Friday, June 26, 2009

Happy 4th of July!

Please leave links to articles that you think the cognoscenti who visit this site should see.  I’ll be back after the 4th.

God bless America.

“What can I do?”

Robert Reich calls for political action, writing and calling your elected representatives.  I’d go further and say that Americans have to stop being afraid to get out in public to rally in support of their initiatives.  We need to throw the authorities’ labeling of protesters as “terrorists” that I recently noted back in their faces.  Where’s your courage, America?  There is strength in numbers.  The more people show their faces, the less they can be persecuted.  Recent history teaches that political action works.  We haven’t seen the action we expected from Obama, but as Reich points out, he’s only a politician.  He can only do what the people demand of him.

Via:  Robert Reich’s blog

What Can I Do?"

Someone recently approached me at the cheese counter of a local supermarket, asking "what can I do?" At first I thought the person was seeking advice about a choice of cheese. But I soon realized the question was larger than that. It was: what can I do about the way things are going in Washington?

People who voted for Barack Obama tend to fall into one of two camps: Trusters, who believe he's a good man with the right values and he's doing everything he can; and cynics, who have become disillusioned with his bailouts of Wall Street, flimsy proposals for taming the Street, willingness to give away 85 percent of cap-and-trade pollution permits, seeming reversals on eavesdropping and torture, and squishiness on a public option for health care.

In my view, both positions are wrong. A new president -- even one as talented and well-motivated as Obama -- can't get a thing done in Washington unless the public is actively behind him. As FDR said in the reelection campaign of 1936 when a lady insisted that if she were to vote for him he must commit to a long list of objectives, "Maam, I want to do those things, but you must make me."

We must make Obama do the right things. Email, write, and phone the White House. Do the same with your members of Congress. Round up others to do so. Also: Find friends and family members in red states who agree with you, and get them fired up to do the same. For example, if you happen to have a good friend or family member in Montana, you might ask him or her to write Max Baucus and tell him they want a public option included in any healthcare bill.

Let me just say, as a long-time independent, that this red state-blue state thing is a red herring. 

There is only one party in America, the Money Party, and it needs to be knocked down a peg, in my humble opinion.  Here’s a comment I left on Yves’ blog on her article about the potentially snapping American middle class:

Via: Naked Capitalism

I'd like to see the phone lines of Congress flooded with calls to RAISE MARGINAL TAX RATES ON RICH FOLKS (say, with incomes over $250K a year) with the rates steepening as income climbs into the obscenosphere so that incomes over $1 million would be taxed at 75% or so--and get rid of the "hedge fund exemption."

Obama has been too timid to pursue this, poor man. This would be the clearest signal "the people" could send to "the ruling class" that they've got to learn to share. And then maybe pay multiples in American corporations might come down, as the idea that sharing is *good* spread.

Don't like it? Emigrate. See if you can get your money out of the country.

Who can get their rep to introduce a steeply graduated progressive income tax bill on the floor of the House? Sell it as shared sacrifice. The problem here is that the libertarians and Republicans don't like to raise taxes on anyone, even though at our most successful times in history, marginal tax rates have been much higher, reflecting a much tighter social cohesion. We are stuck with our government and need to try to make it work--and even use it to instill a values change.

My position has always been that it's okay to raise taxes on people who make more than I do. Screw a VAT! That's just more regressive taxation! The rich in the this country are supremely well set-up, and would be wise to give back to their ailing government and countrymen.

And then on the other end, start livable workfare for the growing ranks of the unemployed to avoid radicalization and upheaval.

Hope springs eternal.

Happy 4th of July!

Thursday, June 25, 2009

U.S. economic situation promotes “war-seeking”


Red = unemployment, blue = inflation, YOY percent change

The current situation most resembles the early 1950s, when the nation also carried a heavy debt load, though not altogether as heavy as today.  Inflation shot up during the Korean War and then settled into about a two percent range for the rest of the decade.  The wage-price spiral took off in the mid-‘Sixties, with repeated red and blue peaks spiraling upward until Paul Volcker snuffed out the big inflation in 1982.

Given that the massive Baby Boom generation remembers the Vietnam War and its inflation, and are trembling in their boots about having enough money for retirement, any hot war breaking out now might reignite a wage-price spiral quickly.  With chaos abroad, the greenback would still look good as a reserve currency for a while.  The Fed might tolerate a ~5 percent inflation for a few years in the interests of debt reduction and household balance sheet “rebuilding.”  It helps to have a hot war to get an inflation going.

My inference: the U.S. economic situation promotes “war-seeking,”  if we follow the old patterns of realpolitick.  But there is no lasting reward following this path.

George Washington wrote:  “I do not mean to exclude altogether the idea of patriotism. I know it exists, and I know it has done much in the present contest. But I will venture to assert, that a great and lasting war can never be supported on this principle alone. It must be aided by a prospect of interest, or some reward.”

Triggering an inflation might well destabilize the entire Bretton Woods fiat money system, and create a much worse situation than a “limited” war—a bigger war.

George Friedman of, a well-informed hawk and follower of realpolitick, says we are squandering our treasure in Afghanistan.  I agree.  Let’s get out before it spreads out of control and triggers an inflation.

(thanks to Ted R. for challenging me to clarify this)

Why we need to audit the Fed

Via: Credit Write-Downs  I often wonder about how much our cognitive capacities have been hurt by the crisis—the propaganda machine is on all the time.  Ed Harrison reminds us that much if not most of the toxic waste is now on the Fed’s balance sheet.  More and more it is clear that our near-century-long experiment with a central bank is failing—again.  I would bet that the Fed will never be able to come out whole selling these assets.  They may have to remain on the Fed’s balance sheet.  The Fed will be insolvent, but who cares?  The commercial banks won’t be.  The Fed will have to use reserve requirements more to reign in credit money if inflation picks up.  One possible future…. We’re in uncharted waters… and USS Greenback is listing….

Will banks exiting TARP take back their toxic waste now?

Posted by Edward Harrison on 24 June 2009 at 11:03 pm  

Just last week, we saw a parade of banks exiting the dreaded TARP program set up last year by the U.S. government and used to temporarily recapitalize the U.S. banking system.  The banks were able to do so in no small measure because of the unrealistically rosy scenarios in the stress tests used to determine how adequate the banks’ capital levels were.  On the back of these tests, the banks raised shed loads of capital and promptly ditched the TARP program and the likely restrictions, scrutiny and reputational risk which comes with it.  Goldman Sachs and JPMorgan Chase even promised not to abuse government largesse by issuing FDIC-insured bonds.

So, then, when will these institutions give back the Treasury securities they borrowed from the Federal Reserve in exchange for the toxic waste they used as collateral?  Let me remind you of what I am talking about.  Do you remember when large financial institutions were forced to go hat in hand to the Federal Reserve when asset markets seized up post-Lehman?  Well, these companies had all sorts of Asset backed securities, CDOs and CDOs of CDOs – generally known as toxic waste and euphemistically called ‘hard-to-price assets.’  They off-loaded these assets onto the Fed ‘temporarily’ through mechanisms like the discount window, the Primary Dealer Credit Facility and the Term Securities Lending Facility.  The goal was to give the markets time to return to normal, to allow ‘liquidity’ to return to the markets so that these assets could start being traded again.

Why isn’t this happening now?

This is a highly relevant question at this juncture for a number of reasons.

  1. If this has been a liquidity crisis, then the crisis is pretty much over as most measures of risk like LIBOR, the TED spread or LIBOR-OIS are now back to pre-Lehman levels.  So, if liquidity has been normalized, those loans from the Fed aren’t necessary, are they?
  2. If the banks exiting TARP are truly well-capitalized, then they can afford to take the derivatives they schluffed off onto the Fed back onto their own balance sheets.
  3. If the banks exiting TARP are really no longer dependent on government largesse then there would be no better way to prove it than by taking back their junky derivative assets and helping the Fed restore its balance sheet.

But, I am sure you know this is not going to happen.  This has not been a liquidity crisis.  It is a solvency crisis. The banks are not well-capitalized because the stress tests were just a big charade and an effort to buy these firms time.  Moreover, it is painfully obvious that the banks are very much dependent on the government still – or they would be getting their dodgy assets back.

Meanwhile the Bloomberg lawsuit filed under the Freedom of Information Act to uncover what kinds of assets the Fed is now holding as collateral is still ongoing.

So, if you are wondering like me, when the Fed is going to start shaping up its balance sheet or when the Fed is going to come clean about what kinds of dodgy assets it now holds on that balance sheet, you’re likely to be waiting for answers for a very long time.

Wednesday, June 24, 2009

Recommended reading and chart of the day

Via:  Business Week  Chart of the day.  And the jobs that have been created have been in the EdHealthGov sector mostly.


Via:  Jesse  The Weimar hyperinflation was accompanied by high unemployment and massive debt issuance.

Some common fallacies about inflation and deflation:  the Weimar experience

There are several fallacies making the rounds of the economic community, often put forward by pundits on the infomercials for corporate America, and also on the internet among well-meaning but badly informed bloggers.
The first of these monetary fallacies is that 'the output gap will prevent inflation.' The second is that a lack of net bank lending or other 'debt destruction' will require a deflationary outcome. Let's deal with the output gap theory first.
Output gap is the economic measure of the difference between the actual output of an economy and the output it could achieve when it is most efficient, or at full capacity.
The theory is that when GDP underperforms its potential, with unemployment remaining high, there can be no inflation because demand is weak and median wages will be presumably stagnant. This idea comes from neoliberal monetarist economics, and a misunderstanding of the inflationary experience of the 1970s.
The thought is that sustained inflation is due to a 'wage-price' spiral. Higher wages amongst workers cause prices to rise, prompting workers to demand higher wages, thereby fueling inflation. If workers do not have the ability to demand higher wages there can be no inflation.
While this is in part true, it tends to confuse cause and effect.

The cause of a monetary inflation, which is a broadly based inflation across most products and services relatively independent of demand, is often based in a monetary expansion of the currency resulting in a debasement and devaluation.

A monetary expansion is relatively difficult to achieve under an external standard since it must be overt and often deliberative. A gradual inflation is an almost natural outcome under a fiat currency regime because policy-makers can almost never resist the temptation of cheap growth and the personal enrichment that comes with it.
There can be short term non-monetary inflation-deflation cycles that tend to be more product specific in a market that is not under government price controls. But this is not the same as a broad monetary inflation or deflation.

The key difference is the value of the dollar which has little or nothing to do with a business cycle or product demand/supply induced inflation/deflation.
In the modern era the Federal Reserve can increase the money supply independent of demand by the monetization of debt, with the only restrictions on their ability to increase supply being the value of the dollar and the acceptability of US sovereign debt. This requires the acquiescence of the Treasury and the cooperation of at least one major money center bank.
People tend to invent 'rules' about how the money supply is able to increase, and confuse financial wagers and credit with money. This is in part because the average mind rebels at the reality behind modern currency and the ease at which it can be created. Further, people often invent facts to support theories that they embrace in an a priori manner.
In a pure fiat currency regime, the swings between inflation and deflation are almost always the result of policy decisions, with the occasional exogenous shock. A government decides to inflate or strengthen their money supply relative to productivity as a policy decision regarding spending, central bank credit expansions, banking requirements and regulations, among other things.
As a prime example of a rapid inflation despite a severe economic slump, what one might call uber-stagflation, is the Weimar experience.
Since pictures are worth 1000 words, let me be brief by showing you a few important charts.

The basic ingredients of the Weimar experience are...

A high level of official debt issuance relative to economic growth

High unemployment with a slumping real GDP

Wage Stagnation

I should stop here and note that although the statistics at hand involve union workers, in fact unemployment was widespread in the Weimar economy. The saving grace of being in the union was that one was more often able to retain their jobs and some level of nominal wage increases.

Anyone who has read the history of the times knows that unemployment, underemployment and slack demand was rampant, and that hoarding was commonplace as people refused to trade real goods for a rapidly devaluing currency.
Rapidly Rising Prices Despite Slack Demand and High Unemployment

So much for the wage price spiral and the output gap.
A Booming Stock Market, at Least in Nominal Terms

Booming Price of Precious Metals as a Safe Haven Even While Basic Material Prices Slumped

Notice the plunge in the price of copper as the economy collapsed and gold and silver soared.

If one can obtain a copy, as it is out of print, one of the best descriptions of the German inflation experience is When Money Dies: the Nightmare of the Weimar Collapse by Adam Fergusson. There is a copy of the book available online for free here.
From my own readings in this area, the people who tended to survive the Weimar stagflation the best were those who:
1. Owned independent supplies of essentials including food and shelter and were reasonably self-sufficient.
2. Had savings in foreign currencies that were backed by gold such as the US dollar and the Swiss Franc
3. Possessed precious metals
4. Belonged to a trade union and/or had essential skills or government position which guaranteed a wage
5. Were invested in foreign equity markets, and even in the domestic German stock market for a time

People will argue now that the Fed understands that inflation is caused by perceptions, and that by managing those perceptions inflation can be avoided because even those prices are rising and the currency is being devalued, if they ignore it the inflation cannot reach harmful levels.
This is what I call the "psychosis school" of behavioral economics.
Granted, perception is important, and managing perception may delay outcomes for a period of time. But unless the underlying cause of the problem is remedied during what is at best is an extended interlude, the resulting break in perception will ignite a firestorm of cognitive dissonance, loss of confidence, and social unrest.
In summary, in a purely fiat currency regime a sustained monetary inflation or deflation is an outcome of policy decisions regarding fiscal policy, monetary policy, and economic balance and output.

As long as the government is able to generate debt, deflation is a highly unlikely outcome. And when the government reaches the practical limits of debt creation, the underpinnings of the currency give way and the economy tends to collapse in a stagflationary slump.
There are no predetermined outcomes in a fiat monetary regime. Deflation, stagflation and hyperinflation are not 'normal' but are certainly possible if the central authority is permitted to abuse the real economy and the money supply for protracted periods of time.
What about Japan? Japan is the perfect example of a policy decision made by a fiat currency regime in what was decidedly NOT a free market, but under the de facto control of a highly entrenched bureaucracy, a single political party, and large corporate giants in pursuit of an industrial policy that favored exports and domestic deflation.
The difference between the Japan of the 1980s and the US of today could not be more stark. Choosing a deflationary policy and high interest rates as a debtor nation is economic and political suicide. It would be interesting to see what happens if the US elites try to take that path.
We will know if there is a true monetary deflation in the US because the value of the dollar will start increasing dramatically with regard to other hard assets, other currencies, goods and services, and precious metals and commodities. Prices will decline especially for imports as the dollar gains in purchasing power.
Remember that a true monetary inflation and deflation would only show up over time. Even in the Great Depression in the US, as demand slumped and prices fell, the stage was set for a significant devaluation of the US dollar and a rise in consumer prices well in advance of the eventual recovery of the economy that caused the Fed to tighten prematurely. As I recall the actual contraction in money supply lasted two years. This again highlights was an amazing piece of bad policy that Japan represents in its 'lost decade.'
People embrace beliefs for many motivations. So often I find they are not 'rational' and based on a scientific study of the facts, even on the most cursory level. Fear and greed and prejudice are often motivations that are surprisingly resilient, even in the face of overwhelming evidence against them. Leadership understands this well.
There are often appeals to private judgement. I do not care what you say, this is what I believe, what I think, what I feel. This is appropriate in the supra-natural realm, but in the natural realm there may be private judgement but the facts are public, and the outcomes are well beyond the complete control of the most fully-managed perceptual campaigns, at least so far in human experience.

"The lie can be maintained only for such time as the State can shield the people from the political, economic and or military consequences of the lie. It thus becomes vitally important for the State to use all of its powers to repress dissent, for the truth is the mortal enemy of the lie, and thus by extension, the truth is the greatest enemy of the State." Joseph Goebbels, of the perception modification school of economic thought

What is truth? It is difficult to estimate but not completely out of reach.

Our own view is that a serious stagflation with further devaluation of the US dollar as it is replaced as the world's reserve currency is very likely, after a period of slackening demand and high unemployment. A military conflict is also a probable outcome as countries often go to war when they fail at peace.

Weimar was not an anomaly although the level of inflation was indeed legendary. Argentina, post Soviet Russia, and most recently Zimbabwe are all similar examples. Serious Instances of Monetary Inflation Since World War II
There are many, many variables in play here, and policy decisions yet to be made. It is highly discouraging to see Obama's Administration fail so miserably to do the right things, but there is always room for hope, less so today than six months ago however.
Argue and shout grave oaths and wave our hands though we might, we are in God's hands now.
Let's see what happens.
A very special thanks to our friend Bart at Now and Futures who makes these charts, among other things, available on his highly informative web site for public review. If you are not familiar with his work you might do well to view it. We do not always agree, but he demands attention because of the rigor which he applies to his work for which we are grateful, always.

Via:  Market Ticker  If you’ve wondered what the fuss about CDSs is, read this. 

Congress has no more excuses

If you haven't seen this, you need to. 

Christopher Whalen is a principal of a firm that rates the performance of commercial banks, Institutional Risk Analytics.  I have featured some of his writing before in Tickers, but this one, submitted to The Senate Committee on Banking, Housing and Urban Affairs yesterday, takes the cake.  You must read this in full but for those who are incapable of understanding it, I'll spell out details for you.  Some excerpts:

Simply stated, the supra-normal returns paid to the dealers in the closed OTC derivatives market are effectively a tax on other market participants, especially investors who trade on open, public exchanges and markets. The deliberate inefficiency of the OTC derivatives market results in a dedicated tax or subsidy meant to benefit one class of financial institutions, namely the largest OTC dealer banks, at the expense of other market participants.

Translated: The banks make extra-large profits by extracting money from other people in the rest of the market.  That is, they have effectively been given the power to levy a tax - something supposedly reserved to Congress.

The taxpayers in the industrial nations also pay a tax through periodic losses to the system caused by the failure of the victims of OTC derivatives and complex structured assets such as AIGs and Citigroup (NYSE:C).

Worse, when they blow it, you eat it, not they.  Why?  Because they have effectively bribed the regulators to speak on their behalf and for their interests, much as allegedly happened with Stanford and the so-called Antiguan banking regulator.

With CDS and more obscure types of CDOs and other complex mortgage and loan securitizations, however, the basis of the derivative is non-existent or difficult/expensive to observe and calculate, thus the creators of these instruments in the dealer community employ "models" that purport to price these derivatives. The buyer of CDS or CDOs has no access to such models and thus really has no idea whatsoever how the dealer valued the OTC derivative. More, the models employed by the dealers are almost always and uniformly wrong, and are thus completely useless to value the CDS or CDO. The results of this unfair, deceptive market are visible for all to see – and yet the large dealers, including JPM, BAC and GS continue to lobby the Congress to preserve the CDS and CDO markets in their current speculative form.4

The dealers, the large half-dozen banks that control this market like a cartel, basically making it all up.  There is no actual underlying pricing and therefore the price is whatever their computer model says it is, and you can't see it.  Only they can, and they use this against everyone else to effectively rip off everyone trading with them.

Let's be clear: Chris is using one example here where the dealer (the big bank) is the SELLER.  But there are also cases (e.g. AIG and Goldman) where the big dealer is the BUYER; the seller is in fact selling SHORT, effectively, a product that the dealer has exclusive control of the pricing and model on by which their gains or losses are calculated!

In my view, CDS contracts and complex structured assets are deceptive by design and beg the question as to whether a certain level of complexity is so speculative and reckless as to violate US securities and anti-fraud laws. That is, if an OTC derivative contract lacks a clear cash basis and cannot be valued by both parties to the transaction with the same degree of facility and transparency as cash market instruments, then the OTC contact should be treated as fraudulent and banned as a matter of law and regulation. Most CDS contracts and complex structured financial instruments fall into this category of deliberately fraudulent instruments for which no cash basis exists.

The clear version of the above, in English.

To put this in "Joe Six Pack" speak this "market" is exactly like playing Blackjack against a dealer who has a supply of aces and kings under the table, and uses them to deal blackjacks to himself any time he would like.

Would you knowingly sit at such a table?

It is my view and that of many other observers that the CDS market is a type of tax or lottery that actually creates net risk and is thus a drain on the resources of the economic system. Simply stated, CDS and CDO markets currently are parasitic. These market subtract value from the global markets and society by increasing risk and then shifting that bigger risk to the least savvy market participants.

And let's not forget who gets all the money.  JP Morgan, Goldman,

Seen in this context, AIG was the most visible "sucker" identified by Wall Street, an easy mark that was systematically targeted and drained of capital by JPM, GS and other CDS dealers, in a striking example of predatory behavior. Treasury Secretary Geithner, acting in his previous role of President of the FRBNY, concealed the rape of AIG by the major OTC dealers with a bailout totaling into the hundreds of billions in public funds.

Any questions?

Chris has been one of the consistent bright lights in this mess since it began.

I have called for all swaps and other OTC derivatives to be forced onto an exchange.  Why?  In no small part because I know that not all derivatives can be exchange traded, and should this be forced all the "sham" products would be immediately exposed for what they are and eliminated from the marketplace.  Those that are legitimate products would trade with transparent pricing, open interest and volume, thereby contracting spreads to a reasonable level and eliminating the ability of the cabal of dealers to screw their customers.

Items like FX and Interest-Rate swaps can easily be exchange traded, as the closing price can be computed daily and for most of these products a minute-by-minute price can be computed using transparent and simple formulae.  The underlying instruments for these products are real and trade every day - interest rates of course are a matter of public knowledge and trades in the treasury and agency debt market, while currency pairs are quoted on a near-continuous basis.  Both sorts of OTC contracts have no real reason to change hands over-the-counter, except to allow some bank to insert a hinky clause here or there that disadvantages the customer, charging an outsize spread or commission for the "privilege."  Indeed there have been several major disputes over this practice between these banks and municipalities that were sold complex interest-rate swaps that in some cases came with allegations of outright bribery or inside dealing.

But when it comes to these other things like CDOs and CDS, there is no observable market price on which to base the derivative as there is no actual underlying basis.  What, for example, is the "risk that GE will go out of business in the next year"?  Document how you arrive at your answer please, and good luck coming up with anything that is objectively defensible.

In short, the nonsense, patronage and outright fraud within both our government and the cabal of dealers must stop now.

This marks two warnings Congress has had on this matter in written testimony, the first prior to the repeal of Glass-Steagall predicting exactly what has now happened and now, this from Mr. Whalen.

I have written to Congress on many occasions, including spending thousands of dollars faxing Tickers, white papers and other documents to all 535 members over the previous two years on these points.  Congress seems to think that America is a bunch of dolts and will tolerate being literally stuck up at gunpoint to the tune of hundreds of billions if not trillions of dollars in a massive collusive scam that reaches all the way to the top of the American Regulatory and Political Systems.

The American people have every right to hold The Board of Governors of The Federal Reserve, The Federal Reserve Bank of New York, Henry Paulson, Tim Geithner and all 535 Congressional members personally responsible if the abuses, frauds, and scams that have been enabled by the intentional blindness and even complicity of these individuals are not stopped immediately and all past transgressions prosecuted to the fullest extent of the law.

We the people have every right to demand and expect that a passel of special prosecutors be empaneled immediately to go over each and every one of these allegations, investigate every agency including The Federal Reserve and its member banks, and where appropriate bring indictments and prosecutions for frauds perpetrated upon the taxpayers, investing public, the states and municipalities of this nation.


Tuesday, June 23, 2009

Where are the aliens when we need them?

One of the most amazing graphs I’ve seen in a long time is Emmanual Saez’ graph of the share of income going to the top ten percent of the American income distribution:

Recent levels of inequality exceed those preceding the Crash of 1929 and the Great Depression!  What is amazing, however, is how inequality dropped between 1939 and 1942 as the American people apparently banded together to fight a common enemy in World War II. 

It is ironic that Ronald Reagan should have invoked a common alien enemy to make all of humankind band together.  This suggests that the notion of the need for a common enemy is pretty deeply ingrained in Beltway-think.  The Project for a New American Century pined for a “Pearl Harbor of the 21st century” to motivate Americans.  “Section V of Rebuilding America's Defenses, entitled ‘Creating Tomorrow's Dominant Force’, includes the sentence:  ‘Further, the process of transformation, even if it brings revolutionary change, is likely to be a long one, absent some catastrophic and catalyzing event––like a new Pearl Harbor’ (51).[13]” (source).

If 9/11 was supposed to be the Pearl Harbor of the 21st century, it didn’t work.  We didn’t band together in any measurable way, except to have a financial crisis that booted the Republicans out of office.

So, with a nod to the Gipper and perhaps a flashback to Will Smith punching an alien in the face and saying, “Welcome to Earth!” in “Independence Day”… here’s Ronnie:

Let’s hope we find another way to band together than war.  Where are the aliens?

Seriously, let’s start by raising the marginal tax rates that Ronnie lowered, that started us down the primrose path toward fiscal excess to benefit the rich.  Shared sacrifice!  The government needs their money. 

For those of you who think the “supply side” tax cuts worked, here’s what actually happened:  Ronnie raised taxes more than he lowered them.  First he lowered them on the rich, then he raised them on the working folks:

One major tax cut, then lots of raises


Reagan in 1981 proposed — and Congress passed — a massive tax cut, the centerpiece of which was a 25 percent reduction in marginal tax rates.

The result was that taxes paid as a share of gross domestic product immediately began to decline from the post-World War II peak of 20.2 percent that they hit that year.

Reagan didn't cut entitlements either — a promise he'd made during his 1980 campaign. But that's not to say he didn't consider it. In 1982, Reagan went along with a plan by GOP Sen. Pete Domenici of New Mexico to slow the growth of spending on Social Security and cut $40-billion from the program. Reagan also called for a 10 percent reduction in total spending for Medicaid in his budget proposal that year.

In the end, both ideas came to naught, in the face of Democratic opposition in Congress.


In 1983, Reagan signed legislation aimed at preserving Social Security's solvency by raising payroll taxes and taxing Social Security benefits of upper-income Americans.

The plan certainly preserved Social Security but also demonstrated that Reagan was willing to impose tax increases, even if he didn't propose them and rarely accepted them with enthusiasm.

As former Reagan adviser Bruce Bartlett wrote in a 2003 article for National Review, Reagan signed two major tax increases in 1982 that took back much of the break he'd provided in his 1981 tax bill. After the Social Security tax increase of 1983, Reagan approved further tax increases — in one form or another — in 1984, 1985, 1986 and 1987.

None of them was particularly draconian and taxes as a share of GDP continued to decline until 1984, when they bottomed out at 18.4 percent but then rose back to 19.2 percent by 1989, when Reagan left office. The overall percentage then was still lower than during Reagan's first year in the White House.

Note the acceleration in public debt from 1980, except for later Clinton years.  Come on, Barack—raise marginal tax rates!  Bubba [Clinton] did it!  You can do it!  Raise marginal tax rates on earned incomes over a million dollars to 75 percent, and do away with the obscene “hedge fund exemption” that lets the richest Americans pay 15 percent tax rates on their earned income, less than their administrative assistants pay.


“The spectre of default”

Sudden Debt offers a perspective consistent with mine (big picture here), but with a couple of charts I haven’t presented.  The classic deflationary “collapse of effective demand” occurs because the bottom 90 percent of the income distribution goes into debt trying to keep up with the top fraction (there are natural tendencies to compare one’s situation with that of others around one).  The debt load becomes excessive, as it has tended to do throughout history, as Michael Hudson points out here:

What to do?  Open debtors’ prisons and pack everyone in?  Have a war like World War II that somehow miraculously brings everyone together?  Not easy to pull off, that last one—the rich might just take the money from the war and retire to their gated communities (see On the coming neo-feudalism).  Sudden Debt argues for debt forgiveness—because default is already in the cards.  I agree.  What the imbecilic government of the United States of America has done is to guarantee that bad private debts mostly owed to the well-heeled investor class of American society will become United States Treasury obligations when they default.  This will cause the coming defaults, instead of being defaults on private debts, to become currency-destroying defaults on the world’s reserve currency.  Because outright default is unthinkable, the Fed will try the old “inflate our way out of this debt” trick. 

How many times does this story have to be told for the Senators and Congressmen to hear it?  I’m sorry, I forgot—”the banks own this place,” to paraphrase one senator.  Let me make clear though, that it is primarily high-flying New York banks, including the two former investment banks, that are at fault here.  The symbiotic relationship of Goldman Sachs and the Fed/Treasury is well-known.  For the record, there are thousands of honest bankers out in fly-over land whose balance sheets are pristine and who are mad as hell at the New York slicksters.

To be clear:  the problem is that our American social contract is broken (see this and this).  The income and wealth distributions have become unequal across industries; it’s not just banking.  We’re strangling the lower income classes.

There will be no significant recovery from the current severe recession without debt forgiveness.  The economy will stabilize for a few years as per our updates, and then effective demand will collapse again, for the same reasons it collapsed this time:  most households just won’t have enough money.  The obtuse macroeconomists will chorus in favor of “stimulus” that will run through the system (now “like a gasoline engine hitting on one cylinder”) and explode on the other end in some sort of price inflation.  And because all the currencies in the world are fiat currencies, and virtually everyone’s banks are messed up, we will see the Bretton Woods system finally go supernova, as all currencies inflate.  This will create a level of uncertainty about relative prices and the value of future cash flows that could depress aggregate demand on an international scale (even as nominal “aggregate demand” may be skyrocketing everywhere—happy, doctrinaire “Keynesians”?). 

Please also click through onto Simon Johnson’s set of charts on the global crisis (“Is it over yet?”  IMHO--no.) for a World Bank conference in Seoul. 

Here is Sudden Debt’s post:

Governments the world over are hoping to publicly borrow their way out of the stupendous mess created by the private financial sector. They are thus engaging in a monetary and fiscal experiment of Titanic proportions, steering a patchwork ship of State constructed from traditional Keynesianism and radical free-market ideology. Unfortunately, they are either blind to, or are nervously whistling past, the largest iceberg field in the history of economic navigation.
We are not going to escape unscathed.

Let's quickly set out what went wrong: oceans of debt blew asset bubbles for everything from clapboard houses and dinky mortgages to smelly shares, hedge funds, LBOs and 2/20 private equity funds. If an "asset" as much as fogged the mirror it was sliced, diced, indexed and leveraged to the hilt, transformed into a creative financial "product". A private banker friend told me two years ago that his nouveau riches customers from as far afield as Bangalore, Dubai, Sao Paolo and Moscow cared about one thing and one thing only: how many times can I leverage this baby up? At the top, if the answer was less than 40-fold they just sniffled and turned their noses away. (That's 97.5% margin, in case you were wondering..).

What happened next, predictably enough, was a debt crisis of historic proportions - and it's still going on. Amazing isn't it, how the newest generation of suckers always jump with glee into the oldest trap in the world* ?

Debt In The Yihaa !! Era

Governments, particularly in the U.S., are now desperately trying to avoid their biggest bugaboo: persistent asset deflation through debt destruction. Why? Because most assets are held by that tiny minority of the population for whom the golden rule applies (he who who owns the "gold" makes the rules). The vast majority of the rest have debts. To get a sense of the vast divide, in 2007 half of all American families had a net worth of $58,000 or less. By contrast, the top 10% had a net worth of $4,000,000 on average.

Chart: Federal Reserve

For a pluralistic republic like the U.S., does it make any sense to salvage the top 5-10% of the population's assets by placing more debt on the shoulders of everyone else - who already own next to nothing? Would it not be better to work out a debt default and reduction plan, instead of pumping the debt bubble even bigger?

But, mention debt default by (intelligent) design during a polite conversation and watch it grow hot and indignant - that's the moralistic Protestant Ethic weaving through most of us, I guess. Putting it another way, the Spectre of Default haunts, increasingly with as much fear as the other one did, back in 1848.
I am starting to believe that what America ultimately needs is a modern-day Solon and a healthy dose of seisachtheia.

Monday, June 22, 2009

The terrorist meme spreads among authoritarian governments

Is there a terrorist hiding under your bed at night?  The [insert name of national government] will protect you!

Via: Mail

Monday, Jun 22 2009 This Afternoon  21°C This Evening 12°C 5-Day Forecast

Ten Iran protesters die in one day as police target 'terrorists' in crackdown

By Mail Foreign Service
Last updated at 12:04 AM on 22nd June 2009

Opposition clerics in Iran stepped up criticism of the authorities yesterday after more than a week of unprecedented protests.

At least ten demonstrators were killed on Saturday alone and dissident clerics declared that resisting the 'people's demand' was against religious law.

But in a sign of their determination to crack down on unrest, officials dismissed the protesters as 'terrorists' and rioters.

Iranian leaders also took another swipe at Britain, with hardline anti-Western President Mahmoud Ahmadinejad accusing the UK of interfering in Iran's affairs. Its foreign minister said Britain had 'sinister designs'.

Black-clad police wielding truncheons, tear gas and water cannon were last night accused of brutality over Saturday's protests in Tehran.

Injured demonstrators were said to have been arrested while being treated in hospital.

Via: Salon

JUNE 14, 2009 7:35PM

DoD Training Manual: Protests are "Low-Level Terrorism"

Update appended at the end:

The Department of Defense is training all of its personnel in its current Antiterrorism and Force Protection Annual Refresher Training Course that political protest is "low-level terrorism."

The Training introduction reads as follows:

"Anti-terrorism (AT) and Force Protection (FP) are two facets of the Department of Defense (DoD) Mission Assurance Program. It is DoD policy, as found in DoDI 2000.16, that the DoD Components and the DoD elements and personnel shall be protected from terrorist acts through a high pirority, comprehensive, AT program. The DoD's AT program shall be all encompassing using an integrated systems approach."

The first question of the Terrorism Threat Factors, "Knowledge Check 1" section reads as follows:

Which of the following is an example of low-level terrorism activity?

Select the correct answer and then click Check Your Answer.

O   Attacking the Pentagon

O   IEDs

O   Hate crimes against racial groups

O   Protests


The "correct" answer is Protests.

A copy of this can be found on the last two pages of this pdf.

The ACLU learned of this training and on June 10, 2009 sent a letter to Gail McGinn, Acting Under-Secretary of Defense for Personnel and Readiness, objecting to their training all DoD personnel that the exercise of First Amendment rights constitutes "low-level terrorism." 

For those who have worried about a trend - evident, for example, in the USA PATRIOT Act, the universal and ongoing government surveillance of all of Americans' electronic communications that began in February of 2001 (seven months before 9/11), the global war on a tactic (terrorism), therefore making this war unending, the unprecedented pre-emptive arrests of protestors at the 2008 Republican National Convention with those protesters being charged as "domestic terrorists," the justifications for torture, pre-emptive wars of aggression, ongoing occupations, American gulags such as Bagram, suspension of habeas corpus, and "prolonged detention" for acts someone might commit, not what they have done, FBI et al infiltration of protest groups and the government's acknowledged use of undercover agents (agents provocateurs) in said infiltration, thus giving the government under the rubric of fighting domestic terrorism unrestrained and unsupervisable power to suppress legitimate political activities, the unleashing and justifications for Christian fascists to murder those they do not like (such as the assassination of Dr. George Tiller and the killing at the Holocaust Museum a few days ago) - this news adds further fuel to the fire.

These are not items from some famously vilified, non-US dictatorial regime. These are items from the good ole USA, land of the free and home of the brave.

Just how brave are we now? How free are we still? Are we brave enough to be "winter soldiers" and stand up against these fascist moves? Or will we go down in history in infamy, the way the "Good Germans" of the 1930s and 1940s did? 

Update at Salon.

Sunday, June 21, 2009

Numbers on Welfare See Sharp Increase

Via:  WSJ h/t cryptogon  


Welfare rolls, which were slow to rise and actually fell in many states early in the recession, now are climbing across the country for the first time since President Bill Clinton signed legislation pledging "to end welfare as we know it" more than a decade ago.

Twenty-three of the 30 largest states, which account for more than 88% of the nation's total population, see welfare caseloads above year-ago levels, according to a survey conducted by The Wall Street Journal and the National Conference of State Legislatures. As more people run out of unemployment compensation, many are turning to welfare as a stopgap.

The biggest increases are in states with some of the worst jobless rates. Oregon's count was up 27% in May from a year earlier; South Carolina's climbed 23% and California's 10% between March 2009 and March 2008. A few big states that had seen declining welfare caseloads just a few months ago now are seeing increases: New York is up 1.2%, Illinois 3% and Wisconsin 3.9%. Welfare rolls in a few big states, Michigan and New Jersey among them, still are declining.

The recent rise in welfare families across the county is a sign that the welfare system is expanding at a time of added need, assuaging fears of some critics of Mr. Clinton's welfare overhaul who said the truly needy would be turned away.


"To me it's good news," says Ron Haskins of the Brookings Institution, who helped draft the 1996 welfare-overhaul law as a Republican congressional staffer. "This is exactly what should happen."

Welfare cases peaked at above five million in 1995 and declined sharply after the 1996 law put time limits on benefits and emphasized moving recipients from welfare to work. The time limits vary by state, but the federally mandated maximum is five years with some exceptions; after that, benefits end.

The cash assistance program, called Temporary Assistance for Needy Families (TANF), was created by the 1996 law and replaced previous welfare and jobs- training programs. Funded partly by the federal government and partly by the states, it primarily assists women who have children and no job -- or a very low-paying one. The number of families on welfare had been falling steadily and, nine months into the recession, stood at 1.6 million in September 2008, the most recent date for which national tallies are available.

"This is the first real test," said Liz Schott, a welfare analyst at the Center on Budget and Policy Priorities, a liberal Washington think tank. "We always said how is it going to perform? How is TANF going to perform in an economic downturn?"

One clue, she says, can be found in a different measure. Although the TANF program seems to be accommodating increased need, it is doing so at a slower rate than another government initiative: the food stamp program. The number of food stamp recipients has risen in every state and was 19% higher in March than a year ago, a much bigger increase than the number of people on welfare.

[Welfare caseload]

Food-stamp eligibility is significantly easier than the criteria for receiving welfare, so food-stamp assistance tends to rise first. The food-stamp program covers a much larger pool of people who have trouble making ends meet but make more money than the allowable limits under TANF. In general, a family of four must have a monthly income of less than $2,297 to qualify for food stamps. Welfare, on the other hand, is designed as a last resort.

The average monthly welfare benefit in 2006, which reflects the most current data collected by the government, was $372.

Article continues here.

Saturday, June 20, 2009

The obtuseness of macroeconomics

Consider The Economist’s Romer roundtable:  Debt will keep growing.

Not one macroeconomist acknowledges what I believe to be the true cause of the current collapse of effective demand, the extreme skewness of the income distribution and the attendant indebtedness and inability to spend at previous levels of the bottom half or better of the household income distribution.  My reference rant on this subject is here

The macroeconomists keep talking about “monetary stimulus” and “fiscal stimulus” as if they’re talking about stepping on the accelerator of a gasoline internal combustion engine.  Except that the engine is running on one cylinder, and if they “prime” the engine, all the gasoline is only going to fire on one cylinder, the one that’s getting the gas—in terms of this metaphor, the rich folks at the top of the currently neo-feudal pecking order.

The fiscal and monetary stimuli of the Great Depression failed to make the income distribution more equal, and failed to reduce unemployment to reasonable levels.  Most households weren’t participating in the flow of income to a sufficient degree for that to happen.

It’s time for the policymakers to realize that the economy is in the middle of a vast transition from a debt-financed consumption-heavy economy to one that is higher saving and more investment oriented.  That’s a big change, one that will take years.  Businesses aren’t going to want to invest in capital formation for consumer markets when they won’t know what the prospective returns are until we burn off some of our excess capacity and consumption patterns stabilize, in sum and in composition, in some new configuration. 

It took World War II to equalize the American income distribution last time, a frightening thought.  I have no idea what it will take this time.

The best macroeconomic policy right now, and the only one we can afford, is to provide honorable workfare to the growing ranks of the unemployed—in part so that they do not become radicalized and alienated from America—and health benefits so that we don’t compound the losses of the current slump with avoidable sickness.

Macroeconomics in toto—the academic work plus the way it has entered policy—is a joke.  The Keynesians misinterpreted Keynes in the 1960s to fund a guns-and-butter expansion that blew up prices; somebody told Richard Nixon that putting on price controls while the Fed was pumping up the money supply would help cure the ‘Sixties inflation; we suffered through Jerry Ford and Jimmy Carter relearning the lesson of monetary history that to stop an inflation you have to slow down money growth, and Jimmy appointed Paul Volcker in 1978 to do that, ensuring that he, Carter, would be a one-term president; Ronald Regan came in and took credit for Carter’s decision, saying “stay the course,” and took advantage of the schadenfreude generated among the majority of the population to lower tax rates on the rich in the massive con known as “supply side economics” (the tax cuts were supposed to reduce the federal deficits, but instead, Reagan started the growth of federal debt on the meteoric rise that George W. Bush consummated with his massive tax-cuts-for-the-rich-and-a-stupid-war-to-boot that have put us so deep in the hold).  And at every step, a credible, academically certified macroeconomist or ten has stood ready to offer “proof” of why these were going to be the right policies.

It’s time to give the macroeconomists some time off, a collective sabbatical, perhaps.  Let’s concentrate on people, the American people, by providing, quite simply, a means for them to survive the crisis that was not of their own making; by providing a livable dole, as they call welfare in Europe, in the form of workfare, while these people look for jobs in a recovering private sector.  Let’s not plunge the federal budge into massive deficits with pork-barrel projects that will provide yet another opportunity for the massively corrupt, money-compromised federal government to prove how corrupt it is in handing out taxpayers’ money.

There are 25 million unemployed and underemployed people in America right now.  That number could easily double within five years.

Because if we’re taking care of the people, won’t the rest work itself out?  I can’t get on board with the ultra-conservatives who say “do nothing,” because it is plainly evident that doing nothing will cause human misery, waste of productive potential, and ultimately, I believe, a revolution or severe repression in the United States of America.

But listening to macroeconomists talking about the dangers of “withdrawing the stimulus too early” makes me gag.  So far the stimulus has done very little for the unemployed.  Look at who got the big windfalls from the banking crisis!  Goldman Sachs and a host of rich bankers!  Who’s going to get the rich government contracts that will come with the stimulus?  Beltway insiders, friends of the Democrats!

More direct aid to the unemployed may not do anything to equalize the income distribution.  More and more, I think such an outcome is a quasi-mystical occurrence that requires a national crisis (or not—we could settle into neo-feudalism). 

But let’s not become a nation of debt-slaves more than we already are.  America was the world’s greatest creditor in 1930—now we’re the greatest debtor.  Substantially more debt—which caused the problem we’re in now—could sink us.  Anyway, you can’t trust the macroeconomists.

Bail out the people directly.  Give them honorable work and a means to survive a crisis that is likely to last a decade.  The people know what to do with the money.  They will spend it well.  Keep the government and the macroeconomists du jour out of it.

Say no to a recourse refi

Via:  Market Ticker  Posted as a public service.  See also On the coming neo-feudalism 

The Dumbest Thing I've Seen Yet

President Obama and James Lockhart have decided to (financially) rape Americans.

Yes, really:

June 19 (Bloomberg) -- President Barack Obama’s program to help more homeowners refinance may be expanded to include borrowers who owe more than 105 percent of their homes’ values, Federal Housing Finance Agency Director James Lockhart said.

The Obama administration is considering allowing Fannie Mae and Freddie Mac to refinance loans with current loan-to-value ratios of 125 percent or higher, Lockhart said at a National Association of Real Estate Editors Association conference in Washington yesterday.

Let me be absolutely clear so nobody can ever accuse me of being less than straightforward on this.

If you are underwater on your house and take a deal like this, you are as dumb as a box of rocks and have just consented to being bent over the table and violated repeatedly.  That our government would propose "allowing" such a thing is fomenting financial rape upon The American Public.  Period.

Under conventional financing terms loan-to-value (LTV) ratios over 80% have required what is called "PMI" - private mortgage insurance.  The purpose of this is to guarantee for the lender that they can recover if you don't pay and, post-foreclosure, your home isn't worth enough to satisfy the mortgage.

One of the reasons for this requirement is that in most states purchase money first mortgages are non-recourse.  That is, if you default they can take the house and ruin your credit - but it ends there.  In those states they cannot pursue you beyond foreclosure and reclamation of the house.

In every state if you refinance the resulting mortgage is a recourse loan, which means they can sue you for any deficiency if you subsequently default and come after any other assets (other than retirement funds - which is why you NEVER EVER raid a 401k or IRA to stay afloat!) and even try to get a wage garnishment - and they just might!

For this and other reasons nobody should ever refinance a mortgage that is in trouble without getting qualfiied legal and accounting advice.  It could be the cheapest $500 you ever spend.

President Obama's original "refi" program exempted LTVs from 80-105% from PMI requirements, ostensibly as a way of "helping" homeowners.  What it really did was rape the taxpayer, because such loans are very dangerous in that if there is a subsequent default the lender will, after expenses, almost always lose money, and may lose a LOT of money.

We have since discovered that the majority of "refinanced" workout loans default again, because the underlying problem is that the buyer used exotic financing to get around their inability to actually cover the fully-amortizing payment of a conventional mortgage.  When faced with a fully-amortizing payment, even when restructured, they re-default because they bought through a fraudulent device - they were never able to afford the house in the first place.

This plan will not change that. 

Only one thing will change that: lower house prices.

But see, the NARites and other politically-connected rubes will not allow the truth to be told, or the market to assert itself so long as the government can bury you in insoluble debt.

The Chinese and Japanese will fully rise (they're already half-awake) soon and when they do, the curtain will be called down on this stupidity via the bond market.  Indeed, the blow-out of MBS spreads yesterday might have been due to a leak of this stupidity - there is no more-certain way to guarantee that Fannie and Freddie, now wards of the Federal Government, will detonate and leave a thermonuclear-sized hole in the Federal balance sheet than this piece of stupidity.


Thursday, June 18, 2009

How to compound systemic risk—the Obama plan

The Obama plan is exactly backwards in its approach to systemic risk.  It will increase systemic risk.

As pointed out by one of the leaders of econophysics, Eugene Stanley (here), one of the prime results in the exploding field of network theory is that densely connected networks are chaotic and unstable compared to sparsely connected networks.

This only makes sense.  If every part of a network affects every other part of a network it becomes very easy for large perturbations to propagate through the network, and rebound, and so on. 

The Obama-Summers-Geithner solution to our problem of systemic risk is evidence of an intellectual obtuseness that is breathtaking.

The Fed created or permitted by neglect of its duties the systemic risk that caused this crash, and the Great Depression before it.  Mish got this right. 

The obvious solution given that systemic risk is a characteristic of the structure of the financial system is to change the structure of the system to reduce systemic risk.  Break up investment banks and commercial banks.  Eliminate financial institutions that are big enough to create systemic risk all by themselves (no more “too big to fail”).  Make it impossible for the system to become densely connected by limiting leverage.  The plan does increase capital requirements but not enough.  And it leaves the trading of CDSs, the densely-linked network of derivatives that largely caused the supposed near melt-down of the system last fall, lightly regulated and less than transparent. 

You can’t leave the TBTF institutions in place, or they will capture the regulators again.  Or perhaps it’s better to say they’re not letting them go at this time.

Glass-Steagall and the other laws that the neocons undid over the past thirty years worked.  They kept the system stable for sixty years.

Let’s bring them back. 

Here is Simon Johnson’s take:

Too Big To Fail, Politically

What is the essence of the problem with our financial system – what brought us into deep crisis, what scared us most in September/October of last year, and what was the toughest problem in the early days of the Obama administration?

The issue was definitely not that banks and nonbanks could fail in general.  We’re good at handling some kinds of financial failure.  The problem was: a relatively small number of troubled banks were so large that their failure could imperil both our financial system and the world economy.  And – at least in the view of Treasury – these banks were so large that they couldn’t be taken over in a normal FDIC-type receivership.  (The notion that the government lacked legal authority to act is smokescreen; please tell me which statute authorized the removal of Rick Waggoner from GM.)

But instead of defining this core problem, explaining its origins, emphasizing the dangers, and addressing it directly, what do we get in yesterday’s 101 pages of regulatory reform proposals?

  1. A passive voice throughout the explanation of what happened (e.g., this preamble).  No one did anything wrong and banks, in particular, are absolved from all responsibility for what has transpired.
  2. A Financial Services Oversight Council, which sounds like a recipe for interagency feuding, with the Treasury as the referee and – most important – provider of the staff.  The bureaucratic principle is: if you hold the pen, you have the power.
  3. Some of the largest banks (”Tier 1 Financial Holding Companies”, or Tier 1 FHCs) will now be subject to supervision by the Federal Reserve Board – although under the confusing jurisdiction also of the Financial Services Oversight Council in many regards (e.g., in the key setting of material prudential standards) and subsidiaries can have other regulators.
  4. Tier 1 FHC should have higher prudential standards (capital, liquidity and risk management), but “given the important role of Tier 1 FHCs in the financial system and the economy, setting their prudential standards too high could constrain long-term financial and economic development.”  Sounds like a banker drafted that sentence.  None of the important details/numbers are specified, although the Fed should use “severe stress scenarios” to assess capital adequacy.  Is that the same kind of actually-quite-mild stress scenario they used earlier this year?
  5. In terms of risk management, “Tier 1 FHCs must be able to identify aggregate exposures quickly on a firm-wide basis.”  There is no notion here that risk management at these big banks has failed completely and repeatedly over the past two years.  How exactly will FHCs be able to identify such risks and how will the Fed (or anyone else) assess such identification?
  6. In case you weren’t sufficiently confused by the overlapping regulatory authorities in this plan, we’ll also get a National Bank Supervisor (NBS) within Treasury.  Regulatory arbitrage is not gone, just relabeled (slightly).
  7. There is no greater transparency or public accountability in the regulatory process.  We still will not know exactly what regulators decided and on what basis.  Such secrecy, at this stage in our financial history, clearly prevents proper governance of our supervisory system.
  8. There appears to be no mention that corporate governance within these large banks failed totally.  How on earth can you expect these banks to operate in a responsible manner unless and until you address the reckless manner in which they (a) compensate themselves, (b) destroy shareholder value, (c) treat boards of directors as toothless wonders?  The profound silence on this point from the administration – including some of our finest economic, financial, and legal thinkers – is breathtaking.

There’s of course more in these proposals, which I review elsewhere and Secretary Geithner’s appearances on Capitol Hill today may be informative – although only if his definition of the underlying “too big to fail” issue uses much stronger language than yesterday’s written proposals.

But based on what we see so far, there is little reason to be encouraged.   The reform process appears to be have been captured at an early stage – by design the lobbyists were let into the executive branch’s working, so we don’t even get to have a transparent debate or to hear specious arguments about why we really need big banks.

Writing in the New York Times today, Joe Nocera sums up, “If Mr. Obama hopes to create a regulatory environment that stands for another six decades, he is going to have to do what Roosevelt did once upon a time. He is going to have make some bankers mad.”

Good point – but Nocera is thinking about the wrong Roosevelt (FDR).  In order to get to the point where you can reform like FDR, you first have to break the political power of the big banks, and that requires substantially reducing their economic power - the moment calls more for Teddy Roosevelt-type trustbusting, and it appears that is exactly what we will not get.

By Simon Johnson

Wednesday, June 17, 2009

On the coming neo-feudalism

It does seem as if the vast majority of people in the United State of America are going to become like medieval serfs, living at what feels in the post-gilded-age new realities like subsistence, watching a small slice of society from a distance as they jet in and out of the country, monopolize the ski resorts, continue to live in big houses with two or three thousand square per person, and so on.

The Baby Boom doesn’t have enough money to retire (quaint notion) and will be working till they drop, which will actually extend their lives.  The Gen X’ers will continue to live on scraps.  The Millennials are idealistically waiting their turn to be heroes while trying to find a way to support themselves in a workforce that is top-heavy with whining Boomers and cagey Gen X’ers.  Most of us will work for large or small corporations at a wage that is enough to support a modest lifestyle, but holidays will be spent close to home.  We will worry that we may be next to join the ranks of the unemployed, many of whom and whose stories we know—stories of lost jobs, houses, children’s sense of security in forced moves to strange communities.  The health consequences of the current crisis are no doubt predictable.  In a PBS special on other countries’ health programs, a German was asked if unemployed people lose their health benefits there.  Of course not, he said.  They are under great stress and risk to their health.  They need health benefits more than anyone. 

For a developed nation, America is a barbaric place.

Demand will not recover.  The Stimulus, piling upon preexisting terrifying trillions in deficits courtesy of Bush, will not work.  Spending will be cut to satisfy our external creditors.  The sheer weight of the debt will slow the economy.  The narrow U3 unemployment rate will rise into the double digits and stay there through the president’s term.  The “real” under- and unemployment rate U6 will hit twenty percent, and stay in the high teens. 

The poor and disenfranchised may even take to the streets at some point.  Americans are pretty timid now, worried that they’ll be called terrorists and disappear in the night or be put on the no-fly list.  Habeas corpus is gone.  Last September Hank Paulson said we may need martial law.  The government has been preparing for it.  There are empty prison camps standing ready, according to reliable reports.  (Many were built by Halliburton, allegedly.)  The Katrina experience showed us what to expect:  mercenaries will disarm the public; impose martial law; tell you to stay in your house or get shot.  FEMA’s National Level Exercise scheduled for late July is supposedly a counter-terrorism drill, but I would bet it involves practicing how to impose martial law.  Some believe the true purpose of the exercise itself will be to disarm the public.  Lots of luck with that.  That might provoke the first shots of a revolution.  But perhaps that is the intent, to show force and discourage any further dissent.  Like Iran now.  Like China twenty years ago.

Will President Obama be able to prevent this?  I don’t think so.  His government has thrown trillions at financial institutions, but we don’t even have workfare or income support for the long-term unemployed, and not everyone is even covered by unemployment insurance.  There are 25 million people in the U6 category today.  What happens when there are 50 million?  Will the government help them, or try to lock them all up?  We have a higher percentage of our population behind bars than any other developed country.  Will the fortunate just sit in their houses and hope that the Xe guys (formerly Blackwater—great name for a mercenary outfit) will protect them and their property from roving gangs? 

Americans have lost confidence in their government and themselves.  Their elected representatives do not listen to them.  The President is an agent of the status quo.  He has enabled the largest wealth transfer to a privileged elite in American history during the financial crisis, at the expense of the American taxpayer for years to come.  Does any American believe the new financial regulations will break the grip of the rich upon the resources of the nation?  Will we all come together all can-do, gung-ho style and pitch in together and the income distribution suddenly become more equal as it did in World War II and pull ourselves out of this? 

It ain’t happening.

These problems, of course, are replicated in many other countries, including our ostensible long-term rival and enemy, China.  Which is why the next ten years are a breeding ground for fascism around the world, and for the seeds of war.  We went into Iraq to build military bases to protect “our” oil, if push comes to shove.  But our military policies are backward-looking to the last war, as John Robb and others point out.  We will look pretty stupid when someone pulls off what Robb calls a systempunkt right here at home while we’re blowing billions in Afghanistan.  We don’t require our kids to get educated well.  Obama is backing off a single-payer health insurance plan, the one preferred by the American people and the one that makes the most sense from an insurance point of view.  The American social contract is broken.

People say Europe will be a museum in a decade, a lot of pretty castles and tourist attractions and mamoni hanging around at cafes.  America might be like a ski resort, with some beautiful neighborhoods in the cities and trailer parks outside where the workers and retired people live.  The Chinese will buy up real estate and companies and immigrate in large numbers, as they did to Vancouver from Hong Kong, having bought enough members of Congress to get their way.  They won the financial war, fair and square.  They might even teach us how to make state capitalism work, as the Japanese taught us how to make quality automobiles.

Or we could try democracy, for a change.

A glance at the NIPA data from Q1


Consumption appears to have stabilized after the portion due to the housing ATM was deducted in third and fourth quarter 2008, but at 71 percent of GDP is still quite high.  Investment and goods exports were the big losers in Q1.  Government’s contribution was slightly negative, surprisingly.  The effects of the stimulus have yet to be felt from government spending directly.

With industrial capacity utilization at 67 percent and weakened consumer demand and higher saving, derived investment demand (from consumer demand) is likely to remain weak for some time, although I expect an upturn from current extremely depressed levels about yearend. 


Gross domestic product



Personal consumption expenditures



Nonresidential investment



Residential investment



Change in private inventories



Net exports



Government expenditures



I persist in thinking that the problem of achieving appropriate levels of aggregate demand would be best achieved by providing the unemployed with a livable dole in the form of workfare and health benefits while they seek private sector employment.  America is going to have to come to something like this if external funding does not appear for our deficits.  We don’t save enough to finance them.  Triage will be necessary.  Reminds me of a line from an old Supertramp song, “Soapbox Opera”:

I said father Washington, you’re all mixed up,
Collecting sinners in an old tin cup.

Tuesday, June 16, 2009

‘Animal spirits’ and the election cycle

Just for kicks I have forecast unemployment to rise to over 12 percent over the next 18 months on the assumption that the NBER will declare an end to the recession to have occurred in about mid-2009 and for unemployment to rise another 18 months after that, somewhat more than after the last recession.  Unemployment then declines at a typical rate through April 2013.


“Animal spirits” climb to about zero in time for the next presidential election.  It will probably be a bitterly contested election, perhaps with a third party spoiling the Republicans again.  With soft labor markets and excess capacity in manufacturing, the only inflation threat is a supply shock that will not require the Fed to raise rates. 

Any double-dip recession coming before the next “scheduled” recession in 2014 will be signaled well in advance (as in 1981) by an inversion of the 1/10 Treasury yield curve.  Such an inversion will be caused not by inflation but by failing Treasury bill auctions requiring the Fed to raise short-term rates.  Just as one of the largest tax increases in history followed Ronald Reagan’s massive tax cuts in 1981, when the “supply side miracle” didn’t happen, so Barack Obama and his Congress will probably be obliged to make some of the largest cuts in government spending in history when his stimulus fails to convince our external funders of its success (sse previous post).  There is no “recession” in the NBER sense in sight in the next 12 months or more (see last update).


What comes after April 2013, the last month in the forecast period?  That looks to me like the set-up to a short expansion as in the early 1970s, when inflation surged, the Fed tightened, and the economy fell into deep recession. 

The danger of the increasing though still negative "animal spirits” over the next four years is to foster a sense of complacency that precludes real action on the fiscal problems America faces.  The next slump may qualify as a depression by anyone’s definition.

Reference:  Animal spirits in America, April 2009

Tight Spot for Fed, Blind Spot for Investors

Via:  h/t Zero Hedge.  Pretty well sums up the macro circus of the last four decades.  I liked the fact that he recognizes the role of “animal spirits” in what’s happening now.

Market chatter over green shoots and rising prices has fueled a bear market rally that won't last, despite policymaker 'noise.'

By Andy Xie, guest economist to Caijing and a board member of Rosetta Stone Advisors Ltd.

(Caijing Magazine) A combination of growth optimism and inflation fear has catapulted asset markets in the past few weeks. These two concerns should drive markets in different directions: Inflation fear, for example, should limit room for stimulus and prompt stock markets to retreat. But the investment camps expressing these opposite concerns go separate ways, each pumping up what seems believable. As a result, stock and commodity markets are mirroring the behavior seen during the giddy days of 2007.

Regardless of what investors or speculators say to justify their punting, the real driving force is the return of animal spirit. After living in fear for more than a year, they just couldn't sit around any longer. So they decided to inch back. The resulting market appreciation emboldened more people. All sorts of theories began to surface to justify the market trend. Now that the rising trend has been around for three months globally and seven months in China, even the most timid have been unable to resist. They're jumping in, in droves.

When the least informed and most credulous get into the market, the market is usually peaking. A rising economy and growing income produces more funds to fuel the market. But the global economy is now stuck with years of slow growth. Strong economic growth won't follow the current stock market surge. This is a bear market rally. People who jump in now will lose big.
Over the past three weeks, the dollar dove while oil and treasury yields surged. These price movements exhibited typical symptoms of inflation fear, which is complicating policymaking around the world. The United States, in particular, could be bottled in. The federal government's fiscal stimulus and liquidity pumping by the Federal Reserve are twin instruments for propping up the bursting U.S. economy. The fiscal deficit could top US$ 2 trillion (15 percent of GDP) in 2009. That would increase by one-third the total stock of federal government debt outstanding. Such a massive amount of federal debt paper needs a buoyant Treasury to absorb. If the Treasury market is a bear market, absorption becomes a huge problem.

U.S. Treasury Secretary Timothy Geithner recently visited China to, among other things, persuade China to buy more Treasuries. According to a Brookings Institution estimate, China holds US$ 1.7 trillion in U.S. Treasuries and GSE paper (about 15 percent of the total stock). If China stops buying, it could plunge the Treasury market into deep bear territory. If China does not buy, the Treasury market will get worse. But China can't prop up the market by buying.

In the past few years, purchases by central banks around the world have dominated demand for Treasuries. Central banks have been buying because their currencies are linked to the dollar. Hence, such demand is not price sensitive. The demand level is proportionate to the U.S. current account deficit, which determines the amount of dollars held by foreign central banks. The bigger the U.S. current account deficit, the greater the demand for Treasuries. This is why the Treasury yield was trending down during the bulging U.S. current account deficit period 2001-'08.

This dynamic in the Treasury market was changed by the bursting of the U.S. credit-cum-property bubble. It is decreasing U.S. consumption and the U.S. current account deficit. The 2009 deficit is probably under US$ 400 billion, halved from the peak. That means non-U.S. central banks have much less money to buy, while the supply is surging. It means central banks no longer determine Treasury pricing. American institutions and families are now marginal buyers. This switch in who determines price is shifting Treasury yields significantly higher.

The 10-year Treasury yield historically averages about 6 percent, with about 3.5 percent inflation and a real yield of 2.5 percent. This reflects the preferences of marginal buyers in the United States. Foreign central banks have pushed down the yield requirement substantially over the past seven years. If marginal buyers become American again, as I believe, Treasury yields will surge even higher from current levels. Future inflation will average more than 3.5 percent, I believe. Some policy thinkers in the United States believe the Fed should target inflation between 5 and 6 percent. The Treasury yield could rise to between 7.5 and 8.5 percent from the current 3.5 percent.

A massive supply of Treasuries would only worsen the market. The Federal Reserve has been trying to prop the Treasury market by buying more than US$ 300 billion – a purchase that's backfired. Treasury investors are terrified by the inflation implication of the Fed action. It is equivalent to monetizing national debt. As the federal deficit will remain sky-high for years to come, the monetization could become much larger, which might lead to hyperinflation. This is why the Treasury yield has surged in the past three weeks.

One possible response is to finance the U.S. budget deficit with short-term financing. As the Fed controls short-term interest rates, such a strategy could avoid the pain of high interest rates. But this strategy could crash the dollar.

The dollar index-DXY has fallen 10 percent from the March level, even though the U.S. trade deficit has declined substantially. It reflects the market's expectations that the Fed's monetary policy will lead to inflation and a dollar crash. The cause of dollar weakness is the outflow of U.S. money, in my view. It is the primary cause of a surge in emerging markets and commodities. Most U.S. analysts think the dollar's weakness is due to foreigners buying less of it. This is probably incorrect.

The dollar's weakness can limit Fed policy options. It heightens inflation risks; a weak dollar imports inflation and, more importantly, increases inflation expectations, which can be self-fulfilling in today's environment. The Fed has released and committed US$ 12 trillion (83 percent of GDP) for bailing out the financial system. This massive overhang in money supply could cause hyperinflation if not withdrawn in time. So far, the market is still giving the Fed the benefit of the doubt, believing it will indeed withdraw the money. Dollar weakness reflects the market's wavering confidence in the Fed. If the wavering continues, it could lead to a dollar collapse and make inflation self-fulfilling.

The Fed may have to change its stance, even using token gestures, to assure the market it won't release too much money. For example, signaling rate hikes would soothe the market. But the economy is still in terrible shape; unemployment may surpass 10 percent this year. Any suggestion of hiking interest rates would dampen growth expectations. The Fed is caught between a rock and a hard place.

Oil prices have doubled since a March low, even though global demand continues to decline. The driving forces again are expectations of inflation and a weaker dollar. As U.S.-based funds flee, some of the money has flowed into oil ETFs. This initially impacted futures prices, creating a huge gap between cash and futures prices. The gap increased inventory demand as investors tried to profit from the gap. Rising inventory demand caused spot prices to reach parity with futures prices. Rising oil prices, though, lead to inflation and depress growth. It is a stagflation factor. If the Fed doesn't rein in weak dollar expectations, stagflation will arrive sooner than I previously expected.

Stagflation in the 1970s spawned the development of rational expectation theory in economics. Monetary stimulus works by fooling people into believing in money's value while the central bank cheapens it. This perception gap stimulates the economy by fooling people into demanding more money than they should. Rational expectation theory clarified the underpinning for Keynesian liquidity theory. However, as they say, people can't be fooled three times. Central banks that tried to use stimuli to solve structural problems in the '70s saw their stimuli didn't work. People saw through what they tried again and again, and began behaving accordingly, which translated monetary stimulus straight into inflation without stimulating economic growth.

Rational expectation theory discredited Keynesian theory and laid the foundation for Paul Volker's tough love policy, which jagged up interest rates and triggered a recession. The recession convinced people that the central bank was serious about cooling inflation, so they adjusted their behavior accordingly. Inflation expectations fell sharply afterward. The credibility that Volker brought to the Fed was exploited by Alan Greenspan, who kept pumping money to solve economic problems. As I have argued before, special factors made Greenspan's approach effective at the same. Its byproduct was asset bubbles. As the environment has changed, rational expectation theory will again exert force on the impact of monetary policy.

Movements in Treasury yields, oil and the dollar underscore the return of rational expectation. Policymakers have to take actions to dent the speed of its returning. Otherwise, the stimulus will lose traction everywhere, and the global economy will slump. I expect at least gestures from U.S. policymakers to assuage market concerns about rampant fiscal and monetary expansion. The noise would be to emphasize the "temporary" nature of the stimulus. The market will probably be fooled again. It will fully wake up only in 2010. The United States has no way out but to print money. As a rational country, it will do what it has to, regardless of its rhetoric. This is why I expect a second dip for the global economy in 2010.

While inflation expectations are causing some in the investor community to act, the rest are betting on strong economic recovery. Massive amounts of money have flowed into emerging markets, making it look like a runaway train. Many bystanders can't take it any longer and are jumping in. Markets, after trending up for three months, are gapping up. Unfortunately for the last-minute bulls, current market movements suggest peaking. If you buy now, you have a 90 percent chance of losing money when you try to get out.

Contrary to all the market noise, there are no signs of a significant economic recovery. So-called green shoots in the global economy are mostly due to inventory cycles. Stimuli might juice up growth a bit in the second half 2009. Nothing, however, suggests a lasting recovery. Markets are trading on imagination.

The return of funds flowing into property is even more ridiculous.  A property burst usually lasts for more than three years. The current burst is larger than usual. The property market is likely to remain in bear territory for much longer. The bulls are talking about inflation as the bullish factor for property. Unfortunately, property prices have risen already and need to come down even as CPI rises. Then the two can reach parity.

While rational expectation is returning to part of the investment community, most investors are still trapped by institutional weakness, which makes them behave irrationally. The Greenspan era has nurtured a vast financial sector. All the people in this business need something to do. Since they invest other people's money, they are biased toward bullish sentiment. Otherwise, if they say it's all bad, their investors will take back the money, and they will lose their jobs. Governments know that, and create noise to give them excuses to be bullish.

This institutional weakness has been a catastrophe for people who trust investment professionals. In the past two decades, equity investors have done worse than those who held U.S. market bonds, and who lost big in Japan and emerging markets in general. It is astonishing that a value-destroying industry has lasted so long. The greater irony is that salaries in this industry have been two to three times above what's paid in other sector. The key to its survival is volatility. As markets collapse and surge, possibilities for getting rich quickly are created. Unfortunately, most people don't get out when markets are high, as they are now. They only take a ride.

Indeed, most people who invest in the stock market get poorer. Look at Japan, Korea and Taiwan: Even though their per capita incomes have risen enormously over the past three decades, investors in these stock markets lost money. Economic growth is a necessary but not sufficient condition for investors to make money in the stock market. Most countries, unfortunately, don't possess the conditions for stock markets to reflect economic growth. The key is good corporate governance. It requires rule of law and good morality. Neither is apparent in most markets.

It's a widely accepted notion that long term stock investors make money. Actually, this is not true. Most companies don't last for more than 20 years. How can long term investment make money for you? The bankruptcy of General Motors should remind people that this notion is ridiculous. General Motors was a symbol of the U.S. economy, a century-old company that succumbed to bankruptcy. In the long run, all companies go bankrupt.

Property on the surface is better than the stock market. It is something physical that investors can touch. However, it doesn't hold much value in the long run either. Look at Japan: Its property prices are lower than they were three decades ago. U.S. property prices will likely bottom below levels of 20 years ago, after adjusting for inflation.

China's property market holds even less value in the long run. Chinese properties are sitting on land leased for 70 years for residential properties and 50 years for commercial properties. Their residual values are zero at the end. The hope for perpetual appreciation is a joke. If you accept zero value at the end of 70 years, the property value should only be the use value during those 70 years. The use value is fully reflected in rental yield. The current rental yield is half the mortgage interest rate. How could properties not be overvalued? The bulls want buyers to ignore rental yield and focus on appreciation. But appreciation in the long run isn't possible. Depreciation is, as the end value is zero.

The world is setting up for a big crash, again. Since the last bubble burst, governments around the world have not been focusing on reforms. They are trying to pump a new bubble to solve existing problems. Before inflation appears, this strategy works. As inflation expectation rises, its effectiveness is threatened. When inflation appears in 2010, another crash will come.
If you are a speculator and confident you can get out before it crashes, this is your market. If you think this market is for real, you are making a mistake and should get out as soon as possible. If you lost money during your last three market entries, stay away from this one – as far as you can.