Tuesday, June 9, 2009

The new realities

The demand for short-term Treasuries spikes as doubts grow about Fed Chairman Ben Bernanke’s ability to contain inflation and to prevent depreciation of the dollar on the foreign exchange markets:


Via:  Telegraph

The head of China's second-largest bank has said the United States government should start issuing bonds in yuan, rather than dollars, in the latest indication of the increasing importance of the Chinese currency.

How insulting!  Forecasting is difficult and should be practiced often, but I am sticking with my basically deflationary view in the near term.   Reasons?  (1)  There is simply too much excess capacity in the world; (2) consumers in the rich world are flat on their backs along with their banks; (3) the Fed has shown a preference for instigating asset bubbles rather than wage-price spirals since Greenspan and the clueless central bankers of the fiat funny-money systems of the world are all imitating the Fed; and (4) the Fed doesn’t deflate asset bubbles (it actually seems to like them).  We may get consumer price inflation, but it will take years.

One of the “secrets” of financial management, taught in virtually every introductory finance textbook, is that recessions are predictable with a high degree of confidence.  Each time the yield curve has inverted over the postwar business cycle a business slump has followed within an average of 13 months.  Nitpickers will say the 1965 inversion was a failure—but notice that I said “slump”—the economy’s growth rate in 1966 during the guns-and-butter boom dropped about ten percentage points but didn’t quite quality as a recession.  The yield curve was steeply inverted in 1929 as well.  Here is a chart of the 1/10 yield curve:


Those who are looking for a W-shaped double dip recession such as occurred in 1980-1982 are going to have to show me an inversion of the yield curve to convince me it’s going to happen (although I like the irony immensely, as it was George W. who fatally busted the U.S. government’s budget—and the Republican party—in one fell swoop).  And from these levels of steepness and absent tightening by the Fed that is not going to happen anytime soon it would take a massive change in demand patterns from domestic and international holders of U.S. Treasury debt to accomplish an inversion.  The U.S. may enjoy relatively low short-term rates for quite a while.

I am not saying the economy is going to grow rapidly or that unemployment will stop going up.  My baseline case calls for the standard measure of unemployment to exceed 11 percent within a year.  But the economy will soon stabilize and grow slowly, cramped by the debt load on Americans.  My suggestion for an appropriate government policy is livable workfare and national health care for the unemployed, and let the market and investment tax credits take care of the rest.  To do nothing (“Cut government spending!  Let it play out!  Cut welfare for the bums at the bottom!”) is just to shout out to the world, “The social contract in America is broken!”  (See this for my take on the big picture.)  The recently publicized statistics on our national health relative to other countries bears out that our social brokenness has physical health consequences.

My recession forecasting model (update here) saw trouble coming way back in 2005, and saw the end of the recession in first half 2009 from early 2008.  The economy has its own dynamics; the causal attributions we read about in the press are illusory.  Confidence or “animal spirits” largely drives turns in the business cycle, and the confidence of Americans is coming back (you can’t panic forever).  The economy was going to stabilize in first half 2009 no matter what the government did, including the massive transfer of wealth to some of the richest people in the country that happened with the banking bailout.  That was Panic of 2008 greed-grabbing under the guise of preventing “total financial meltdown.”  You gotta hand it to Hank Paulson—he actually threatened that the country would need to go under martial law if he didn’t get his way (watch this).  At least the government lent most of the money to the banks, and didn’t buy the toxic assets at par as Paulson would have done.  The taxpayers should get their TARP money back over time at 5 percent.

Not that the ruling class is no longer fearful of social chaos.  FEMA is practicing for martial law this summer with “National Level Exercise 2009” that should be interesting as it is a matter of public record that several large-scale “counter-terrorism training exercises” were under way during 9/11.

Source:  http://www.fema.gov/media/fact_sheets/nle09.shtm

National Level Exercise 2009 (NLE 09)

National Level Exercise 2009 (NLE 09) is scheduled for July 27 through July 31, 2009. NLE 09 will be the first major exercise conducted by the United States government that will focus exclusively on terrorism prevention and protection, as opposed to incident response and recovery.

NLE 09 is designated as a Tier I National Level Exercise. Tier I exercises (formerly known as the Top Officials exercise series or TOPOFF) are conducted annually in accordance with the National Exercise Program (NEP), which serves as the nation's overarching exercise program for planning, organizing, conducting and evaluating national level exercises. The NEP was established to provide the U.S. government, at all levels, exercise opportunities to prepare for catastrophic crises ranging from terrorism to natural disasters.

NLE 09 is a White House directed, Congressionally- mandated exercise that includes the participation of all appropriate federal department and agency senior officials, their deputies, staff and key operational elements.  In addition, broad regional participation of state, tribal, local, and private sector is anticipated.  This year the United States welcomes the participation of Australia, Canada, Mexico and the United Kingdom in NLE 09.


NLE 09 will focus on intelligence and information sharing among intelligence and law enforcement communities, and between international, federal, regional, state, tribal, local and private sector participants.

The NLE 09 scenario will begin in the aftermath of a notional terrorist event outside of the United States, and exercise play will center on preventing subsequent efforts by the terrorists to enter the United States and carry out additional attacks. This scenario enables participating senior officials to focus on issues related to preventing terrorist events domestically and protecting U.S. critical infrastructure.


I am disappointed to hear on NPT last night that the President’s suggestion to raise taxes on the rich to help finance health care reform is dead on arrival in Congress.  Raising marginal tax rates on the rich is one way to take the wind out of the sails of the ruling class (see these graphs) as Franklin Roosevelt did in the 1930s. 

I stick by the Strauss and Howe hypothesis that it will take a crisis worse than anything we can imagine now to knit the country back together—or not.  (See this and this.)  Be prepared for a new dark age, neofeudalism, stylishly mentioned as one of the “next big thing[s]” by Foreign Policy

The ruling class is going to keep a very tight grip on the country.  As Dmitri Orlov says, make friends with your local law enforcement or warlord, as the case may be.


  1. A major difference "then" and now, is that the US interest rates (long and short) were largely a function of the domestic economy (past present and assumed future). More and more now it is a function of foriegn investment monetary flows which have less and less to do with the US economy. It is not at all clear that the financial and economic globalisation of the world and US economy allows us the "luxury" of assuming previous economic correlations with "leading indicators" will persist.

  2. Imperfect information is what makes forecasting fun!

    I don't think the fundamentals have changed enough to upset the yield curve relationship to recessions, but we shall see.