the economic collapse

The economic propaganda being issued

2012-05-07T00:30:00.000-07:00

It is not complicated to understand how laws are being violated by the FDIC. Karl Denninger in his post details that and why there should be no losses from bank closings (unless there is bank fraud involved). Simply stated, it is the FDIC that is causing the losses by not closing banks when their mandate says they must. Leaving them open beyond this point enables losses to continue to mount to the point that, when they are finally closed, taxpayer funds are needed to bail out depositors. Timely closings would ensure taxpayer funds would not be needed.
There are two possible reasons why the FDIC is in violation of the law. First, they are inept. Second,
they are “playing politics.” While all government agencies suffer from the first (and most from the second), the FDIC has a rather simple task and Sheila Bair, at least based on TV appearances, does not appear incompetent.
It is my belief that the FDIC is playing a form of politics. Whether this is willingly or out of necessity might be debated. Thus far they have closed just over 100 banks. Losses (which should not occur) have been increasing as a percentage of closed bank assets, indicating their “oversight” is becoming worse. Speculations by some analysts of eventual total bank closings exceed 1,000. Whatever the correct number, many eventual closings are already in loss positions and should, by law, have been closed already. So why has the FDIC not performed according to its mandates? There are several reasons:
1. Politically it would not coincide with the economic propaganda being issued by the Administration.
2. Economically, it might not be possible because they are out of funds. Eventually Congress will provide them with whatever funds are needed, but the timing for such an admission, while never good, seems especially bad given the current state of politics.
3. Physically, it is probably not possible to “seize” many more banks than the 5 or so they have been closing most weeks. Staffing levels probably do not allow many more than that.
4. It is doubtful that the FDIC actually knows much beyond the biggest problem banks. Bank regulators have adopted a “pretend and extend” policy that allows banks to “pretend” their loans are good in hopes that they can weather the economic storm. While these regulators are outside the FDIC (and just as guilty as the FDIC in dereliction of duty and law), it means that bank balance sheets represent part GAAP and part fantasy. How can anyone know which banks are in trouble if the balance sheets cannot be trusted?
There is plenty of guilt to go around beyond the FDIC. It starts from the very top, and it started before the Obama Administration. This culture of corruption appears so rampant in Washington that one wonders how we ever return to normal. By normal, I am not naive enough to say that corruption goes away; merely that it returns to less shameful and expensive levels. That is the best we can hope for.

The stronger banks

2012-05-05T10:23:00.000-07:00

The bailout fiasco is just now starting to show up for the act of desperation that many suspected it was. Instead of allowing markets to resolve a severely over-leveraged and distorted economy, the government decided to try to “bluff” its way through one more time. This strategy has been one used for almost 5 decades. Each time the credit stimulus required is bigger than the last. Each time the distortions to relative prices is made worse. Each time the misallocation of resources becomes greater. Each time the credit levels of individuals and government expand. Each time inflation becomes a bigger problem. Finally, a time comes when malinvestment and credit burdens are too large to be supported. It is probable that we have reached that point. To appreciate how far we have come regarding the abuses of credit creation, one need only note that since the Federal Reserve was created in 1913, the dollar has lost about 96% of its purchasing power. Most of that loss (probably in excess of 90%) has occurred since 1980.
There are still many that believe that government actions will get us out of our predicament. They
won’t. When we come out of this mess, it will be in spite of these actions. They will serve to make the problem worse and cause it to last much longer. Japan has been employing similar stimuli for two decades, and its economy has still has not recovered.
As time passes, it will become apparent to all but the dullards that these interventions were non-helpful and actually harmful. Most understand economics only experientially. Events as discussed in the following post by Rolfe Winkler today are what will continue to surface with the passage of time and provide enough instances for the experiential learners.
Besides being a terrible decision that will cost taxpayers dearly, the article also talks about the unintended consequences of drawing deposits away from smaller, solid banks to the weaker GMAC. The unintended consequence is to weaken the stronger banks.
The government has already poured $12.5 billion into GMAC since last December, and now the company is negotiating for $2.8-$5.6 billion more. Oh, and FDIC will allow the company to max out its borrowing capacity under TLGP, bringing the total there to $7.4 billion.
Yet another argument against those who say we “made money” on TARP because Goldman, AmEx and a few others bought back their warrants at a small premium. All the profits from those warrants wouldn’t add up to the amount we’ve already poured into GMAC, never mind this latest infusion. There’s also the small matter of $100 billion+ we’re never getting back from AIG….
Readers may recall that FDIC was rather peeved at GMAC for previously offering high rates on deposits. This is the ultimate moral hazard of deposit insurance. Depositors aren’t willing to impose discipline on the bank — taking their money out — because they know it’s guaranteed. GMAC knew this and, through its subsidiary GMAC Ally Bank, offered the highest deposit rates in the nation for a time.
In order to sell more government backed debt under TLGP program, FDIC struck a deal by which GMAC will “keep its [deposit] rates at certain amounts,” according to WSJ.
One would think a change of management might be in order. Well, it’s not gonna happen. CEO Alvaro de Molina — formerly CFO at Bank of America — will stay on.
The real reason behind this bailout is GM. In an age when cars are still purchased on credit, someone has to front the money if automakers are going to move inventory. For GM, that means GMAC, which in turn means taxpayers.
Taxpayers are lending themselves money to buy cars (via GMAC). To buy houses (via Fannie, Freddie and very soon FHA). To buy anything and everything that has to be financed.
My question: When are we actually going to pay for any of it? Also: When we realize we can’t, what’s going to happen to the economy?

The economic condition of the country

2012-05-03T01:21:00.002-07:00

Paulson, Bernanke and Geithner have horrible forecasting records. Anyone forecasting, leaves himself open for a certain amount of embarrassment. Yet these people persist in pretending that they are capable of managing the economic condition of the country. That is truly scary!
Now we have the latest bit of evidence of their prowess. Look at this statement (one of many in a detailed report) made by Frederick Mishkin when he was on the Federal Reserve Board: “… they clearly illustrate that Iceland is a well run, advanced Nordic country that has little in common with emerging market countries, a fact important to recognize when we start discussing financial stability in the next section.” Shortly thereafter, Iceland inconveniently and totally collapsed into financial rubble.
Perhaps it isn’t Bernanke; perhaps it is his aides that are so wrong. Actually it is neither. No one can accurately forecast such things. That they are wrong is not surprising; that they have the hubris to pretend to know these things is what is amazing. Frederick Hayek’s Nobel acceptance speech entitled The Pretence of Knowledge has much to say both about the problem and professional hubris. Perhaps this speech should be required reading by all Washington economic and other policy dunderheads.

The Honeymoon Is Over

2012-05-02T05:23:00.003-07:00

For the first time in recent years, voters trust Republicans more than Democrats on all 10 key electoral issues regularly tracked by Rasmussen Reports. The GOP holds double-digit advantages on five of them.
As a libertarian I have equal distrust for all political parties, but this report is quite telling in what it could mean for the balance of power in Congress come the next general election.
Here’s some more from the report:
Republicans have nearly doubled their lead over Democrats on economic issues to 49% to 35%, after leading by eight points in September.
On the highly contentious issue of health care, voters now give the edge to Republicans 46% to 40%. The parties tied on the issue last month, after Republicans took the lead on it for the first time in August.
Most voters (54%) oppose the health care reform plan proposed by the president and congressional Democrats, but 42% are in favor of it.
On taxes, Republicans are now ahead of Democrats 50% to 35%, nearly doubling their September lead on the issue. Prior to July, the percentage of voters who trusted the GOP more on taxes never reached 50%. It has done so three times since then.

Major currencies has fallen

2012-05-01T23:11:00.000-07:00

A nice article detailing the recent history of the dollar. The fact that the dollar has declined 79% in the last 9 years versus the Euro is shocking. What is even more astounding is that it has declined so much against a currency not backed by a country and a region that has underperformed for decades. The socialistic economies of “Old Europe” have been stagnant for many years, especially regarding job creation. What does this say about the US for the past 9 years? Obviously it has implications for our economy, regardless of what government-reported GDP statistics say. It says even more about our loose monetary policy which would reflect even more directly into exchange rates.
The image to the right depicts a unit of currency issued by the United States of America. On the back is the phrase: “In God We Trust.” To the extent that the dollar has much value left, it may be as a result of this phrase. I assume that means it is less valuable to atheists than believers, but that is purely speculation.
Home > Euro Bests Dollar by 79% in This Millennium
Euro Bests Dollar by 79% in This Millennium

The dollar’s value against major currencies has fallen in recent months as the U.S. fiscal outlook worsened and amid expectations that interest rates will remain close to zero for some time to fight the economic downturn.
This week, the euro broke above the psychologically important level of $1.50 driving gold prices to record levels, prompting many global central banks intervening on currency markets to slow the dollars fall.
How Did We Get Here?
Since the financial crisis last fall, currency markets have taken their cues mostly from stock markets. When stocks plunged in March of this year, investors rushed to the safety of U.S. government bonds, pushing the dollar index up to 89.62, the highest point this year.
Since then, however, it has been a steady downward drift for the greenback. As markets steadied into a rally, traders sold Treasuries and Dollars for riskier assets and higher returns, pushing the dollar lower against other major currencies.

The value of the euro has risen by 79% in nine years since euro hit 0.84 in Oct. 2000, and the White House has done little to curb the dollar’s slide during this period. Loose monetary policy and a weak U.S. dollar are part of the consequences resulting from the U.S. recent trends of unprecedented spending, fiscal deficits, and accumulations of government debt.
“Strong Dollar Policy”…Not

Although the current Administration officially supports a strong dollar, the latest indications came from Federal Reserve Chairman Ben Bernanke and Larry Summers, President Obama’s chief economic advisor.
Mr. Bernanke said this week that the U.S. should cut down on its budget deficit and increase the savings rate in order to reduce global imbalances. Bernanke’s statement chimed with that by Summers earlier this year, when Summers said that
“the rebuilt American economy must be more export-oriented and less consumption-oriented… and less oriented to income growth that disproportionately favors a very small share of the population.”
World War III – Currency
There are only so many paths you can take to be “more export-oriented”, and at the same time save more/spend less. We could increase our savings rate; however, with the unemployment rate around 10%, it is certainly a challenge, to say the least, for middle class Americans. Therefore, the most likely options are
Devaluation of the dollar to help exports
Slapping taxes on imports; or
A national sales tax or a value-added tax (VAT), which seems to have gained traction in Washington, to discourage spending and fund federal deficits.
The problem is that much of the world is also working on increasing its exports to help recover from the global financial crisis. Many countries fear that strong domestic currencies (against the dollar) could harm their still fragile recoveries. A steep drop in the dollar has already enraged our chief creditors and trade partners resulting in Gulf States, Russia, and China reportedly ready to stop pricing oil and gas in dollars, and U.S. clashes with EU and China on trade .
Tails, Dollar Loses
There have been increased signs recently that central banks and governments in many parts of the world may gradually end the massive quantitative easing programs. Australia, for instance, hiked rates to 3.25% and highlighting inflation concerns. The U.S. Federal Reserve, on the other hand, has shown little indication that it is anywhere close to removing the massive liquidity injected into the system.
In fact, last Tuesday, San Francisco Federal Reserve President Janet Yellen said she doesn’t expect the central bank to tighten monetary policy “in the next few months.” This suggests the U.S. will stay on its current course of stratospheric fiscal deficits, zero interest rates, easy money, and… a weak dollar in the near term. Worse yet, in a recovering world, any good news about growth could provoke dollar selling.
Double Dip, Hyperinflation or Both?
A weaker dollar would be beneficial to exporters and to the balance of payments with a narrowing trade deficit as imports would fall faster than exports. So, with domestic demand depressed from the recession, a short to medium term boost to exports could be good for the US.
However, the flip side is that the diminishing purchasing power of the dollar will inevitably drive up prices for goods and services, among other long term effects. This could only result in three likely scenarios manifesting by the end of next year:
W-shaped double dip recession as higher prices crimp recovery
Hyperinflation, if we have a stronger than expected economic growth
Another plausible scenario is that the U.S. could lapse into a double-dip recession with high inflation in commodities, i.e., a stagflation scenario.
Based on the latest economic data and the near 50% one-year gain of the Goldman Sacks Commodity Index (blue line in Fig. 3), my money is on stagflation.
Dollar Status Intact, For Now
The U.S. remains the largest economy in the world. The absence of a credible alternative to the dollar, means that, despite its declining value, its status as the world’s reserve currency is not seriously under threat. In addition, the complexity, geopolitical realities would arguably rule out the re-pricing of oil in non-dollar currencies at this time. All that might change in the future, but it will be a very long, long (think decades) debate.
Strategy: Anti-Dollar & Anti-Inflation
Meanwhile, the dollar will continue to weaken as interest rates in many countries and the eurozone are higher than the current rock-bottom U.S. rates, providing currency traders carry-trade opportunities. This will encourage more selling of the dollar and buying up stocks, commodities and other currencies, which has been the general trend since spring.
So, based on the discussion so far, prudent investors should allocate a portion of their portfolios to hard assets like silver, agri products, and non-dollar currencies such as Brazil’s Real (BRL) or the Australian Dollar (AUD) to hedge against inflation risk and the US Dollar`s devaluation.

Currencies against the greenback

2012-05-01T03:11:00.002-07:00

“Some sort of crisis is looking inevitable,” said Neil Mellor, a currencies analyst at the Bank of New York Mellon in London. “You can’t continue down this road without something giving way, and it’s clear that the U.S. is not going to do anything to put meat on the bones of its strong-dollar policy.”
Dollar decline draws international protest
LONDON — This could end up being viewed as the week when dollar weakness became too much for the rest of the world to bear, setting the scene for tense encounters at the upcoming meeting of finance ministers from the world’s 20 largest economies.
Brazil has now imposed a tax on some foreign-exchange inflows. The Bank of Canada has cranked up its negative tone on the strength of the Canadian dollar. And a whole slew of European officials have practically begged the U.S. to step in and boost the buck.
This chorus of pain marks a rise in international pressure on the U.S. to live up to its oft-quoted “strong-dollar policy,” after central banks in South Korea, Taiwan, the Philippines, Thailand,
Indonesia and Hong Kong all stepped in to weaken their currencies against the greenback earlier this month.
Now, the G20 meeting scheduled for Nov. 6-7 in Scotland will offer a perfect forum for such concerns over dollar weakness to be aired.
“I think there will be fireworks at the G20,” said Stephen Jen, a well-respected currencies investor at hedge fund BlueGold Capital Management in London. “The G20 has such diverse membership” that disagreement over how to handle the dollar’s decline is very likely, he added.
When measured against a basket of currencies from the U.S.’s trading partners, the dollar is now only around 7% above its lowest point since 1971. The greenback has recently hit some notable lows against a range of currencies, with the euro briefly nudging $1.50 Wednesday.
“Some sort of crisis is looking inevitable,” said Neil Mellor, a currencies analyst at the Bank of New York Mellon in London. “You can’t continue down this road without something giving way, and it’s clear that the U.S. is not going to do anything to put meat on the bones of its strong-dollar policy.”
The strain is certainly starting to show. Most countries would greatly prefer to see their currencies weaken, because it makes their exports appear cheaper — a boost when economies are edging out of the global downturn. Instead, many currencies are climbing, not necessarily because of domestic factors, but because the dollar is sliding as newly optimistic investors pull funds out of the greenback, to which they had turned as a safe haven in deeply troubled times.
Brazil’s government took action Tuesday, slapping a 2% tax on foreign purchases of bonds and shares in a direct effort to rein in the Brazilian real, which has risen by nearly 31% against the dollar since March.
The new tax rule sent some investors scurrying for the exits and immediately shoved the dollar 3.75% higher against the real in just one day — a very substantial single-day move in the currency markets.
Currencies watchers are divided about the likely long-term impact of Brazil’s move. Some think that with bumper returns still lying ahead in Brazilian assets, many investors will stick with the country, pushing the currency still higher. The Institute of International Finance has estimated that capital flows into emerging markets will almost double from 2009 to 2010.
David Lubin, an emerging-markets economist at Citigroup in London, said Wednesday that he sees little chance of countries in Central and Eastern Europe adopting similar measures, although he cautioned that investors should “never say never.”
But skeptics, fearing a potential dollar rout, aren’t so sure. “I take the move as a real statement of intent. This could be the thin end of the wedge. There’s a crunch coming, and the only route is the Brazilian route — I think we will see more moves like this,” said Mr. Mellor at The Bank of New York Mellon.
Some authorities around the world are more sanguine about dollar weakness, with the Reserve Bank of New Zealand Governor Alan Bollard stating this week that the strength of the New Zealand dollar was no impediment to raising interest rates.
However, Brazil is not alone. Canada’s central bank warned Tuesday that persistent strength and volatility in the Canadian dollar could “more than fully offset” other encouraging developments seen in the Canadian economy since July.
The market read this as an indication that intervention to weaken the Canadian dollar could be close to hand, prompting traders to push the U.S. dollar nearly 2% higher against its neighboring currency.
Finally, European officials were particularly forthright this week. French Finance Minister Christine Lagarde said Tuesday that “we want a strong dollar; we need a strong dollar.” A senior advisor to French President Nicolas Sarkozy also said that “the euro at $1.50 is a disaster for the European economy and industry.” Currency traders, however, decided to ignore these words.
That’s because few see a real prospect for a successful unilateral program of intervention in the euro zone. Particularly in the case of this heavily traded currency pair, U.S. involvement in a joint effort to sell euros is seen as crucial, because such large sums would be needed to push the rate around. Intervention programs involving just one country are rarely successful.
For its part, the U.S., publicly favors a strong-dollar policy, mindful that the world’s largest economy relies heavily on the goodwill of foreign investors buying its dollar-denominated bonds. However, U.S. Treasury Secretary Timothy Geithner appeared to soften this stance last month, when he indicated that a U.S. transition towards a heavier reliance on exports would be “healthy” and “necessary.” Naturally, a weaker dollar would help in that process.
In the end, most experts agree that unless the dollar’s decline becomes much more rapid, or unless it provokes a rush away from U.S. government bonds — both unlikely prospects at this point — then the U.S. authorities will continue to stand by and let the buck fall.

Waiting for the next crisis

2012-04-30T12:11:00.001-07:00

Hope and Change in the Banking System seems to be “hope” that the system can get through this economic cycle while “change” is non-existent. “Too big to fail” creates incentives for risk-taking that would not occur in a true free market. Taxpayers underwriting risk and backstopping failure ensure that firms will take on more, rather than less, risk.
Legislated rules need to be imposed to contain excessive risk-taking based upon taxpayer guarantees. While a truly free market could handle this better than legislation, there appears to be zero hope for that occurring. Thus, a reinstatement of Glass-Steagall or its equivalent is necessary. Without some type of legislation, we are merely waiting for the next crisis to occur. With it, crises will still occur, but they should be more manageable.
The return to risky behavior is already underway. An analysis of JP Morgan’s recent financial results concludes:
You might as well label JP Morgan the new Lehman Brothers because they are operating like an investment bank. So much for those bailouts helping the average American. The media really needs to scrutinize how these companies make their earnings. They are simply using hot and easy money to double down in the Wall Street casino on the taxpayer dime. No reform has happened since the collapse of Wall Street because these banks own our politicians.

Intervening into the housing market

2012-04-27T02:17:00.001-07:00

Interventionism is economic intervention by the government into the free market. It typically involves subsidies or penalties to particular groups. Interventions never improve the economy. Indeed, many interventions lead to additional interventions to attempt to correct the harm done by the first action. Interventions may improve the lot of a targeted group, but does so at the expense of society. While a particular group may be said to benefit, the total economy is always made worse off. As stated by Henry Hazlitt:
The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.
Others like Bastiat expressed a similar views about a hundred years before. Based on Bastiat, this
wrong-headed Keynesian thinking has become known as “The Broken Window Fallacy.”
Why do governments continue to do something that doesn’t work? Because it works for politicians in terms of “vote-buying.” The beneficiaries know that they have received a gift. The harm done to the other individuals cannot be traced back to the “beneficial” program. Hence, the harm cannot be blamed on anyone. It is terrible economics but wonderful politics.
Barry Ritholtz discusses the intervention of providing Credit for First-time Homebuyers. (Similar and equally disturbing analyses were produced regarding the Cash for Clunkers program.)
$15,000 Home Buyers Credit Costs $292,000/home

By Barry Ritholtz – October 22nd, 2009, 6:00AM
I have long argued that home prices are elevated, and until they normalize, the economy will be stuck in the doldrums. I even wrote a chapter of Bailout Nation, titled “The Virtue of Foreclosure.” I make a basic economic argument that the excess credit of the 2001-07 era is unwinding, and foreclosures are part of that process.
The simple premise is that the abdication of lending standards by both bank and nonbank lenders created an enormous credit bubble. Easy money drove home prices to unsustainable and unaffordable levels. People bought homes far more expensive than they could reasonably afford. Many assumed they would be able to refinance, paying for the excess costs by cashing out the price appreciation everyone knew was sure to follow.
Of course, we know what happened next. Prices rose unsustainably, credit tightened up, and the supply of greater fools abated. So much for the real estate perpetual motion machine.
What we were left with was an oversupply of new homes, and 4-8 million people in homes they couldn’t really afford. When measure by traditional metrics like median price to median income, costs of ownership relative to renting, or Homes as a % of GDP, houses were extremely expensive.
Running 300,000 monthly foreclosures — on pace to do 3 million foreclosures this year — the prior boom process is now unwinding. Excess prices are normalizing — but they still remain somewhat elevated compared to historical ratios. Perverse though it may be, the mass Foreclosures are helping to drive prices back to normalized historic levels.
Although this process is a necessary evil, Politicians of all stripes hate it. Between the NAR and NAHB, they have ready lobby fighting market forces. The lobbyists shamelessly ignore the role their members played in blowing up the bubble, and how they encouraged irresponsible and in many cases illegal behavior. The NAR and the NAHB have yet to offer up their mea culpas for their contributions to the mess, but their roles were substantial.
All of the home mortgage modification programs and foreclosure abatements are attempts by politicos to “ease the pain.” These programs have proven themselves to be ineffective in preventing defaulting mortgages from going into foreclosure. More than 50% of all mods slip into foreclosure again, and in some instances, we see 70-80% delinquency rates.
But the real question is “Why are we trying?” Except for those instances where there has been fraud or predatory lending, we really should not intervene. The foreclosure process is restoring prices to where they should be. (Note I suggested a voluntary program last year that helped banks forestall writedowns, and allowed viable homeowners to keep their houses, but also lowered prices).
Now comes the latest attempt by politicians to intervene in the housing market: Expanding the about to expire, $8,000, first time home buyers tax credit to a $15,000 credit for everyone. This is counter productive. (Won’t that just make prices more expensive?) The lobbyists want to goose the housing market by any means possible — even if it is an expensive and unhealthy method.
A recent Brookings Institute analysis demonstrates persuasively that the $8,000 subsidy actually costs $43,000 per extra house sold; worse yet, the new $15k tax credit will ultimately cost $292,000 per home.
How does that math work? :
“[The] refundable tax credit, which was part of the February stimulus bill, gives $8,000 to first-time homebuyers (but is phased out at higher incomes). It is scheduled to expire on December 1, 2009, although the sponsor of the initial proposal, Senator Johnny Isakson, now wants to extend the credit for another year, and expand it to $15,000. This extension would be a mistake.
Approximately 1.9 million buyers are expected to receive the credit, but more than 85 percent of these would have bought a home without the credit. This suggests a price tax of about $15 billion – which is twice what Congress intended – for approximately 350,000 additional home sales. At $43,000 per new home sale, this is a very expensive subsidy . . .
An extension and expansion of the tax credit will cost far more than the $15 billion of the current credit, likely in excess of an additional $30 billion. And the cost per new house sale will likely be much higher going forward, as a greater proportion of the sales will be for those who would have bought anyway, without the credit. (emphasis added)
In a latter posting, Gayer does the math on the new tax credit: A one-year, $15,000 tax credit apply to all home buyers, would cost the Treasury ~$73.9 billion. Gayer estimates that beyond the people who would have purchased homes anyway, the increase in house sales would be about 253,000. Each extra home sales costs the Treasury $292,000 ($73.9 billion divided by 253,000.)
Randall Forsyth points out a lower (but still absurd) figures calculated by the NAHB:
The National Association of Home Builders, not exactly a disinterested bunch, figures the subsidy would boost house sales considerably more, by 700,000 homes. That implies each of those additional sales would cost American taxpayers only $133,000 — still “a very expensive and poorly targeted subsidy,” writes Gayer.
Its one thing to argue as to whether the government should be so brazenly intervening into the housing market, and I can understand reasonable people disagreeing. But the subsidy — whether its $133,000 or $292,000 — is absurd.

A slack employment environment

2012-04-26T02:37:00.002-07:00

Death of Muddle Through
The US government is on an unsustainable path. Deficits are soaring and the Obama administration is planning massive tax hikes.
Moreover, businesses have little reason to hire already because of massive overcapacity. Add increasing health care costs to the list of reasons for businesses not to hire.
Given that government spending crowds out private investment, these policies all but assures that unemployment is going to remain high for a long time as noted in Structurally High Unemployment For A Decade.
Killing The Goose
Last week in Thoughts on the Economy: Problems and Solutions I listed the problems and some of the solutions facing the economy. It was a discussion between John Mauldin and I about his weekly E-Letter Killing The Goose.

John and I agreed on many, but not all solutions. I would also like to add something I have proposed before, killing the Davis-Bacon prevailing wage act.
Muddle Through Where Art Thou?
Back in 2002, the usually optimistic Mauldin proposed the economy would somehow manage to “Muddle Through”.
However, because of the unsustainable path we are on. John has changed his mind. Please consider these excerpts from Muddle Through, R.I.P?
I defined a Muddle Through Economy in the past as one of slow growth (in the area of 1-2%) and a slack employment environment, such as we had in 2002 and the early part of 2003. In early 2007, I suggested we would return at some point to such an environment at the end of the recession I was predicting.
However, gentle reader, never in my wildest dreams did I think we could be
looking at government deficits of $1.5 trillion dollars and actually budgeting future
deficits of over $1 trillion as far as the eye can see. And there is real reason to think that under current plans, $1 trillion deficits are optimistic.

Look at the graph above from the Heritage Foundation. They suggest that current policy would bring us closer to a $2 trillion deficit by 2019. And that assumes nominal growth that is north of 3% and unemployment dropping back below 5% in reasonably short order.
Japanese Disease
Some readers wrote this week telling me I am far too worried about a rising government deficit. Right now we are at roughly 42% of debt to GDP. In 1989, at the
start of the lost decades, Japan had a debt-to-GDP ratio of 51%. Now it is at 178%, and the world has not come to an end for them. In fact, they are running massive government deficits today and plan to do so for a long time. Why, I am asked, can’t we be like Japan?
In 1989, private Japanese debt (businesses and consumers) was at a debt-to-GDP
ratio of 212%. Now it is at 110%. And the total of both government and private debt is roughly the same (within 5%) of where it was 20 years ago. Along with running large trade surpluses, private debt has been exchanged for government debt. Savings have fallen from the mid-teens to about 2% today, as the country is rapidly aging and now using its savings to live on. And how much has all that government spending helped the country?
Before I answer that, read these paragraphs from Hoisington Asset
Management’s latest letter (last week’s Outside the Box):
“The federal government’s promise to extricate the U.S. economy from this
recession involves more spending (increasing public debt) and more subsidies for
consumers, such as car rebates and home buying incentives (more private debt). In other words, more debt is supposed to solve the problem of over-indebtedness. The truth is that this policy merely indentures its citizens further without providing any income for repayment of debt.
“This means there is no long term income benefit from stimulus programs.
According to the latest academic research, the most recent $800 billion stimulus plan will boost economic activity in the short run, but will surely depress economic activity over time. The government problem is complicated by the fact that the tax multiplier is 3, meaning that a 1% change in taxes will change GDP by about 3% over time. More recent research (Barro & Redlick, September 2009, “NBER Working Paper 15369″) suggests that a 1% cut in the marginal tax rate would raise GDP in the ensuing year by 0.6%. With the deficit rising due to a zero spending multiplier, the tendency will be to try to raise taxes to pay for this higher level of expenditures, which will further depress aggregate spending and output.”
For all intents and purposes, Japan has had no growth for almost two decades.
Their nominal GDP is where it was 17 years ago, and the number of employed people is at 20-years-ago levels. An aging population has masked their unemployment problems, as older citizens retire. Their savings went to government debt. Taxes were raised numerous times. Since government deficit spending has no long-term multiplier effect, growth has been nonexistent. (By the way, that research about multiplier effects has also been done by Christina Romer, the chairman of the current President’s Council of Economic Advisors, and further explored by European economists. There is general agreement on these facts.)
Large government deficits choke off the very investment that we need to create
jobs. In the name of doing good, the unintended consequence is to make it more difficult for small businesses to start up and create jobs. And we all know that small business is the engine for job creation.
The New Muddle Through Economy
This is not a prescription for a return to normal growth. We are headed for a New
Normal that is less than what the market currently believes. Unless the deficit comes
under control at some point, we face the real prospect of catching Japanese Disease and suffering yet another lost decade. Can we Muddle Through? We have no choice but to do so. But it will not be fun. It will not be long-term 2% growth and employment going back to 6% any time soon. Can we reverse the course? With a different attitude and leadership in Congress, maybe we can. But it won’t happen next year, and it’s unlikely in 2011.
I am afraid we will have to put my old friend Muddle Through, as I previously
defined him, back in his box for a while.

The world needs more food

2012-04-24T03:54:00.000-07:00

Not much to disagree with here, at least in the intermediate to long-term. If we have a market correction in the US, which seems almost inevitable, then the whole world will be affected including, if not especially China. There is much not to like short-term in China — the banking systems, centrally-directed economy (when they make mistakes they tend to be doozies), dependence on US for exports, coming currency adjustments, etc. Despite these near-term concerns, I am in agreement with the article. Just don’t “double-down” right now.
Jim Rogers on the Next 10 Years
I’m moving to China … possibly to live in a bunker. At least that was my inclination after listening to a presentation by Jim Rogers Thursday.
Now don’t get me wrong―Mr. Commodities wasn’t all doom and gloom. In fact, his talk was both informative and highly entertaining. But Rogers doesn’t sugarcoat things―he’s very matter-of-fact about his concerns and projections for the future. And most of them don’t bode well for the U.S.
I’ll be posting an interview with Jim Rogers on the site in the coming week, but for now, I just
wanted to offer some highlights from his speech at ETF Securities’ mini-conference and the Q&A that followed.
1. The 21st century belongs to China
According to Rogers, the 19th century was the era of the British Empire and the 20th century was the U.S.’ heyday. But the 21st century is China’s (though the rest of Asia is definitely going to get a boost too).
The reasons for this are many, but some points brought up by Rogers include the following:
The Chinese want to live like we do;
They are more eager to work;
They are better at saving;
There are 1.5 billion Chinese citizens (and 3 billion people in all of Asia), and we owe them money. They are, according to Rogers, “among the best capitalists in the world.”
There will be some setbacks, of course, Rogers says, but these are opportunities. “If you see setbacks in China, you should pick up the phone and get more involved,” he advised, before adding his favorite refrain, “The best advice of any kind that I can give you is to teach your children and grandchildren Chinese.”
China’s path to world domination started with Deng Xiaoping’s capitalist programs in 1978, and there hasn’t been any looking back since. Rogers views China’s dominance as nigh-on unstoppable except for one little thing: its water problem. There are parts of the country that are running out of water, and when the water disappears, Rogers points out, so does civilization. However, the country is acting aggressively to combat the problem, and he doesn’t view it as that much of a threat.
2a. Jim Rogers is not a Ben Bernanke fan
Yep, it’s a fact. No “Team Bernanke” shirts for Jim Rogers (who said to scattered applause during the Q&A session that if he was in charge of the U.S. economy he would “abolish the Fed and resign.”).
Rogers is appalled by the government’s actions—Bernanke’s in particular. The U.S. government’s strategy calls for the debasement of the dollar, he says, calling it a “horrible policy.” While he concedes it can work in the short term, it NEVER works in the mid- or long term.
“He’s going to run those printing presses until we run out of trees, because that’s the only thing he knows,” Rogers said of Bernanke.
Add that on top of the country’s rapidly growing astronomical debt, and Rogers believes you’ve got a recipe for disaster.
2b. The U.S. dollar is screwed
Consider this a corollary to point 2a. Its status as a reserve currency is teetering on a precipice, in Rogers’ opinion, and he’s not alone. In fact, so many people are selling dollars right now that he’s sitting tight, waiting for a possible—and ultimately unsustainable—rally in order to exit the market. Of course, if it fails to rally and just drops again …
“I’ll just have to panic and sell like everyone else,” Rogers said.
3. Commodities, commodities, commodities
OK, as mentioned before, there are 3 billion people in Asia, most of whom are aspiring to play the home version of the American Dream game show. And let’s face it: American society is largely about consumption. We like stuff―we buy it, we wear it, we eat it, we flaunt it, we sometimes even bedazzle it (yeah, Google that). So that’s a lot more consumption on the global level. Rogers notes that while consumption is expected to increase exponentially, not a lot of capacity has been added in the last few decades for a lot of commodities. Meaning, not a lot of new refineries have been built, and not a lot of new resources have been discovered or excavated for a variety of commodities.
In terms of oil, Rogers cites the fact that Saudi Arabia has not seen any new oil discoveries but has consistently said for the past two decades that its reserves are at 260 billion barrels (in which time it has sold 60 billion barrels). He also points out that farmers are a rapidly disappearing species. So to sum up―that’s a lot more people competing for diminishing resources (including the all-important energy and food). Basic supply and demand theory pretty much takes it from there.
“Commodities are the second-largest asset class in the world,” Rogers noted. And they are “the best anchor” for your portfolio, he adds.
Rogers says the typical life span of a commodities bull market is 18-20 years. We’re currently in year 11 right now. Yeah, it could end tomorrow, but that whole supply and demand imperative could also extend this bull beyond its typical time frame.
During the Q&A session, though, the conversation took a darker turn. One questioner asked if the increased competition for resources might lead to war, and Rogers allowed it was a possibility, though he hoped it would not come to that. He pointed out that when a rising power clashes with an established power, the result is usually war, and said that research consistently shows that resource shortages lead to war.
So, sure, commodities shortages might start World War III, but if you invest in the commodities themselves, you might at least be in decent financial shape when the shelling stops—and I’m not being flippant at all. War drives up the costs of commodities.
4. U.S. government bonds are the next big bubble
Well, would you lend money to us? Rogers says short-term bonds are probably OK, but he advises getting out of anything with a longer maturity. He calls it “inconceivable” that anyone would lend money to the U.S. for 30 years at the going rate, and notes that the U.S. was a creditor nation as recently as 1987.
“Now the U.S. is the largest debtor nation in the history of the world,” he said.
And for bond portfolio managers, he had some very pointed advice: “Get a new job.”
5. Protect yourself
The underlying theme of Rogers’ entire speech was that the world is changing, and here are some things you should know if you want to come out the better for it (and for your family members, clients, etc., to also come out the better for it) financially. Based on Rogers’ observations, it seems recognizing that change is a key step, but so is adapting to it (see advice regarding learning Mandarin, for example).
And in Rogers’ eyes, commodities are a good way to achieve this protection. No investment is certain of course, but right now, he thinks commodities look pretty darn good.
Best Comment Of The Night
Addressing one audience member’s question, Rogers asked if the young man were an MBA. The questioner admitted to holding an MBA and was promptly told he should swap his MBA for an agriculture degree from Texas A&M.
“You should become a farmer,” Rogers said.
That’s an old line for Rogers, but he added a new wrinkle. If you’re not going to become a farmer, you should open the first Lamborghini dealership in Iowa. Because with farmers closing in on extinction just as the world needs more food, that’s probably what they’ll be driving in a few years.

Monetary system

2012-04-22T01:43:00.001-07:00

This is a piece that I wrote in response to a request for a guest post over at ZeroHedge. It ran there yesterday garnering some nice attention and a diverse range of comments beneath.
Based on some of those comments, this article represents nothing more than my attempt to find an explanation that matches the data.
My central thesis to this crisis, developed a few years before it even hit, is that the economic troubles are the symptoms, while the money system itself is the cause.
My views on this are expressed in the opening of an article that I initially penned in 2006 but updated in 2008:
Within the next twenty years, the most profound changes in all of economic history will sweep the globe. The economic chaos and turbulence we are now experiencing are merely the opening salvos in what will prove to be a long, disruptive period of adjustment. Our choices now are to either evolve a new economic model that is compatible with limited physical resources, or to risk a catastrophic failure of our monetary system, and with it the basis for civilization as we know it today.

In order to understand why, we must start at the beginning. While it was operating well, our monetary system was a great system, one that fostered incredible technological innovation and advances in standards of living, two characteristics that I fervently wish to continue. But every system has its pros and its cons, and our monetary system has a doozy of a flaw.
It is this: Our monetary system must continually expand, forever.
The article above provides the big-picture backdrop that drives my long-term vision and thinking. I raise it now so that you’ll understand that I principally view the economic world through a monetary lens.
The hot topic of the day is “Inflation or Deflation?” and the camps are firmly divided into groups of inflationistas and deflationistas. When asked which camp I am in, I reply “Yes.” Some would say that puts me in the confusionista camp, but I actually have an explanation for why are living in a world encompassing both.
From a technical perspective, we are absolutely in one of the most powerfully deflationary periods in history, yet, besides housing prices and a few over-produced consumer goods, we find that stocks, bonds, and commodities are all well-bid at the moment.
While we can ascribe some of this to the artificial wall of liquidity (come to think of it, is there any other kind?) currently being thrown into the financial market(s) by the Fed, it leaves hanging the question of why that money is not being completely swallowed into the bottomless black hole that the deflationist camp says lies at the heart of our current financial system.
And they are right; there is a black hole at the center. If we treat the credit doubling that occurred between 2000 and 2008 (from $26 to $52 trillion) as a normal bubble that will follow the same pattern of decline as numerous historical bubbles, then we might reasonably predict that some $26 trillion of debt will somehow “go away” over the next 6 years. This is indeed a massive black hole.
Yet everything just keeps perking along. What gives?
The answer, I believe, requires us to ask a Zen-like question along the lines of, “What is the sound of one hand clapping?” That question is, “If nobody recognizes a defaulted debt on their balance sheet, does it exist?”
Suppose, for the sake of argument, that there is a world in which banks are allowed by their regulators to pretend their default losses simply do not exist. And, even more outlandishly, some of these banks are allowed to sell heavily damaged loans to their central bank at nearly their full original price.
What does “deflation” mean in such a world? Not much, as it turns out. At least from a monetary perspective, because money is not being destroyed at nearly the rate that would be expected or predicted by the size and rate of the defaults.
This is the world in which we currently live. Trillions in probable and provable losses quietly exist, out of sight, on the balance sheets of the Federal Reserve and other financial institutions. If they ever come out of hiding and onto the books, I think the deflationists will be proven correct beyond all doubt.
But let me ask this: What prevents the authorities from simply storing them out of sight forever? Or at least long enough to allow the wave of liquidity to work its inevitable magic? So far, much to my great surprise, they’ve managed to do exactly that, with hardly a squeak from the mainstream press (although the blogsphere is on the job, as usual). I am now wondering if they cannot keep this up indefinitely.
So from a purely monetary perspective, money can only be “destroyed” if banks and other financial institutions are compelled to recognize the losses and take a hit to capital. If the loss is not recognized, no money is destroyed. At least it is not recognized as gone.
Perversely, when a bank sells a ruined loan ‘asset’ to the Federal Reserve, it is a double shot of money to the system – the money initially created upon the issuance of the original loan, which is still out there in circulation, and a second bolus when the Fed creates money out of thin air to buy the failing ‘asset’ from the bank. One blob of money into the system when the loan is made, another when it is bought by the Fed. One loan, two blobs of money. Many have failed to recognize this feature of the Fed’s asset purchase programs.
So from this perspective, we could even argue that by employing the ‘pretend and extend’ strategy, coupled with an aggressive Fed purchase policy, it is possible that more money is being created than destroyed right now. Which means that from a strictly monetary perspective, I am not yet sold on the idea that money is being destroyed at the rates sometimes implied by the deflationary arguments.
Also, the data is not really in support of that notion either:
Of course, this money needs willing lenders and borrowers, which brings us back to the matter of price deflation.
Out in the real world, where consumers and producers exist, the bursting credit bubble has severely cut off consumers’ access to and desire for new credit, and producers have dialed back excessive capacity and cut their prices in order to attract business and survive.
There is no doubt about this process, but here I would argue that falling prices are currently as much a matter of supply and demand as they are a monetary issue. In other words, the price deflation that we are currently seeing is not a pure monetary phenomenon.
Which means I think we are in a bizarre hybrid world, where deflation should be the order of the day, but it currently is not, because its impacts are being held in abeyance by the simple expedient of pretending the losses do not exist.
My current outlook calls for productive capacity to continue to fall out in the real world, even as the Fed conjures more money into existence in the make-believe world of ‘high finance.’ (What are they smoking over there?).
Is this not a recipe for eventual inflation? More money, but fewer goods and services? History says ‘yes.’
All that said, I would not disagree with the notion that there’s another year or three of grinding along (where stock and bond prices are concerned), possibly down, but maybe not, before the monetary/goods imbalance comes charging out of the chute ready to throw off the unwary and trample them in a blistering round of inflation.
But it could be sooner than that. Or later. The point here is that we really don’t know, and because our monetary system operates on faith, it means that we have to be prepared for the fact that a shift could happen at any time. Nobody can predict when a school of fish will suddenly turn to the left. Who knows what final trigger will cause a critical minority to suddenly determine that they’d rather hold things other than paper?
For now, while I understand and appreciate the deflationist argument, the only thing that would convert me fully to that camp would be a sudden return to rigorous application of honest accounting. If you derisively snorted at that last sentence, then we share the same assessment of the likelihood of that happening any time soon.

The necessity of government spending

2012-04-22T01:02:00.001-07:00

A depression was borne out of high levels of private sector debt made apparent by a financial crisis.
The effects of this depression have been lessened by economic stimulus and government support.
Government intervention led to a reduction in asset price declines, which led to stock market increases, which led to asset price stabilization and more asset price increases. This has led to a false sense that green shoots are leading to a sustainable recovery.
In reality, the problems of high debt levels in the private sector and an undercapitalized financial system are still lurking, waiting for the government to withdraw its economic support to become realized
Because large scale government deficit spending is politically impossible, expect a second economic dip within three to four years at the latest.
While I might quibble with his time frame and the necessity of government spending (a bit too Keynesian), it is a valuable piece that provides background for those attempting to understand better what has happened and what the future may hold.

Another trillion dollars

2012-04-20T02:07:00.000-07:00

Tim Geithner hadn’t slept well on Friday night, having again decided to stay in one of the grim rooms on the 12th floor of the Federal Reserve. By six a.m., he had returned upstairs to his office dressed in an oxford dress shirt and sweatpants.
In his mind, he was already making battle plans. He had made it safely to the weekend but was worried about what would happen on Monday.
“John’s holding on to a slim reed,” Paulson had told Geithner about John Mack’s perilous position on a phone call the night before. Paulson was also still anxious about Goldman Sachs, his former employer. “We’ve got to find a lifeline for these guys,” said Paulson, and they reviewed the possible options.
On note cards that morning, Geithner started writing out various merger permutations: Morgan Stanley and Citigroup. Morgan Stanley and JPMorgan Chase. Morgan Stanley and Mitsubishi. Morgan Stanley and C.I.C. Morgan Stanley and Outside Investor. Goldman Sachs and Citigroup. Goldman Sachs and Wachovia. Goldman Sachs and Outside Investor. Fortress Goldman. Fortress Morgan Stanley.
It was the ultimate Wall Street chessboard.

Lloyd Blankfein arrived at his office at just past seven on Saturday morning. On Friday, Gary Cohn had had another conversation with the Fed’s Kevin Warsh, who encouraged him to keep looking at merger options, especially at Citigroup. Initially Cohn’s notion was that Citi should buy Goldman; he had even established an asking price. But Warsh suggested that Cohn approach it the other way around: Goldman should be the buyer. To Cohn, that made no sense, given that Citi was so much bigger. But what Warsh knew—and hadn’t yet shared with Cohn—was that Citigroup’s balance sheet had so many holes that its value was likely a lot lower than its current stock price reflected.
Blankfein was reading an e-mail when John Rogers, Goldman’s chief of staff, arrived. As they were reviewing their own battle plans, Geithner called. In his usual impatient tone, he insisted that Blankfein immediately call Vikram Pandit, Citigroup’s C.E.O., and begin merger discussions. Blankfein, surprised at the directness of the request, agreed he would place the call.
“Well, I guess you know why I’m calling,” Blankfein said when he reached Pandit a few minutes later.
“No, I don’t,” Pandit replied with genuine puzzlement.
Citigroup C.E.O. Vikram Pandit. By Chip Somodevilla/Getty Images.
There was an awkward pause on the phone. Blankfein had assumed that the Fed had pre-arranged the call. “Well, I’m calling you because at least some people in the world might be thinking that combining our firms would be a good idea,” he said.
After another few moments of uncomfortable silence Pandit finally replied, “I want you to know I’m flattered by this call.”
Blankfein now began to wonder if Pandit was putting him on. “Well, Vikram,” he said briskly, “I’m not calling with any flattery towards you in mind.”
Pandit hurriedly ended the call: “I’ll have to talk to my board. I’ll call you back.”
Blankfein hung up and looked up at Rogers. “Well, that was embarrassing. He had no idea what I was talking about!” From Blankfein’s perspective, he had done what he was asked to do, only to be shown up.
Blankfein phoned Geithner back immediately. “I just called Vikram,” he said testily. “As I think about it, you never told me whether Vikram was expecting a call, but I inferred it. He behaved as if he wasn’t expecting the call, and he convinced me that he wasn’t expecting the call.”
Geithner had miscalculated—could Pandit not see the gift that was being handed to him? It defied all reason. But Geithner had no time to deal with anybody’s injured feelings. “O.K., I’ll talk to you later,” he said and then hung up. Blankfein sat there, wondering what the hell had just happened.
Bob Steel, of Wachovia, had considered canceling his appearance on the second day of Teddy Forstmann’s weekend conference, but flew into Aspen that morning, having left the East Coast at four a.m. to arrive on time. But as the moderator, Charlie Rose, got to the Q&A portion of the panel, “Crisis on Wall Street: What’s Next?,” Steel was nervously checking his watch because he knew he had to get to New York fast. Jumping into a red Jeep Wrangler that he had rented at the airport, he finally had a minute to check his BlackBerry and discovered that Kevin Warsh had sent him several e-mails urging him to contact him immediately.
“Listen, I have a call for you to make,” Warsh told Steel when he finally reached him. “We think you should connect with Lloyd!”
Steel, reading between the lines, was stunned: the government was trying to orchestrate a merger between Goldman Sachs and Wachovia! On its face, he knew that it could be a politically explosive deal, considering the two firms’ connections to Treasury. Paulson, he imagined, must be involved somehow. But, given Steel’s former role at Treasury, Paulson wasn’t allowed to contact him directly. Steel was immediately anxious about the idea. If Goldman had really wanted to buy Wachovia, he thought, it would have done so long ago. After all, up until this week, when he spoke to Mack, Goldman had been on Wachovia’s payroll as its adviser and, as such, knew every aspect of its internal numbers. So, if there was a bargain to be had, then Goldman hadn’t seen it. Still, Steel saw the merits in such a deal, and because it was being encouraged by the Federal Reserve, he imagined it might just happen.
“I spoke to Kevin, and he said to give you a call,” Steel began when he got through to Blankfein.
This call, unlike the Citigroup fiasco, had been pre-wired. “Yes, I know,” Blankfein said. “We’d be interested in putting a deal together.”
As his plane headed to New York, Steel mused how a deal with Goldman would be something of a homecoming, even if it had been the result of a direct order from the government. Perhaps he could even wrangle the chairmanship.
Jamie Dimon had been hoping to take his first day off in two weeks. That was until Geithner called him early Saturday morning and instructed him—the president of the New York Federal Reserve seldom suggested anything—to start thinking about whether he’d like to buy Morgan Stanley.
“You’ve got to be kidding me,” Dimon replied.
No, Geithner said, he was quite serious.
“I did Bear,” Dimon objected, referring to JPMorgan’s taking over Bear Stearns the previous March at Paulson’s behest. “I can’t do this.”
Geithner ignored the answer. “You’ll be getting a call from John Mack,” he said and hung up the phone.
Mack, who had had a similar peremptory call from Geithner, phoned Dimon five minutes later. Dimon reiterated that he didn’t want to buy Morgan Stanley, which he had already told Mack earlier in the week. But Dimon was under orders to try to help Mack, so the two rivals talked about whether JPMorgan could offer Morgan Stanley a credit line that might give it some breathing room. Dimon said he’d think about it and come back to him with a decision.
As soon as he got off the phone with Mack, Dimon called Geithner. “I talked to John,” he said. “We’re talking about getting him a credit line.”
“I don’t know if that’ll be enough,” Geithner said, frustrated at the news. He wasn’t the slightest bit interested in any temporary measures.
Dimon immediately shot off an e-mail to his operating committee summoning them to the office, and within an hour, dressed in golf shirts and khakis, they had assembled in a conference room on the 48th floor.
Dimon had a grimace on his face as he related the call he’d received from Geithner. On a whiteboard Dimon used a black marker to sketch out what he had been thinking. “We can either buy them, buy part of them, or give them some type of financing.”
But what, exactly, would they be buying? The overlap between the firms was enormous. And what were Morgan Stanley’s toxic assets really worth? These were all but unanswerable questions.
Geithner was by now seriously miffed. He had been trying to reach Pandit since eight in the morning and had just heard back from Blankfein, who had somehow actually managed to get through to Pandit again. The only problem was that Pandit had turned Goldman down, and Geithner hadn’t even had a chance to speak with him.
Finally, he got through.
“I haven’t been able to reach you for four hours,” Geithner barked into the phone. “That’s unacceptable on a day like today!”
Apologizing, Pandit explained that he had been talking to his team about the Goldman proposal, which they had ultimately rejected. “We’re concerned about taking on Goldman,” Pandit said, trying to explain his rationale for turning them down. “I don’t need another trillion dollars on my balance sheet.”
Geithner could only laugh to himself—Pandit should have been so lucky as to own Goldman. “This is a bank,” Pandit said. “And a bank takes deposits and a bank has a prudency culture. I cannot envision a bank taking its deposits and investing them all in hedge funds. I know that’s not what Goldman is, but the perception is that they’d be taking deposits and putting them to work against a proprietary trade. That can’t be right philosophically!”
Having dispensed with pushing Goldman and Citigroup together, Geithner moved on to his next idea: merging Morgan Stanley and Citigroup. Pandit had been considering that option, too, and while he was more predisposed to merging with Morgan Stanley, he still was reluctant. “It’s still not our choice to do this deal, but we could think about it,” he told Geithner.
By two p.m., John Mack had grown concerned that the talks with C.I.C. were going nowhere. Gao hadn’t budged on what Mack was describing around the office as an “offensive” offer. He had no idea what Jamie Dimon would come up with, and he hadn’t heard anything from Mitsubishi.
Downstairs, Paul Taubman, the firm’s head of investment banking, was experiencing much the same panic as Mack. A disarmingly young-looking 48-year-old, Taubman had worked his entire career at Morgan Stanley, rising to become one of the most trusted merger advisers in the nation, and could now only wonder if it was all going to come to an end this weekend.
Morgan Stanley chairman John Mack. By Michele Asselin/Corbis.
Taubman and his colleague Ji-Yeun Lee were on the phone to Tokyo, where it was past midnight, with Kohei Yuki, Morgan Stanley’s vice-chairman and director in Japan, who was trying to coordinate talks with Mitsubishi.
“I think they’ve gone to bed for the night—we’ll pick it up in the morning,” Yuki said.
“That’s not going to work,” Taubman answered. “You need to call them at home and wake them up.”
There was a long pause; this was certainly a breach of Japanese protocol.
“O. … K.,” he said.
Twenty minutes later, Yuki was back on the phone: “I got him.” Mitsubishi was going to wake up its entire deal team and get working.
Goldman co-president Gary Cohn had agreed to engage in talks with Wachovia only on the presumption the Fed would help Goldman off-load some of Wachovia’s most toxic assets; Warsh, in a bold gesture, made a commitment that the Fed would strongly consider it. Paulson had spoken with Blankfein and told him to take the talks seriously. “If you go into this looking for all the problems and how much help you’re going to get, it’s never going to happen,” he said, adding, “You’re in trouble, and I can’t help you.”
In the meantime, Warsh instructed Cohn to make sure they could work out the personal dynamics. “Let’s not waste our time on economics if you guys are never going to solve the social issues,” he said. “If you aren’t willing to accommodate them, if Bob [Steel]’s not willing to do whatever, this isn’t going to happen.”
Steel was scheduled to land at Westchester County Airport, in White Plains, a suburb of New York City, in only a few hours, and Cohn walked into Blankfein’s office and made a suggestion.
“Lloyd, you should go pick Steel up at the airport,” Cohn said, believing it would be a gracious gesture to kick off the merger talks.
Blankfein looked seriously annoyed. He felt that he had not gotten along with Steel particularly well ever since Paulson had made them co-heads of Goldman’s equities division years earlier. “Do I have to?”
“Yes,” Cohn said firmly. “I would go with you, but it would be awkward. You should go pick him up.”
Blankfein was still resistant. “Can you go by yourself?”
“No,” said Cohn, who considered Steel a friend. “I already have a very good relationship with him.”
Blankfein relented. He’d head to the airport. Wearing slacks and a button-down shirt, he was waiting in the parking lot when Bob Steel arrived. As he walked out of the terminal, Steel, always perfectly coiffed, nonetheless looked as if he could use some sleep. He had already been awake for 15 hours, and his day was hardly done.
“What a birthday present!” Blankfein said to Steel brightly when he saw him. Blankfein, who turned 54 that day, was still hoping to get to a birthday dinner later that evening at Porter House New York, a steak restaurant, with his wife, Laura.
As the two men drove into the city they delicately began discussing the outlines of a deal and discussing their history together. Neither knew what to make of the merger idea or, for that matter, each other.
When they reached Goldman headquarters, Steel went directly to the 30th floor, where he once had an office. As he stepped into the conference room, he saw Chris Cole, who had been his firm’s adviser for the past five months. Now Cole would be on the other side, trying to buy Wachovia. Meanwhile, Steel’s lawyer, Rodgin Cohen, was also Goldman’s lawyer. It had all become so confusing and rife with conflicts, but they agreed that if they were going to do a deal they’d have to reach an agreement by Monday morning.
Goldman’s biggest issue was, as it had been with Morgan Stanley, trying to determine the scope of the hole. Wachovia owned $122 billion of pay-option arms—adjustable-rate mortgages—which Goldman Sachs felt weren’t going to be worth much. They each agreed to put teams on it to work up the numbers; Steel said he’d have his group fly up from North Carolina by morning.
Before decamping for the night, Blankfein invited Steel back to his office. He wanted to talk about titles, perhaps the most sensitive issue for men who often measure themselves as much by their business cards as by their wallets. Blankfein said he was thinking of making Steel one of three co-presidents, along with Gary Cohn and Jon Winkelried; Steel would continue to manage Wachovia as the consumer arm of Goldman Sachs.
Steel was taken aback and slightly offended. He was already the C.E.O. of a major bank; he’d been a vice-chairman of Goldman and a Treasury undersecretary in Washington. And now he was being asked to become one of three co-presidents?
“I’m not sure I want to be at the same level with Gary and Jon,” he said diplomatically. “But we’ll figure this out.”
As the sun was setting, Hank Paulson was still in his office and had just gotten off the phone with Geithner. The news was not promising. Geithner told him that Morgan Stanley had no plan apart from what he called the “naked” bank-holding-company scenario. Geithner said he was uncertain whether any investor—JPMorgan, Citigroup, the Chinese, or the Japanese—would come through. And he was skeptical of the Goldman-Wachovia deal.
“We’re running out of options,” he told Paulson.
Paulson, who had been living on barely three hours of sleep a night for a week, was beginning to feel nauseated. Watching the financial industry crumble in front of his eyes—the world he had inhabited his entire career—was getting to him. For a moment, he felt light-headed.
From outside his office, his staff could hear him vomit.
Saturday night, John Mack returned to his Upper East Side apartment, nursing a persistent cold. His wife, Christy, who had driven into the city from their weekend house in the suburban town of Rye to console him, was waiting up.
He was quieter than usual, wondering yet again how he would manage to raise billions of dollars in capital in only 24 hours. “You know, there’s a chance I could lose the firm,” he said, despair in his voice.
He needed some air, he told Christy, and decided to go out for a walk. As he roamed up Madison Avenue, he realized that his entire adult life, his entire professional career, was on the line. But this was not just about his personal survival; it was about the 45,000 people around the globe who worked for him, and for whom he felt a keen sense of responsibility. Images of Lehman employees streaming out of their building the previous Sunday night carrying boxes of their possessions still haunted him. He needed to buck himself up. Somehow, he was going to save Morgan Stanley.
When he stepped into his living room a few minutes later, he admitted to Christy with a grateful smile, “I’d rather be doing this than reading a book in North Carolina.”
Even before the black Suburban had come to a stop in his driveway, in a leafy enclave of Northwest Washington, D.C., on Saturday evening, Hank Paulson was stepping out of the car door, his Razr at his ear. His Secret Service agent preferred that Paulson wait inside until he got out of the vehicle, but Paulson had long since abandoned such protocol.
He raced inside to get on a call with Vice Premier Wang Qishan in China. For the past day, he had been trying to coordinate the call to press his case for China to pursue an investment in Morgan Stanley. Originally, he had wanted President Bush to call China’s president personally and had spoken with Josh Bolten, the president’s chief of staff, about it. But Bolten had concerns about whether it was appropriate for the president to be calling on behalf of a specific U.S. company.
Paulson had scheduled the call with Wang for 9:30 p.m. He knew Wang well from his trips to China as the C.E.O. of Goldman, and they had a comfortable rapport. He also knew it was highly unusual to be orchestrating a private market deal with another country, in this case the largest holder of U.S. debt. Before placing the call, Paulson had reached out to Stephen Hadley, the national-security adviser, to get some guidance. The instructions: Tread carefully.
JPMorgan Chase C.E.O. Jamie Dimon. By Joshua Roberts/Bloomberg.
When Paulson was finally connected to Wang, he moved quickly to the topic at hand, Morgan Stanley. “We’d welcome your investment,” Paulson told Wang. He also suggested that one of China’s biggest banks, such as the Industrial and Commercial Bank of China, should participate, making the investment a strategic one. Wang, however, expressed his anxiety about C.I.C.’s becoming involved with Morgan Stanley, given Lehman Brothers’ bankruptcy.
“Morgan Stanley is strategically important,” Paulson said, suggesting he would not let it fail.
Wang remained unimpressed, asking for a commitment that the U.S. government would guarantee any investment. Paulson, trying to avoid making an explicit promise but also trying to assuage him, said, “I can assure you that an investment in Morgan Stanley would be viewed positively.”

Move investments out of the dollar

2012-04-19T23:18:00.001-07:00

History is replete with situations where the middle class of a country has been wiped out as a result of the profligacy of its government. If one believes the risks of such an outcome are high, steps should be explored that will protect one’s savings and wealth. If you believe the dollar is going to collapse, you move investments out of the dollar. One way for US investors is to invest in non dollar-denominated instruments like foreign stocks, foreign bonds, foreign currencies and CDs in foreign banks. Unfortunately, history is also replete with government reactions in such situations. In virtually all, the government prevents its citizens from protecting themselves by imposing capital controls. Rather than government enabling or encouraging its citizens to protect their savings and wealth, they preclude them from doing so via “emergency” legislation. While such a step is not inevitable, it becomes highly probable as less capital enters this country and more leaves. Capital controls are never discussed in advance; they appear as a “surprise,” effectively precluding any protective actions. If you might be affected by such legislation or merely want to learn more about it, read this post at Naked Capital.

If a bank takes that approach

2012-04-19T23:05:00.001-07:00

Here is an idea so absolutely idiotic that it is hard to believe our government didn’t implement it first. It is from the Japanese, perhaps reflecting the creative thinking responsible for their outstanding economic results of the past two decades. Apparently, if a bank customer is a deadbeat, the bank will not have to classify the loan as non-performing or set up loss reserves against it. Now that is a strategy that should produce stronger banks.
Japanese banks’ bad loans won’t be driven higher by a proposed moratorium on debt payments by struggling small companies, said Financial Services Minister Shizuka Kamei.
Lenders won’t have to classify loans encompassed by the plan as non-performing, Kamei, 72, said in an interview yesterday at his office in Tokyo. That means they won’t be forced to boost provisions when borrowers postpone repayments of interest or principal, he said. At the same time, Kamei vowed to push banks to extend more credit to small businesses after bankruptcies hit a six-year high in Japan.
“We’re going to get financial institutions to provide these firms with more loans,” said Kamei. “Banks won’t have to treat debt on which they provide a moratorium as bad.”
The moratorium, postponing repayment of principal and interest, will be extended to individuals as well as firms Kamei said. It will aim at giving relief to companies with about 100 million yen ($1.1 million) or less in capital.
“As long as I’m financial services minister, I’m not going to leave small companies in the lurch unable to get loans,” Kamei said. “If a bank takes that approach, I’ll hit them with a business improvement order.”
The full article by Mish can be read by clicking on his name.
This may be one of the most asinine economic policies ever implemented, very high praise indeed given all the competition. A third-grader should be able to spot the fallacies in such policy. Weak banks will be made even weaker. Strong banks presumably would be able to stop pouring good money after bad and recognize the loss (although I have no idea how much being hit with “a business improvement order” hurts). Even more damaging will be the unintended consequences. The law effectively coerces banks to overturn contracts at the whim of the State. That has frightening implications for all business, not only banks. For banks, it dramatically raises the risks of lending money, ensuring that future loans will be more restrictive than they otherwise would have been.
The idea is so bad that we should expect to see it surface here. Oh yes, we have already heard it discussed in different variants — forced moratoriums and/or cramdowns on mortgages. Thus, our government has not lost its creativity, but appears to be a bit tardy on applying such ideas. Whether this tardiness reflects ineptness or the acquisition of a conscience should not be too difficult for the reader to figure out. On the other hand, perhaps our creativity is slipping. After all, cash for clunkers was not our idea. We copied others.

Quantity of credit with positive systemic results

2012-04-17T05:25:00.000-07:00

oug Noland of Prudent Bear tackles the flaws in credit and interventionism practiced by our government and concludes: “… it is my view that a flawed Credit apparatus, ill-advised government intervention, and dysfunctional market dynamics ensure economic maladjustment gets worse before it gets better.” His commentary on the current state of economic thinking and what it will produce appears below.The Governator and the Market Operator

I’ll begin with an excerpt from Bill Gross’s latest Investment Outlook:
“But California’s problems, while somewhat unique and self-inflicted, are really America’s problems, and not just because the California economy is 15% of national GDP. While California’s $26 billion deficit is not directly comparable to the federal gap of $1 trillion-plus, they both reflect a lack of discipline and indeed vision to perceive that the strong growth in revenues was driven by the same excess leverage and same delusionary asset appreciation that was bound to approach cliff’s
edge.”
It’s contagious. Both at the state and local level and in Washington, policymakers “lack discipline and indeed vision…” It is said that “bull markets create genius.” I’ll suggest that the downside of the Credit cycle fashions lousy policymaking. I feel for the “Governator” and the California legislature, and I feel for our new President and members of Congress. They confront the harsh post-Bubble reality of no win circumstances – wearing big bullseyes on their backs in an age of slings and arrows.
As much as I respect Bill Gross – and can’t take strong exception with much of what he has been saying and writing of late – I just can’t find it within myself to move on. Newer readers might be unfamiliar with my long-standing – and one-way debate – with the McCulley/Gross view of the financial world. They have over the years been leading proponents for the popular consensus ideology that I have labeled “inflationism.”
It is a basic tenet of Credit Bubble theory that if the system inflates the quantity of Credit it will be spent. Credit Bubbles are fundamentally about a lack of discipline – one could say a confluence of undisciplined behavior. Credit Bubbles evolve specifically because of undisciplined monetary system management, undisciplined lending, undisciplined borrowing, undisciplined investment, undisciplined speculation and, at the end of the day, undisciplined spending throughout. And there are some absolutes: Inflated mortgage Credit, home price gains, and elevated incomes will absolutely inflate the propensity for undisciplined consumption. Inflated tax receipts will absolutely inflate government expenditures – in California, Washington D.C., and all across the country. The discipline problem goes way back but commenced within the bowels of the Credit system.
Mr. McCulley, in particular, was a vocal proponent for post-technology Bubble reflation. This reflation doubled total mortgage Credit in about six years and unleashed Monetary Disorder all over the world. In the process, this historic Credit inflation inflated asset prices, incomes, corporate profits, and government receipts. The state of California was at the epicenter of this massive inflation. Going back to fiscal year 2002-2003, California general fund revenues were about $71 billion. By the beginning of the 2007-2008 year, the state was budgeting for general revenues of $101 billion.
In percentage terms, state revenues inflated about 40% during the five-year boom. And with receipts rising each year, of course legislators were going to extrapolate and increasingly inflate state spending. There’s no mystery here. Keep in mind that in typical Bubble economy form, much of the rising expenditure was the result of rising costs all along the chain of state services. Those campaigning earlier this decade for aggressive monetary ease to fight deflation got, not surprisingly, more than they bargained for.
In hindsight, it is amazing to contemplate the complete and utter lack of vision that afflicted policymakers throughout the golden state and all across the country. How could they not perceive that sophisticated Wall Street financial leveraging and resulting asset Bubbles were only temporarily inflating their coffers? When seemingly everyone bought into the notion of endless prosperity, why couldn’t they have kept their heads? Just because everyone believed the enlightened Federal Reserve had forever mastered the business cycle, why couldn’t they have been more skeptical? And that the economic community, the regulator community, the Federal Reserve and the marketplace all missed this Credit Bubble dynamic is, apparently, no excuse. As I have often written, I sympathize with post-Bubble policymakers.
It is a tenet of Credit Bubble theory that politicians – given the opportunity – will inflate. There is ample history illuminating the dangerous propensity to run the government printing press. Contemporary analysis gets more complex because of the nature of private-sector Credit and the penchant for government (explicit and implicit) guarantees. During the boom, “money” was burning a hole in policymakers’ pockets, but it was Wall Street and the GSEs commanding the electronic printing press 24/7. By far the most precarious absence of discipline and vision belonged to those Operating in and accommodating this historic private-sector Credit Bubble.
I disagree with the policy of massive deficits. Yet the California and U.S. budget quagmires are the direct consequences of the bursting of the Wall Street/mortgage finance Bubble. And as much as greed and leverage have provided easy scapegoats, responsibility lies first and foremost with the nature of contemporary unchecked finance and flawed “activist” monetary management (trumpeted, not coincidently, by our era’s preeminent market Operators). And as much as the consensus view believes that previous financial maladies have been largely rectified, I see a continuation of the same malignant Credit system dynamics. In short, massive government intrusion into the market pricing of Credit continues to fuel economic maladjustment and Bubble dynamics.
Why did Wall Street issue Trillions of ABS, auction-rates securities, CDOs, and private-label MBS? Because they could. Why did the hedge funds and others leverage so egregiously? Because they were making a bloody fortune and the marketplace was more than ok with it. Why did the GSEs increase their MBS guarantees by $400 billion over the past year, and why did the Treasury issue $1.9 Trillion of Treasuries the past twelve months – and will likely do only somewhat less over the next year? And why are cash-strapped state and local governments borrowing so aggressively these days? It’s because the marketplace continues to readily accommodate Credit excess. Who is demonstrating a lack of discipline and vision – the borrower or the lender? The “Governator” or the market Operator? Is this the way the market pricing system is supposed to function?
Why is the marketplace inherently incapable of disciplining the egregious borrower – whether mortgage debt during that Bubble or government debt today? First, there are no inherent system restraints on Credit creation. Recalling the mortgage finance Bubble, recent massive increases in the supply of government debt have been met with a collapse in borrowing costs. Second, the marketplace perceived that fiscal and monetary policymakers were backstopping mortgage Credit during the boom. Today, the market is confident that policymakers are firmly behind the Treasury and agency securities markets. Borrowers are undisciplined for one reason: the distorted market mechanism not only fails to discipline them – it accomplishes the exact opposite.
I could ramble on for pages on the myriad costs associated with unchecked, undisciplined and mispriced finance. Mr. Gross touched upon a key cost, noting today’s uncompetitive California and U.S. economies. This is a key aspect of Bubble economy distortions. The dangerous flaw in inflationism dogma is that the Federal Reserve and policymakers can manipulate the cost and quantity of Credit with positive systemic results. In reality, the consequence of increasingly bold policy activism over time include a more distorted and unbalanced economic structure, as witnessed today. And it is my view that a flawed Credit apparatus, ill-advised government intervention, and dysfunctional market dynamics ensure economic maladjustment gets worse before it gets better.

The personal income tax

2012-04-14T04:11:00.000-07:00

Congress has done a phenomenal job in taxing, spending and borrowing. Nobody does it better. They should get a Congressional gold medal for taxing, spending and borrowing. Up until 1913, the government was limited in their ability to spend because there was no personal income tax and the currency of the United States was backed by hard assets. Woodrow Wilson and Congressmen, under the control of the banking cartel, created the Federal Reserve and the personal income tax in 1913. The unleashing of politicians from any constraints on their spending has led to a predictable result. The US dollar has lost 97% of its value versus gold since 1913. The U.S. National Debt was $2.9 billion in 1913. Today, it is $11.9 TRILLION, a mere 400,000% increase in 96 years. That is the good news. President Obama plans to add at least another $9 TRILLION to our debt in the next 10 years. That is the actual plan. Can you picture George Washington spinning in his grave?
Rather than conclude that the gig is up and that running up huge deficits in order to police the world and provide welfare benefits to the 50% of the population that does not pay income taxes, Obama and Bernanke have decided to double down. Their solution is to double the National Debt, greatly expand the welfare state, and continue to police the world. Does anyone really think it is going to work? Bankruptcy is a certainty.

Raise the cost of building for everybody

2012-04-14T03:55:00.000-07:00

A recovery in the economy can only occur via recovery in the private sector. Much of what has been hailed as “green shoots” results from government stimulus. It is not clear what is being stimulated other than reported GDP, because there are few signs of private sector recovery. One area that has received enormous stimulus is the housing market, even though its reported numbers are still dismal.
In the mortgage issuance area, the private sector has disappeared (see previous post by Chris Martenson). Is this because banks are unwilling to lend? Is it because there are no creditworthy borrowers? The answer to both of these questions is a resounding No! Then why is this happening? The government has driven down interest rates so low in a (foolish) attempt to support housing prices that they have made it unattractive for banks to risk money at these rates. In that sense, the government is subsidizing low interest rates with taxpayer money/risk. Private firms make mortgage loans at interest rates commensurate with risk. When interest rates are held artificially low, there are few loans that meet this requirement. Another way to state this is that the government is taking on risks with your money that prudent investors would not take on with their own money. It is precisely that strategy that gave us the Fannie and Freddie debacle. This is not rocket science. The results are predictable and inevitable as evidenced by the following quote:

Government-guaranteed home mortgages, especially when a negligible down payment or no down payment whatever is required, inevitably mean more bad loans than otherwise. They force the general taxpayer to subsidize the bad risks and to defray the losses. They encourage people to “buy” houses that they cannot really afford. They tend eventually to bring about an oversupply of houses as compared with other things. They temporarily overstimulate building, raise the cost of building for everybody (including the buyers of the homes with the guaranteed mortgages), and may mislead the building industry into an eventually costly overexpansion. In brief in the long run they do not increase overall national production but encourage malinvestment.

Economic activity should subside

2012-04-13T23:31:00.002-07:00

Investors worrying about a significant pullback in economic growth this quarter are sorely mistaken, Deutsche Bank analysts wrote in a note published earlier this week.
As we pointed out yesterday, analysts thinking equities markets are just repeating the same bearish Q2 pattern we saw in 2011 and 2012 have a point:

But according to DB's Markets Research team, this time really is different:
In each of the last two years, the labor market weakened in early Q2 and did not recover until around Q4. Investors are worried a similar profile may emerge again this year. However, as we enter the current quarter, there is one substantial difference between this year and the last two years, and that is initial jobless claims are much lower at present than where they were at similar points in both 2010 and 2011. Provided that claims continue to remain near their recent readings, if not decline further, we expect underlying payroll gains on average to come in well above 200k per month. In the process, worries about a meaningful slowdown in economic activity should subside.

There is no safe store of value

2012-04-12T23:05:00.000-07:00

America has produced its share of radicals, both left and right. Although the definitions of “radical” have shifted over time (our Founding Fathers would be considered extremists today), those that are on the wrong side of prevailing definitions are usually precluded from public roles. Exceptions can be found, usually accompanied by a perceived “road to Damascus” conversion. Senator Robert Byrd of WV, an alleged former member of the Klan, is one example. Another astonishing example is provided below. This man stated the following:
The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.
Deficit spending is simply a scheme for the confiscation of wealth.
… the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes. A substantial part of the confiscation is effected by taxation. But the welfare statists were quick to recognize that if they wished to retain political power, the amount of taxation had to be limited and they had to resort to programs of massive deficit spending, i.e., they had to borrow money, by issuing government bonds, to finance welfare expenditures on a large scale.
In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold.
Based on the above, one would assume this man would have no desire to serve a government whose primary role, as perceived by him, was plunder of the wealth of its citizens. Furthermore, one might also assume that such a man would be judged unfit to serve, because his philosophical framework would be a threat to the myth of government and the bulk of its programs. Yet such a man did go on to serve and serve admirably in the eyes of many. Indeed, in terms of the thinking reflected in the statements above, he became the Chief Officer of Plunder. In more polite terms, the office is known as Chairman of the Federal Reserve. His name, of course, is Alan Greenspan otherwise dubbed “The Maestro” by admirers in the media. Lately, his admirers have lessened as his policies are seen to have been at the root of our current economic problems. Perhaps he should have stuck to his original principles rather than become an instrument of the State and a part of the problem.

Massive tax increases

2012-04-12T23:01:00.001-07:00

We are told that massive tax increases will be needed to cover the large projected deficits. History, however, shows that this strategy will not work. Regardless of the tax rate or the tax structure, tax revenues remain relatively constant as a percentage of GDP. Whether the “Laffer curve” or disincentives are responsible is moot. The fact is that since the mid 1940s there has been a ceiling on tax revenues related to GDP. The ceiling is unaffected by low or high top marginal tax rates that have ranged from 28 to 90%. Government is too large and needs to be cut back. The common man understands this; pompous politicians do not or will not. We now have a government that has become the biggest bubble of all. Like all other bubbles, it too will burst. The deficits are unsustainable. Tax increases will not change that reality.
Federal Income Tax Rates and Total Revenues

Manufacturing events increased

2012-04-12T02:00:00.003-07:00

Employers took 2,690 mass layoff actions in August that resulted in the separation of 259,307 workers,
seasonally adjusted, as measured by new filings for unemployment insurance benefits during the month,
the U.S. Bureau of Labor Statistics reported today. Each action involved at least 50 persons from a
single employer. The number of mass layoff events in August increased by 533 from the prior month,
and the number of associated initial claims increased by 52,516. Over the year, the number of mass
layoff events increased by 803, and associated initial claims increased by 70,356. Year-to-date mass
layoff events (21,184) and initial claims (2,162,202) both recorded program highs through August. In
August, 900 mass layoff events were reported in the manufacturing sector, seasonally adjusted, resulting
in 93,892 initial claims. Over the month, the number of manufacturing events increased by 279, and
associated initial claims increased by 21,626.

Our creditors know this better than we do

2012-04-12T01:59:00.000-07:00

Despite all the hoopla regarding an economic recovery, there can be no recovery until the economy sheds the excess debt. The consumer is tapped out and is adjusting his balance sheet to reduce leverage. That is good, despite what the government wants (another credit bubble).
The so-called stimulus programs can mask economic performance for a limited time only. They may produce increased GDP reports in the third and fourth quarters, not unusual in the middle of recessions. The media and Bernanke have already proclaimed that recovery is underway. Supporters will only become louder if positive GDP stats show up soon. Do not fall for this hype.
The statistics will be hailed as confirmation of a recovery. However, they are merely statistics produced by government that have more to do with GDP methodology and reporting bias than real growth or real recovery. They cannot go on forever, and they do not produce real growth or balanced economic activity. David Rosenberg, in his daily eletter, exposes the effects of stopping such programs:
POST-CLUNKER ECONOMY LOOKING CLUNKY
Edmunds.com just reported that U.S. motor vehicle sales so far in September are running at an 8.8 million annual rate — a 28-year low and a 38% plunge from the incentive-induced 14.1 million tally in August. If this is what autos do, imagine what housing does once the $8,000 first-time homebuyer tax credit expires (if it does) at the end of November (not to mention what the Fed does in terms of extending its mortgage purchase program beyond the December expiry too — it has had a hand in financing 80% of all new mortgage issuance. But look at the good news — at least we will be able to see what the economy can do without the walker.
What is coming will not be pretty! If the government renews these programs or implements new ones targeted at other sectors of the economy, it may be able to produce a short-term effect. However, this “benefit” is only created by pulling demand forward. That is, it pumps up current results at the expense of future results as Rosenberg discussed above. Even if one were to (erroneously) argue that these programs did some good, we are fast approaching the limits of what can be done. Each involves government subsidies of one sort or another. As such, each involves widening the deficit and increasing Federal debt, whether it be via tax rebates or increased spending. There is a limit to Federal debt. We have already passed the tipping point of being able to service government debt and promised social benefits. Our creditors know this better than we do and periodically scold us for our fiscal irresponsibility. We have become the Blanche du Bois of the world

Competing government insurance company

2012-04-12T01:20:00.002-07:00

We are embroiled in a great debate over health care reform. There are two aspects of the debate that are often not identified. The first is whether healthcare is a “right.” The second is the best way to deliver healthcare. When one does not separate the two issues, one biases the solution.

While I do not agree that healthcare is a right (you cannot morally produce a “right” for some by violating the rights of others), let us assume for the moment that it is so deemed. Then the issue becomes how is this “right” best delivered. It seems that the US has answered the first question and now struggles with the answer to the second.
It is the natural tendency of government to want to run things, hence we have the preoccupation with the single payer system or a competing government insurance company. The latter, using the concept of competition and government, is oxymoronic. Is there anyone outside of Washington DC that believes the government at the Federal or local level can run anything efficiently? The empirics regarding this issue are devastating — social security, Amtrak, medicare, medicaid, financial system regulation, the school system, potholes in the streets, the post office, infrastructure maintenance, the court system, garbage collection, department of motor vehicles, etc. etc. ad nauseum. One might reasonably argue that everything government touches deteriorates.
Back in the days of the Cold War, a joke that was popular in Europe went something like this: QUESTION — What would happen if the Soviet Union took control of the Sahara Desert? ANSWER — Initially no changes would be apparent; eventually there would be a shortage of sand.

Contraction must take place

2012-04-12T01:15:00.000-07:00

Economic conditions will be sub-par perhaps for a decade or more as a result of the great credit unwind. For the past 20 plus years consumers spent most or more than their income by taking on extraordinary levels of debt. As Karl Denninger writes today:

We have blown several trillion dollars in a futile attempt to stave off the contraction in debt outstanding and GDP that must come. The contraction is still coming, but the several trillion we wasted in an ill-advised attempt to prevent the inevitable is all gone.

Make sure you thank Bernanke, Geithner, Obama, and of course Paulson and Bush.

Attempts to avoid the necessary adjustments are futile. They only ensure that the US ends up with a lost decade or two like Japan. That is if we are lucky, and the bottom does not drop out. At this point, debt levels exceed the levels where they can be comfortably serviced and contraction must take place.