How monetary policy drives foreign policy

It should now be evident that America's foreign policy is to an extent being driven by our banking mess. Again and again, we see Washington, including Wall Street's handmaiden, the Fed, exporting monetary chaos implicitely in order to weaken the status of potentially competing reserve currencies:

• Wall Street sent a tsunami of bad AAA-rated mortgage debt to Europe, much to Germany, the locus of power for the Euro (and again, implicit admission of guilt is seen in the apparent fronting of billions of bailout dollars to the European banks by the Fed after the crisis);
• Washington has apparently fomented or supported a coup in the Ukraine that increases the likelihood of war in Europe dramatically therefore sending the gigantic pools of liquid financial assets in the world scurrying into the greenback and US Treasuries, which the Chinese have stopped gobbling up;
• the other factor is that the military-industrial complex needs war to get its funding, and when drone-bombing rag-heads can't provoke a serious attack, destabilizing a former Eastern bloc nation and provoking a somewhat justifiably paranoid Russian leader into military action guarantees at least a shot in the arm of crisis funding.

Russia has repeatedly stated over the past decades that an EU move on the Ukraine crosses a red line. The EU ignored the warning, and with the US's help and the ire of Ukrainians sick of a corrupt government crossed Putin's red line. What the Ukrainians want is democracy and relief from their corrupt plutocrats (see previous post's article by Paul Craig Roberts).

The US has no compelling strategic interest in the Ukraine, or in the Crimea remaining part of the Ukraine. Yes, the Ukraine has been looted by its oligarchs, just as Russia was, and just as the US is being looted by its oligarchs right now; incomes of a majority of American households are falling so the banks can collect on bad debts. It would be nice for people everywhere if they could break the grip of the plutocrats over their livelihoods. In the Ukraine, to substitute debt servitude to Western banks for the domination of the oligarchs would only accelerate the collapse of the EU. And it's not clear the EU, if it offers help, won't be ripped off by the oligarchs as well. The new government in the Ukraine has already increased the power of the oligarchs by giving them provinces to rule, so it's not clear the Western "rescuers" are even able to help solve the fundamental problem at all, and might end up losing their shirts again, as they have in Greece, Portugal, et al.

Until democratic governments around the world become strong enough to counteract the power of the plutocrats by taxing them, both their income and their wealth (as Sweden does) the revolving looting of sovereign governments and demolition of middle classes by the plutocrats and their corporations will continue.

A couple of posts ago I said the scariest thing I've heard recently was Catherine Anne Fitts saying what the world needs now is a global debt for equity swap. I should say I generally like Ms. Fitts' analysis and suspect she may even have misspoken when she made this comment. Such a move would concentrate ownership of the world's assets sufficiently to create even more of a Plantation Earth than we have currently.

She identified the problem, but not the solution. What the world needs now is a global jubilee, debt forgiveness. The debt that the Fed is shoving under the carpet via QE is what is known in banking circles as "bad debt." It is loans that never should have been made because they will never be repaid. In honest not crony capitalism such debts come out of the profits (as losses) of the banks that made them. In crony capitalism, with a central bank controlled by the banks, such debts are "paid back" by being monetized and put on the backs of the taxpayers either directly or through inflation.

The austerity programs Europe has put in place so that Wall Street and European banks can be paid back bad debts have destroyed more than one economy and more are probably yet to fall. (The idea promoted ten plus years ago of "convergence" of interest rates in the EU between periphery and core caused me to gag at the time.) Debt slavery to Western banks is not the answer. (China is apparently making similar mistakes; it will be interesting to see what they do with the bad debt. I suspect their strong central government will tell the bankers to go stuff it.) Ms. Fitts suggests that sooner or later the plutocrats will destroy the banks in order to buy them cheap and collect the rents themselves, canny suggestion indeed.

Chaos in the world = a strong dollar. Until it doesn't. Chaos has a way of being unpredictable.

Capitalism has killed democracy. "Free" markets dominated by monopolies and oligopolies are not what Adam Smith had in mind. It's time for democracy to be reborn. There are degrees of economic inequality that are simply immoral and destructive and humankind has the right to reject them. When the top 85 families own as much as the bottom 3.5 billion people, as recently reported, we have reached such a point.

‘Animal spirits’ update: taper off

The downtick in unemployment raised the A metric marginally but its topping formation remains in place. The onset of the next crisis of confidence—the signature characteristic of the business cycle downturn--will probably come in 2014.

As I have pointed out before, ZIRP lasted from 1934 to 1946 last time and there’s no indication it will go away soon this time. There has been less banking reform, the debt load is greater, and the distribution is even more skewed. Here is Shiller’s long term bond rate data:

Note that from 1936 to 1946 the rate went down. Data is through 2013 YTD. We are still awaiting our 1937-38 analog slump.

Unless, of course, the fools running things manage to get a big war going soon.

The next big thing, especially if Summers gets in, will be crypto-MMT debt explosion as America leaders (ruling class) feather their nests with “infrastructure spending.” Saez and Picketty showed us what happened in to the last such “growth endeavor”: it went 93 percent to the top 1 percent.

Sucks, doesn’t it? Find a faith and practice it, and congregate with like-minded people. Stay away from psychopaths (and that means almost anyone at a senior level in a large corporation, nowadays, as they are shooting the zombies climbing up beneath them in the head to protect their positions).

Peace.

Economy at stall speed

Source:  FRED.  Data to 2012Q4.  The blue line is the value of the most recent observation.  Almost every other time this value has been seen the economy has been either going into recession imminently, or within a year or so.  Only in the 21st century has the economy managed to avoid recession by bouncing off the blue line.

The green line is linear trend over the period from 1950.  The red line is the trend over the past 30 years, which suggests that the US economy is headed for a state of secular stagnation and possible collapse.  

Austerity nonlinearities

Before the crisis Spain had a tiny deficit as a percent of GDP, much smaller than the US's roughly 10 percent. Spain's initial austerity measures were in the same range as those contemplated or forecast for the US in 2013, a few percentage points.

 

Economic and Distributional Effects of the Senate Tax Bill

Via: taxfoundation.org (links to study page)

House passed it. Can you say, “Slow is beautiful”?  I am sticking with my forecast that the next NBER-defined recession will [be determined to have] begi[u]n in mid-2013, whenever the NBER gets around to determining it.

A few nuggets: 

• impact on GDP, –1.38 percent;
• effect on deficit, $37.2 billion reduction (on a ~$1000 billion deficit);
• $GDP/delta $Tax , –8.0X

 

Note that the table above obviously doesn’t include the effects of the payroll tax cut expiring.  I have emailed the author and asked him to revise it.

Economy at stall speed; recession imminent

I hypothesize that “animal spirits” or confidence levels in the economy are largely a function of how things in the economy are relative to adaptation level.  In the model presented up to now I have used the psychologically sensitive unemployment variable as the basis for the calculation.  Today I am playing around with Industrial Production.  Just as stock market investors become discouraged when a stock’s price slips below a moving average, I hypothesize that much the same pertains to managers of industrial concerns (and throw in an inventory cycle for good measure).

In this case the measure of “animal spirits” would be

A = (IP – IPMEAN) / Sigma (IP)

where A is the “animal spirits” metric, IP is Industrial Production, IPMEAN is its exponential moving average over a the past several years (heavily front-end weighted compared to the unemployment model), and Sigma is its standard deviation over the same period.

The picture that emerges suggests we are just at the cusp of a new recession starting.

One of my back burner research projects is to customize a composite contraction measure using several salient macro variables. 

“Animal spirits” matter most in the contraction, when discounting is taking place below an anchor level (we discount losses more than we value gains of same size, in “utility points”).

A simple logistic model using this new “animal spirits” metric and a recent percentage change in Industrial Production produces a quite credible contemporaneous indicator of being in an NBER recession, probability of being in recession now running at about 40 percent:

I will update this new model when new data becomes available.  Here is the picture of Industrial Production and its adaptation level, showing that we’re entering the zone of loss discounting:

With one false positive in the period leading up to the 1990-1991 recession, if the exponential moving average used here is down over any six month period then the economy is in recession.  It’s not a great leading indicator, but it’s 100 percent accurate coincidentally:

As the data here is up to October 2012, we should know by April if the economy is in recession.  The adaptation level is 96.65 of Industrial Production.  An April value falling below that will be confirmatory.

US Effective Demand

Source:  FRED  Both charts are percent change from a year ago, data to 2012Q3.

Will exports pick up the slack?

Industrial production may have peaked

Industrial production with 12 and 18 month moving averages:

Data to October 2012.

Western economy growth rates portend recession

This indicator has been making the rounds.  Recession soon follows when real GDP year-over-year falls below two percent, as it has for the past two quarters.  The indicator has a pretty good track record over the past 60+ years, never having missed signaling an ensuing recession a year or so in advance with no false positives.

And the situation in Europe is similar, with a garnish of extreme political instability thrown on for seasoning:

Animal spirits: collapse not imminent

With the unemployment rate at 9.8 percent, confidence continues to chug upward in what I’m afraid will be a vain attempt to regain positive territory, speaking in terms of the relationship of the unemployment rate to adaptation level.  I continue to expect the next collapse of animal spirits—the defining characteristic of a recession—to occur in about 2013.  This assumes no significant improvement in the unemployment rate.  The hopeless political situation in the United States implies that no matter who wins the next presidential election, it will be considered a defeat by the people.  Continued debt defaults, banking problems and contractionary policy will probably be thrown into the mix.  Here are the charts:

For confidence to collapse in 2013 it is sufficient that unemployment begin trending up again, regardless of any (negligible) improvement between now and then.

The yield curve plus animal spirits recession probability forecasting model continues to show no hint of a collapse of confidence in the next year (the NYFRB’s model agrees):

I have written about effect of ZIRP, Zero Interest Rate Policy, on ability of the yield curve to forecast recession.  It may be true as John Hussman points out that it might be more difficult for the curve to invert, but there is no evidence that the relationship between short and long rates has fundamentally changed in magnitude.  If we see the 10-year yield in the neighborhood of one percent, watch out.  It would take only relatively mild pressure at the short end to tip things over (yes, I am expecting deflation of many asset classes in the intermediate term):

Quick comment on double dips

The only time there has been a “double dip” NBER recession in the postwar period was in the 1980-1982 episode, and it was fully signaled by a secondary inversion of the yield curve.  The 1/10 yield curve inverts an average of about a year before NBER recessions begin.  Here is a 12-month smoothed 1/10 yield curve slope over the postwar period:

The unsmoothed yield curve did go positive in between the 1980 and 1981-1982 recessions, but only briefly; as Volcker applied more tight money after an election year acceleration of inflation.  The smoothed yield curve remained fully inverted.  (The only time the curve inverted and a technical recession did not occur was in 1966—but a drop in the GDP growth rate from ~8 percent to near zero did occur; a “growth recession” it was termed).

Today the yield curve is steeply sloped, so no double dip is indicated.  Why should the yield curve send such great signals?  That is beyond the scope of this note.  I don’t argue with 60 years of empirical regularity.  The yield curve was also inverted steeply in 1928-1929.

The quickest drop off of the smoothed slope from a level such as we’re at now over 3 was from 2004:6 to 2007:6, as the Fed raised short rates and deflation began its assault on the US economy and long rates.  Thus, if we match that decline rate, the curve might invert in mid-2013 and the next recession begin in mid-2014.

The unemployment story that goes along with this might go something like this:

Unemployment rate rises slightly for a few months, and then a determined effort is made to report declining unemployment rates, which, however, must remain within the realm of credibility with a populace (or least the marginally well informed part of which) has come to rely on the larger U6 unemployment rate measure and the employment-population ratio for indicators of labor market health.  This will prime “animal spirits” for the election year, after which all hell breaks loose.

Here’s the picture:

Now a run on the dollar or a failed Treasury auction might cause an inversion to occur quicker, but why would the Chinese do that?  They’re having their own bubble-popping problems.  However, the imperial temptation to drive the world into dollars by starting another war, probably in the Middle East, lingers always.  We probably won’t see unemployment rates under 8 percent for many years.  The best summation of the current labor market is Calculated Risk’s chart here.  Job growth has stalled.

Where will the demand for labor come from?  Americans are an adaptable people, and as they adapt to the “new normal,” business will chug on.  People may exit the measured labor force.  We will continue to be in an underemployment equilibrium because the income distribution is unequal enough that balanced demand is not possible.  Wage concessions to benefit wider employment will be made by Americans on the receiving end of the ruling elite’s diktats, and in this way a new social cohesion among the disenfranchised majority may grow, possibly into a democratic movement with the potential to forge a new social contract through the broken-down apparatus of the American government, or possibly into a new class of post-industrial serfs.