhere else: my point is that we have embarked
on the path from which there is likely to be no return, given the way the system
works. And the real kicker is: in response to the crisis, the
system hasn't changed.
The big glaring data point backing this argument is oil prices. Oil prices
in 2008 have shocked everyone, literally everyone, including me -- and
that's saying a lot since I'm a "peak oiler," and already believed high and
increasing rates of inflation were in the cards for purely monetary reasons.
Isn´t is amazing that just a few days after leaving the Fed Bill Poole is
speaking out what the real agenda of the Fed is...... The
interview in the FAZ ( one of the most respected German newspapers ) covers
lots of others topics like the $, China, commodities, real estate etc but the
following quote stands out.
"Historically inflation is one tool to take pressure away from borrowers.
The Fed´s policy is to create inflation to relieve the stress.
The Fed was and will be "easy" as long as the economic situation and the
health of the financial institutions have stabilized/improved "
"Easy as long...." LOL! They are trying always to be easy and keep the ponzi
game going. I urge you to read
How The Bubble Bursts from Mr. Practical via Minyanville for a nice summary
how this will end and why Bernanke & Co will fail this time.
On top of this i have found one of the better rants i´ve seen during the
past quarter. This comes from Aaron Krowne and fits perfectly to the topic.
Debate Over: It's Hyperinflation (and US Economic Collapse) .It´s also gives
a different viewpoint on the inflation/deflation debate.
[Jun 5, 2008]
"The shift from equity to bonds is continuing “unabated” notes Citi’s European
equity strategy team "
Jul 04 | ftalphaville.ft.com
Did you need any more evidence of a tough few months ahead for equities?
How about these lines,
- Buyers lacking - Little support from traditional
institutional investors, hedge funds or private equity. Short-termism
- Traditional Investors Selling - Outflows from European
retail funds €100bn annualised make 2008 the worst for 10 years. Life
and Pension funds also selling.
- Hedge Funds Not Buying - Hedge funds have found
it challenging to raise capital. Short covering could provide support
to the equity market.
There’s a buyers strike on. The shift from equity to bonds is continuing
“unabated” notes Citi’s European equity strategy team - with institutional and
retail investors pulling out at an alarming rate. Take, for example, the
sucking vacuum at the mutual funds left by fleeing consumers:
Retail investors began selling down holdings of equities almost as soon
as fears over sub-prime mortgages took hold in early 2007.
They have been sellers of equities for 15 consecutive
From Juan, in response to a comment in italics by reader DownSouth:
The one place I might disagree with you is to the question as to what high
oil prices represent. Are they a further manifestation of market fundamentalism
run amok? Or are they the antithesis of this, a refusal by non-OECD countries
to participate in a market system that demands natural resources and agricultural
products on the cheap?
If price of oils was determined by cost of production/supply/demand
rather than trade in financial instruments, I would place more weight on
'refusal to participate'. As it's developed since 1987, it strikes me that
the producing nations and major integrated oilcos' abilities to move price
has been substantially diminished.
Neo-liberal market fundamentalisms include financial opening and deregulation
which, in different forms, were applied on a world scale right along with
the theft of public goods through privatizations, et cet -- a 'grand' global
looting had been unleashed in a (partially directed) effort to overcome
Here let me repeat something which I wrote elsewhere three months ago:
Between 1965 and 1973, the U.S. manufacturing sector's rate of profit
fell by 40%, a decline that worsened with the 1974-5 recession, was hit
again by the severe early 80's slump, began recovering in the 1990s but
peaked in 1997, falling into 2003 since which there has been some rise but
- in all cases over the last decades - never to pre-1965-73 levels.
Andrew Glyn considered the world to have been "suddenly projected from
boom to crisis” with the first phase of above.
The failure of political Keynesianism, and then monetarist policies to
ressurect rate of profit dovetailed with a 'we don't know what to do so
lets try 19th c laissez-faire on a world scale' set of policies demanded
by the U.S., given voice by Reagan and Thatcher in her famous statement:
'There Is No Alternative [to a worldwide free market]', or TINA.
Borders to capital flow in all its manifestations had to be everywhere
broken; state owned industries had to be privatized; poor fiscal management
had to be tightened and almost everywhere on the backs of the working class
and poor as needed social services were cut and cut again. Debt payments,
no matter how great a percentage of export earnings, had to be made if a
government were to expect future access to IMF and World Bank funds.
Neoclassical economists and their theories provided ideological justification;
a sort of 'we are all neoliberals now' attitude infected world leaders until,
in 1989, John Williamson coined the term 'Washington Consensus', which was
very much not the consensus of those most subject to the various 'shock
So, how did the world do under this set of misguided fundamentalisms?
"Real global GDP growth averaged 4.9%a year in the Golden Age years from
1950 through 1973, but dropped to 3.4% annually in the unstable period between
1974 and1979. Dissatisfied with the instability,
inflation, low profits and falling financial asset prices of the 1970s,
advanced country elites pushed hard for a switch to a more business friendly
political-economic system; global
Neoliberalism was the result. World GDP growth averaged
3.3% a year in the early Neoliberal period of the 1980s, then slowed dramatically
to 2.3% from 1990-99 as Neoliberalism strengthened, making the 1990s by
far the slowest growth decade of the post war era." (James Crotty)
As would be expected, the post-1973 annual growth rate of world real
gross domestic investment fell substantially through 1996.
With the exception of parts of Asia, economic development throughout
the world failed to gain traction, chronic excess capacity on one hand and
credit fueled financial exuberance on the other.
Given the system's inability to create employment so rapidly as required,
a glut of labor and an expanding informal sectors as well. All the 'better'
to intensify the international (and domestic) competition among workers,
drive and hold wages down so also make consumer credit increasingly important
to retention of living standards, no matter that this has been only another
transfer to loan capital.
Average weekly earnings, constant 1982 dollars, for all private nonfarm
workers in the U.S. peaked in 1972 at $331.59, falling to $257.95 in 1992
until 'recovering' to $277.57 in 2004 and likely having faltered again since
It is at least interesting that conditions of surplus labor, lower wages,
deficit funding, tech innovations, etc, have not been able to generate another
long wave expansionary phase. One might even suspect that finance has been
'pumping' too much from the real and that 'long-felt unease' is related
The primary contradictions which I've seen developing over the last number
of decades have been:
1. The ending of national economies v. what can only be national states,
a contradiction between economic mode of organization and national states.
2. Progressive expansion of fictitious capital
v. the possibility of satisfying such claims,
a 'satisfying' which depends upon a) global creation of surplus value
and b) substitution of credit for a relative insufficiency of realized
surplus value (profit). This has provided much of the 'advanced' world
with what is no more than a superficial prosperity even as it has also
helped undermined its real basis. The spectacle
of finance hides too much.
3. In combination, the above two have
generated greater class, ethnic, international and subnational tensions.
The social relations of the world capital system have
become quite strained, which is not to say that capitalism is 'doomed'
but that its present form has become increasingly untenable and a 'change
in state' is almost certainly unavoidable, in fact seems to be underway.
- mat said...
- why must global GDP growth be maximized in order for a global order
to be considered a success? in spite of some well known ongoing wars, global
violence has decreased since the 50's while average life expectancy has
gone up. if we measure economic orders strictly in economic terms then we
miss the purpose of having an economic order in the first place. and isn't
it possible that in the 60's average weekly earnings in the US reached unsustainable
levels on a relative basis? if we're taking a global perspective of things,
have the declines in the US been offset by gains elsewhere in the world,
particularly in asia?
Clinton administration was part of the same economic trend as Bush II administration
Meanwhile, the twin deficits continue to rise. Our last trade surplus was
in 1975--mostly downhill from then. Strangely enough our account deficit has
risen since then. Conclusion? We relied more and more on credit, both personal
Clintonites will argue, of course, that under their watch, there were account
surpluses. I would point out, however, that the trade balance began to rise
sharply in the Clinton watch, moving from -70 billion in 1993 to -378 billion
Clinton rode the dot.com wave....lucky. He happened
to govern while the U.S. led the world in a marvelous IT revolution. While jobs
increased and government coffers filled, the trade deficit increased sharply,
over 500%. In short, the central issue of trade was muffled.
Have you ever heard a Clintonite brag about trade surpluses?
Since Clinton, of course, the trade deficit has doubled. The only bright
spot in the trade deficit has been services, mostly financial. (Republicans
like bankers. Unfortunately, financial
services while a golden opportunity for a few, were not so good for the average
American.) Various arguments have been used to soften this harsh
reality; economists have gone to measure deficits in terms of percentage of
GDP, hopefully to show us that it aint all that bad. Well, it is. Trade is important.
Some economists argue that the falling dollar will make our goods cheaper
on the world market, thus dramatically improving our trade balance. Hmmmm. Aren't
happened yet. We keep shedding manufacturing jobs.
To keep ahead of the downward curve, businesses outsource or overseas everything,
from teeth to sneakers. Of course, the fallling dollar will encourage foreign
tourists.... but now there is the problem of oil. On this last and most dramatic
of our headaches, I would suggest that it may be the straw that breaks the camel's
back or it may be ironically be our savior.
How our savior? If the present spike in oil is not primarily speculation--and
I suggest that we will know this by year's end-- and if exporting countries
stop subsidizing the cost of oil--, then we may have to become more local. Transportation
costs of goods will rise, from ships and planes to trucks. Rail will be less
expensive. (Now there's an infrastructure worth talking about.)
Additionally, we will have either to find alternatives to oil in the manufacturing
of some goods (plastics, for example) or find suitable alternatives that do
do require oil. We also need cars with much, much better mileage. In other words,
inventiveness will again count. Shortcuts--cheap labor and environmental degradation--will
If you examine the economic and demographic assumptions that together generate
the standard Intermediate Cost alternative of the Social Security Trustees you
see a picture of a future America that is kind of bleak. I mean I lived through
the period from 1968 to 1983 and economically it was not much fun. We had war
and assasinations and oil crises and three recessions and a constitutional crisis
over impeachment. It wasn't all doom and gloom, over that same rough time period
the world transtioned from the baseline assumption that nuclear armeggedon was
pretty much ultimately unavoidable to a place where that prospect seemed inconceivable.
And as a kid who grew up with school "duck and cover" drills that was an unalloyed
good, but still there was a widespread sense that in particular these kind of
economic outcomes were outside the norm, that times had been better before and
that times would be better again. In part this was just nostalgia for an America
that for a lot of people really never was, after all 'Happy Days' and 'Back
to the Future' were not exactly documentaries, but Reagan's 'Morning in America'
had a real resonance to people, there was a real sense that the future could
be better than the immediate past and even the imagined past of the fifties
as seen through the lens of 'Father Knows Best'.
But none of that optimism
shows up in the Tables and Figures of the Social Security Reports. Instead they
and commenters thereon insist that the future is simply going to mirror the
outcomes of 1968-1983, indeed just the other day I had a commenter that insisted
that Low Cost outcomes were impossible because they were inconsistent with the
last forty years. Well that is what happens when you pick a starting point that
manages to take in all of the worst post-war years and ignores everything that
happened before. I will be unpacking some numbers below the fold but want to
leave these doomsayers with a hopefully provocative question.
Why the hell are you betting against America? While we maybe well and truly
entering permanent Roubini-land why are you doubling down based on that?
As I say it all starts with the numbers, and in particular the numbers as seen
in Table V.B1: Principal Economic Assumptions, Table V.B2: Additional Economic
Factors, and Table V.A1: Principal Demographic assumptions, all of which (and
many more) to be found in
2008 Social Security Report: List of Tables. The Economic tables show outcomes
in five year periods since 1960 and annually since 1997 and then turn around
and project annual results for the following ten years and then for multi-year
periods (V.B1) or intervals (V.B2) after that. The Demographic table reports
both by interval back to 1940 and then annually from 1995. Going forward Table
V.A1 projects results with 5 year intervals.
Generally speaking the various models of the Trustees' Report assume that
under all three alternatives (Low Cost, Intermediate Cost, and High Cost) results
will settle out in the relatively short term at ultimate levels. Which is just
another way of defining long term sustainability of the US economy under projections
that are presumed to range from optimistic (Low Cost) to pessimistic (High Cost)
with Intermediate serving as a median. So lets take a look at some of those
numbers and contrast them with 2004, a year of good economic performance but
not one that most people would remember as exceptional.
- Productivity: 2004 2.4%; High Cost ultimate 1.4%; Intermediate Cost
1.7%; Low Cost 2.0%
- Real Wage: 2004 1.8%; High Cost .6%; Intermediate Cost 1.1%; Low Cost
- Unemployment: 2004 5.5%; High Cost 6.5%; Intermediate Cost 5.5%; Low
- Real GDP: 2004 3.6%; High Cost 1.2%; Intermediate Cost 2.1%; Low Cost
- Immigration: 2004 1.25 million; High Cost .77 million; Intermediate
Cost 1.025 million; Low Cost 1.305 million
Now I know some people will want to jump in and start the standard defense
of 'Boomers!' and 'Covered worker ratio!!'. And yeah I get that but these ultimate
numbers are all for period beyond 2050 when the impact of the Boomers on the
economy should be pretty much a fading memory (we will be 86 to 104 in 2050).
Why on earth should we assume that even optimistic numbers for the second half
of the twenty-first century will trail the numbers of the second half of the
twentieth century so badly? I understand that conditions approaching perma-recession
could happen, I am the farthest thing from a global warming denier or from not
recognizing the food/fuel crisis going forwards. On the other hand I am not
just ready to simply write America's economic future off as a lost cause either.
I am not happy with the status of America today. Which doesn't mean I have
lost faith in its possibilities tomorrow. Which know it or not is exactly what
embracers of Social Security 'crisis' have done. Dudes and dudettes what caused
you to lose your faith here? Criminy its the Fourth of July.
Read More on "Soc Sec XXIX: What does patriotism have to do with Social Security
Exhibit A: New York Times reporter Timothy Egan in May 2001 on the
California energy crisis:
Timothy Egan, May 11: Many Utilities Call Conserving Good Business:
Hundreds of miles to the south [of Seattle], the city-run utilities in Los
Angeles and Sacramento, have generally managed to avoid the rolling blackouts
of recent months by opting out of the state's deregulation experiment and
promoting conservation with near-religious fervor.... When Vice President
Dick Cheney said last week that conservation could not be a centerpiece
of energy policy, he left some utilities -- those that have spent 20 years
trying to prove just the opposite -- feeling as though their efforts had
been undermined. In his speech, he said, "Conservation may be a sign of
personal virtue, but it is not a sufficient basis for a sound, comprehensive
These guys in the Bush administration are
doing this manly stuff, putting their horns on to make it sound like conservation
is for sissies," Mr. Royer said.
"But we know from experience that conservation equals generation.
They are the same." Other utilities, even some that embrace
conservation, agree with the Bush administration that the nation cannot
conserve its way to energy independence....
S. David Freeman, the man named by Gov. Gray Davis to oversee the state's
response to its power crisis, said that conservation remained a way not
only to get through the difficult summer ahead but also to meet long-term
energy needs.... Tom Eckman, the conservation manager of the Northwest Power
Planning Council, which was created by Congress to guide major power decisions
in this region. "It's common sense. If you can get something for 10 cents,
why pay a dollar for it?"...
Mr. Cheney said that the Bush administration
would oppose any measure based on a premise that people should do more with
less. His remark was echoed this week by Ari Fleischer, the
White House spokesman. Asked on Monday if Mr. Bush believed that Americans
should change their lifestyles in the face of a power crisis, Mr. Fleischer
dismissed the idea of people using less energy as one solution. "That's
a big no," said Mr. Fleischer. "The president
believes that it's an American way of life, and it should [be] the goal
of policy makers to protect the American way of life. The American way of
life is a blessed one. And we have a bounty of resources in this country"...
The evident explanation for this, the professors conclude, is that “the trend-chasing
behavior of young managers reflects their attempts to learn and extrapolate
from the little data they have experienced in their careers.”
To be sure,
callow and inexperienced youths were far from the only ones who extrapolated
from recent data to find theories of a new economy believable.
Alan Greenspan was 74 and had been chairman of the Federal Reserve board
for 12 years when, on April 5, 2000, he
embraced the new economy and pointed to profit forecasts by Wall Street
analysts as a reason to expect the tech boom to continue.
Mr. Greenwood said he suspected that a lack of experience played a role in
the housing bubble as well, although that is much more difficult to confirm
with data. He said he and Mr. Nagel might look for evidence that younger people
— many of whom would normally be renters — were more likely to buy homes in
bubble markets after prices had soared.
That thesis would gain support if it could be shown that fewer young people
bought in those markets before prices soared, and that the expansion of home-buying
by the young did not take place in markets where home prices never rose as they
did in the most extreme markets, like the Silicon Valley and Boston, where the
two professors live. (Mr. Nagel, who is 35, told me he has always been a renter.
Mr. Greenwood, who is 31, said he had owned a home, but sold it a year or so
before the peak when prices seemed unreasonably high to him.)
The two professors say the experience thesis helps to explain why stock market
bubbles are relatively uncommon. “Once investors have experienced a bubble and
subsequent crash, they are less willing to participate the next time through,”
they write. “The younger fund managers we study in this paper, and perhaps also
the retail investors that allocated money to their funds, may have learned from
their experiences during the technology bubble.”
Natural resources constraints will now cause a significant slowdown in global
The Guardian has a leaked copy of a World Bank study that finds biofuels
to be the biggest culprit in global food price increases. This finding will
not only feed calls to scrap biofuels (save perhaps those derived from sugar)
but may lead to a recognition that resource challenges cannot be pursued in
isolation. In particular, food, water, and energy scarcity are interconnected
problems and need to be addressed on an integrated basis. It also disputes the
claim that increased consumption of meat in developing economies played a significant
role in food price inflation.
Biofuels have forced global food prices up by 75% - far more than previously
estimated - according to a confidential World Bank report obtained by the
The damning unpublished assessment is based on the most detailed
analysis of the crisis so far, carried out by an internationally-respected
economist at global financial body.
The figure emphatically contradicts the US government's claims that plant-derived
fuels contribute less than 3% to food-price rises. It will add to pressure
on governments in Washington and across Europe, which have turned to plant-derived
fuels to reduce emissions of greenhouse gases and reduce their dependence
on imported oil....
Brad DeLong's Semi-Daily
Lehman and the Failed Hedges: It looks as though Lehman Brothers is going
to lose money in the second quarter... because the finance wizards at Lehman
seem to be incapable of hedging their positions...
...We've seen this movie before, most memorably at Bear Stearns.
...Ironically, it was Bear Stearns who had at least some people, led by mortgage
head Tom Marano, who understood this. They knew that the big risk to the firm
was chaos in the financial markets, so they put on a "chaos trade" which would
make lots of money in such an event, and very broadly hedge the risks the bank
faced. But CEO Alan Schwartz, in a fateful decision, reversed that trade. As
Kate Kelly reported,
he wanted specific pessimistic plays that would offset specific optimistic
bets, rather than the broader hedges Mr. Marano had employed.
Yes, gas prices should be kept high enough to create incentives to conserve,
find alternatives, etc. If we work together now we'll leave a much stronger economy
to our kids and grandkids. Is the problem our dependence on "foreign oil" or on
...In a nutshell, that's why we're 58% dependent upon foreign oil. Every
time we have an energy crisis, in 1973, 1979, 1990, and 2008, we rush short-term
expedients and cosmetics into law without doing much to solve the long-term
If we were serious about the long-term problem we would never have allowed
gas guzzling SUV's onto the road; we wouldn't have starved mass transportation;
we would have developed much more renewable energy; we would have done a lot
more conservation; and MOST OF ALL we wouldn't have allowed prices to decline
after the crisis, killing energy saving investments and leading us right back
to profligate energy consumption.
Our energy policy is like our diets. We diet frequently, but we never stick
to our diets long enough or change our lifestyles enough to lose weight. Then,
when diabetes and heart disease sets in, we rush to our doctors for the miracle
cure that isn't there ...
Until we learn to live with somewhat higher energy prices, we'll continue
to be at the mercy of OPEC and of periodic energy crises. As long as we demand
quick fixes from our political leaders, that's all we will get -- quick fixes
that don't work.
Some recapitalization moves may have been motivated by other considerations.
Expectations at Fortis that the U.S. markets are on the verge of "meltdown"
were behind the Benelux bank's decision last week to launch a sweeping recapitalisation
programme, said chairman Maurice Lippens.
"We were saved at the last minute. Things in the U.S. are going far worse
that people think," Lippens said in an interview with De Telegraaf.
Forecasting bankrupties among U.S. banks amid declining credit cover, and
also citing Citigroup and General Motors as blue chip companies impacted by
the turmoil, he was quoted as saying: "The U.S. is heading for complete meltdown."
Fortis last week surprised shareholders with recapitalisation measures worth
a total of 8.3 billion euros, including a 1.5 billion euro capital hike.
...If the Me Generation isn't careful, it could become the Poor-Me Generation.
Over the next 20 years, a record $17 trillion will
move from pension funds and 401(k) accounts into the hands of freshly minted
retirees, says trade group Investment Company Institute. Not
surprisingly, that money pot -- and the fat asset management fees it will generate
-- has financial-services firms salivating.
The problem is that, like Morrill, many retirees and pre-retirees are woefully
unprepared for the shift from "wealth accumulation," or saving and investing,
to "wealth distribution," or drawing down those assets throughout their golden
years. On June 24, MetLife (NYSE:MET
News) research arm Mature Market Institute released a study showing that
69% of pre-retirees overestimate the amount of money they can safely withdraw
from their accounts each year during retirement -- many, dramatically so --
while 49% underestimate their expenses. Likewise, a May study by the research
group National Institute on Retirement Security found that about one in three
households approaching retirement is at risk of running out of money.
Aggressive investment brokers are focusing on that
yawning gap between perception and reality. Promising early retirement, fat
investment returns, and big annual cash withdrawals, they're increasingly succeeding
at seducing investors to turn over their retirement accounts -- and then putting
them in high-fee and often inappropriate investments. "This is
emerging as a big problem," says Mary L. Schapiro, CEO of the Financial Industry
Regulatory Authority (FINRA), the securities industry's private oversight group,
which recently launched a program to train corporate benefits managers to vet
financial advisers who run in-house seminars. "The issue has intensified for
the next generation of retirees -- the largest we've ever seen."
July 4 (Bloomberg) -- Leveraged-buyout loan defaults may be ``significantly
higher'' than ratings companies' estimates as about $500 billion of debt used
to fund the takeovers comes due, the Bank for International Settlements said.
... ... ...
The default rate on high-yield notes worldwide
rose to 2% in May, from 1.7% in April, and is likely to reach 6.3% by May 2009,
according to Moody's Investors Service.
Buyout firms typically borrow to finance about two-thirds of the cost of
acquisitions. The debt they raise is rated below
Baa3 by Moody's Investors Service and BBB- at Standard & Poor's.
Investors are demanding more in interest relative to benchmark rates to buy
high-yield debt. The average U.S. leveraged loan yielded 413.2 basis points
more than the benchmark
London interbank offered rate this year, compared with 270 basis points
at the end of 2007, according to S&P.
Sales of collateralized loan obligations, or CLOs, slowed to $30 billion
in the first quarter, less than half the amount a year earlier, the BIS said,
citing JPMorgan Chase & Co. data. The total of outstanding CLOs expanded to
almost $250 billion in 2007, more than double the amount in 2004, according
to the report, prepared by the bank's Committee on the Global Financial System.
[Jul 3, 2008] Pervasive Pollyannas of Prosperity
The Big Picture
How absurd has the Panglossian cheerleading become? On my pal
Larry Kudlow's show
last night, several of Candide's descendants talked about how great stocks are
if you hold them for 30 years. That's right, the holding period for equities
according to this crowd is three decades. Of course, this means
every pullback is a buying opportunity. Words such as these can only be
spoken by someone who has never worked on a trading desk or managed assets professionally
-- or if they did, they
lost most of
their clients' money.
This is not a surprise, as US policymakers are unwilling to accept what
Yves Smith sees as the inevitable result of years of debt-supported consumption
... ... ...
Perhaps I am lacking in imagination, but
I see lower living standards for Americans an unavoidable outcome. We're
seeing it now, via rising food and energy costs with stagnant wages.
If you were to describe what ails this economy in its most fundamental
terms, we have gone on a borrowing binge to
support an unsustainable level of consumption.
Merely having consumption fall to a healthier level would precipitate
a slowdown. And that's before we get to the problem of "and what do we do
with the debt hangover?"
I have long maintained that this adjustment should
be characterized by weak consumption growth but better-than-expected business
activity overall, particularly in export and import-competing industries. Effectively,
the US is offshoring some of its weakness. The combination should
be something that consumers clearly associate with recession, but with better
than expected output, especially when policy stimulus is added to the mix. This
is very much like the current environment, a recession that still lacks a single
quarter of negative GDP growth. But the level of stimulus is starting to look
excessive, and supporting a more inflationary environment than anticipated.
How long can this process continue? As long as
global policymakers are willing to support it. Indeed, it is almost of a game
of chicken, with US and emerging market policy makers on a collision course,
neither wanting to accept the adjustment, a greater reliance on internal balance,
necessitated by excessive US consumption.
The US is not likely to back down soon. We are seeing increasing calls for
additional stimulus packages, and
Brad DeLong is even suggesting the Democrats abandon any pretense of fiscal
responsibility. The Federal Reserve is stuck, afraid to counter inflation
via a rate hike themselves, instead exhorting foreign central banks – the very
banks keeping the US afloat – to provide space for greater US growth at the
expense of their own. In the meantime, the Dollar turns lower and oil sets a
new record seemingly each month.
Breakeven on the 10 year TIPS tested 260bp today,
settling at 259. With US policy stuck in place, I suspect that
emerging markets will take only baby steps toward changing the current dynamic.
That leaves the ECB as the force most obviously leaning against the wind.
Indeed, until inflation becomes sufficiently
uncomfortable that a broader swath of nations finds meaningful policy tightening
a necessity, I expect current financial trends to continue.
Values Crisis, the Politics of Reality and why there’s Going to be a Common
Sense Revolution in this Generation (continued
A FEW NOTABLE CHARACTERISTICS OF THE DOOMSDAY ECONOMY
•Corporatization and increasingly centralized control.
• Reliance on coercion (both physical and ideological) to maintain control
• Drive to Commodify all aspects of life.
• Community fragmentation/cultural decay (replacement of lived experience
with representation— image based mass culture, television addiction,
• Elevation of consumerism to the center of public life (consumer monoculture).
• Increased mechanization and blind faith in technology (trend towards
•Fetishization of speculative/financial wealth.
• Accounting flaws that mask liquidation of ecological and social capital.
• Pathological values/flawed assumptions.
• Undermining of planetary life support systems
[Jul 02, 2008] Ryding Sees `Most Serious' U.S. Inflation Risk Since 1960s
Phillips curve does
not make sense in this environment as unemployment and inflation are rising simultaneously.
Weak dollar contributes to inflation. Gold and oil prices are payback for 1% and
2% rates. Exporting easy monetary policy led to "credit abundance". High energy
prices might be side effect of outsourcing production to China. Right now
the base investment policy to to move money to cash. See also
Tom Keene On the Economy Show
July 1 | Bloomberg
John Ryding, chief economist at RDQ Economics and former top economist at
Bear Stearns Cos., talks with Bloomberg's Tom Keene about U.S. inflation, the
outlook for Federal Reserve monetary policy and the labor market.
[Jul 02, 2008] Yergin Says Supply Concerns Driving Oil Prices Higher
Pretty light-weight interview from the adept of free markets and unlimited growth...
July 1 | Bloomberg
Daniel Yergin, chairman of Cambridge Energy Research Associates, talks with
Bloomberg's Tom Keene about his testimony before the Joint Economic Committee
in Washington on global energy markets, factors driving crude oil prices, and
the outlook for oil supply and demand.
May be not 100% but 80% but you better be safe then sorry. that is especially
true for baby boomers. As Harrison remarked "People are still conditioned to
chase reward". But in reality we entered entirely different phase of the long
term market cycle and the slowdown can last five years. It can last considerably
more then that. And market completely changed as globe is too small for so many
people. Its like bacterial colony on dead squirrel story. but the colony can
find another dead squirrel. So growth of GDP is much less meaningful in
Todd Harrison, founder and CEO of Minyanville.com, generated a firestorm
last week when he
declared his long-term cash account to be 100% in cash.
This comment, from Yahoo! Finance user "odgoggmg," typified the response
among the Tech Ticker community: "If you are EVER 100% cash, it's pretty
much admitting that you don't know what's going on or how to profit from
it. If you do fall into that scenario, the last thing you should be doing
is giving advice." In the accompanying video, Harrison explains
his rationale for being ultra-conservative in his long-term account
still trading his short-term "bucket" from both the long and short side).
In a nutshell, Harrison believes we are
heading for a "prolonged period of socioeconomic malaise," and investors
need to shift their focusing from "chasing performance" to capital preservation.
According to the Federal Deposit Insurance Corp., $45.4 billion of the $631.8
billion in construction loans outstanding at the end of the first quarter were
delinquent. When banks announce second-quarter results in coming weeks, they
are expected to report sharp increases in loans that builders can't repay.
Demand for industrial commodities including oil will fall, pressuring prices,
because the financial sector is in ``disarray'' and the U.S. economy will continue
to slump, investor Marc Faber said.
``The industrial-commodity complex is
vulnerable because demand will slow down,'' said Faber, publisher of investment
newsletter the Gloom, Boom and Doom Report. ``The economy is weakening, corporate
profits will disappoint, valuations are not particularly attractive, and the
financial sector that serves to channel savings into investment is in disarray.''
Demand for commodities will fall after raw materials including oil, corn,
copper and gold touched record highs in the first half, Faber said in an interview
on Bloomberg Television. The global economic slowdown will last a ``very long
time,'' he said.
``The financial crisis has been the appetizer,''
Faber said, referring to the $400 billion in writedowns at the world's largest
banks and securities firms in the past year. ``We still need the main dish.''...
The U.S. economy went into recession last October and
current statistics are hiding the ``severity'' of
the recession, Faber said. Economists
have also understated the rate of inflation as higher food and energy costs
impact consumers, he said.
Commodities will face a ``correction'' after a seven-year rally and prices
will decline in the next six months to one year, Faber said on June 26. Faber
told investors to abandon U.S. stocks a week before 1987's so-called Black Monday
The rise in delinquent home-equity accounts was the biggest since the ABA
began collecting data in 1987, Kaplan said. It was also the highest in 11 years.
Delinquencies often don't peak until late in an economic slowdown.
ABA chief economist James Chessen said in the statement that because of job
losses, slow income growth and falling real estate and equity markets, there
is ``little relief'' in the coming months.
High yield bonds might tank...
Credit option contracts on the Chicago Board Options Exchange that would
pay out if GM or Ford default before September 2012 ticked higher. The contracts,
which remain lightly traded, point to a roughly 73-percent default risk for
GM and a 69-percent risk for Ford over that period.
As seen in the Fed Funds vs. Crude Oil graphic above, clearly that hasn't been
water coming out of Ben Bernanke's fireman's hose.
This morning's Ahead of the Tape
column($) in the Wall Street Journal trots out the same old tired axiom
about recent Federal Reserve policy as it relates to financial instability and
rising prices, particularly rising oil prices - the old "fireman" metaphor.<
Like many others, the "fireman
as arsonist" model always seemed to make more sense to me.
Follow the logic, if you will...
With the prospect of a world-wide meltdown in banking and credit during an
era of rising prices that show up everywhere but in the government's inflation
statistics, faced with the choice of saving the global financial system by creating
even more money and credit OR reducing the amount of money and credit pumping
through its veins in order to contain rising prices, the Bernanke Fed is said
to have chosen the lesser of two evils by selecting the former.<
In fact, since the credit crisis began almost
one year ago, the idea of central banks "tolerating more inflation", erring
on the side of more money and credit creation to ensure stability, has become
almost conventional wisdom.
And so it was again this morning:
As seen in the Fed Funds vs. Crude Oil graphic above,
clearly that hasn't been water coming out of Ben Bernanke's fireman's hose.
In a sense, the Fed's decisions of the past few months were easy ones.
Inflation worries never went away, but when
the house is on fire, nobody complains to the firemen about water damage.
Two Party System
as Polyarchy :
Corruption of Regulators :
and Control Freaks : Toxic Managers :
Harvard Mafia :
: Surviving a Bad Performance
Review : Insufficient Retirement Funds as
Immanent Problem of Neoliberal Regime : PseudoScience :
Who Rules America :
: The Iron
Law of Oligarchy :
War and Peace
Finance : John
Kenneth Galbraith :Talleyrand :
Oscar Wilde :
Otto Von Bismarck :
George Carlin :
Propaganda : SE
quotes : Language Design and Programming Quotes :
Random IT-related quotes :
Somerset Maugham :
Marcus Aurelius :
Kurt Vonnegut :
Eric Hoffer :
Winston Churchill :
Napoleon Bonaparte :
Ambrose Bierce :
Bernard Shaw :
Mark Twain Quotes
Vol 25, No.12 (December, 2013) Rational Fools vs. Efficient Crooks The efficient
markets hypothesis :
Political Skeptic Bulletin, 2013 :
Unemployment Bulletin, 2010 :
Vol 23, No.10
(October, 2011) An observation about corporate security departments :
Slightly Skeptical Euromaydan Chronicles, June 2014 :
Greenspan legacy bulletin, 2008 :
Vol 25, No.10 (October, 2013) Cryptolocker Trojan
Vol 25, No.08 (August, 2013) Cloud providers
as intelligence collection hubs :
Financial Humor Bulletin, 2010 :
Inequality Bulletin, 2009 :
Financial Humor Bulletin, 2008 :
Bulletin, 2004 :
Financial Humor Bulletin, 2011 :
Energy Bulletin, 2010 :
Malware Protection Bulletin, 2010 : Vol 26,
No.1 (January, 2013) Object-Oriented Cult :
Political Skeptic Bulletin, 2011 :
Vol 23, No.11 (November, 2011) Softpanorama classification
of sysadmin horror stories : Vol 25, No.05
(May, 2013) Corporate bullshit as a communication method :
Vol 25, No.06 (June, 2013) A Note on the Relationship of Brooks Law and Conway Law
Fifty glorious years (1950-2000):
the triumph of the US computer engineering :
Donald Knuth : TAoCP
and its Influence of Computer Science : Richard Stallman
: Linus Torvalds :
Larry Wall :
John K. Ousterhout :
CTSS : Multix OS Unix
History : Unix shell history :
VI editor :
History of pipes concept :
Solaris : MS DOS
: Programming Languages History :
PL/1 : Simula 67 :
History of GCC development :
Scripting Languages :
Perl history :
OS History : Mail :
DNS : SSH
: CPU Instruction Sets :
SPARC systems 1987-2006 :
Norton Commander :
Norton Utilities :
Norton Ghost :
Frontpage history :
Malware Defense History :
GNU Screen :
OSS early history
Principle : Parkinson
Law : 1984 :
The Mythical Man-Month :
How to Solve It by George Polya :
The Art of Computer Programming :
The Elements of Programming Style :
The Unix Hater’s Handbook :
The Jargon file :
The True Believer :
Programming Pearls :
The Good Soldier Svejk :
The Power Elite
Most popular humor pages:
Manifest of the Softpanorama IT Slacker Society :
of the IT Slackers Society : Computer Humor Collection
: BSD Logo Story :
The Cuckoo's Egg :
IT Slang : C++ Humor
: ARE YOU A BBS ADDICT? :
The Perl Purity Test :
Object oriented programmers of all nations
: Financial Humor :
Financial Humor Bulletin,
2008 : Financial
Humor Bulletin, 2010 : The Most Comprehensive Collection of Editor-related
Humor : Programming Language Humor :
Goldman Sachs related humor :
Greenspan humor : C Humor :
Scripting Humor :
Real Programmers Humor :
Web Humor : GPL-related Humor
: OFM Humor :
Politically Incorrect Humor :
IDS Humor :
"Linux Sucks" Humor : Russian
Musical Humor : Best Russian Programmer
Humor : Microsoft plans to buy Catholic Church
: Richard Stallman Related Humor :
Admin Humor : Perl-related
Humor : Linus Torvalds Related
humor : PseudoScience Related Humor :
Networking Humor :
Shell Humor :
Financial Humor Bulletin,
2011 : Financial
Humor Bulletin, 2012 :
Financial Humor Bulletin,
2013 : Java Humor : Software
Engineering Humor : Sun Solaris Related Humor :
Education Humor : IBM
Humor : Assembler-related Humor :
VIM Humor : Computer
Viruses Humor : Bright tomorrow is rescheduled
to a day after tomorrow : Classic Computer
The Last but not Least Technology is dominated by
two types of people: those who understand what they do not manage and those who manage what they do not understand ~Archibald Putt.
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September 12, 2017