Friday, August 28, 2009

Consumer confidence weak; finances abysmal

Via:  Yahoo finance

Consumer mood at four-month low

NEW YORK (Reuters) - U.S. consumer confidence fell to its lowest in four months in August on worries over high unemployment and dismal personal finances, though the mood managed to improve from earlier this month, a survey showed on Friday.

The Reuters/University of Michigan Surveys of Consumers said its final index of confidence for August fell to 65.7 from 66.0 in July.

That was the lowest since 65.1 in April but above economists' expectations for 64.5 and also higher than this month's preliminary reading of 63.2

"Confidence rebounded in late August as consumers increasingly expected improved conditions in the national economy even as they reported the worst assessments of their finances since the surveys began in 1946," the report said.

Consumers rated the current economic conditions the worst since March, when the stock market hit 12-year lows. This index fell to 66.6 from 70.5 in July. However this was also an improvement from 64.9 earlier this month.

Consumers' one-year inflation expectations fell to 2.8 percent from July's 2.9 percent. Five-year inflation expectations also dropped to 2.8 percent from July's 3.0 percent.

This slight drop is consistent with the usual level of noise in the Consumer Sentiment series.  Given the unemployment rate forecast shown (or considerably worse) the cycle is set to stagger forward to 2013 or 2014 when I expect the debt “death spiral” to kick in.  In my view it is very unfortunate that the policymakers will probably use the facsimile of a normal expansion to do nothing significant to reform the political economy. 

Next “animal spirits” update September 4.


It’s the debt *and* the politics, stupid

Paul Krugman has a good liberal heart but his attachment to macroeconomic figments has made him more than a little obtuse.  The bigger the deficit the better, says Paul, if it worked in World War II it will work this time.  But this flies in the face of history.  As Emmanual Saez has shown, WWII produced a miraculous equalization of the income distribution, which did not equalize much as a result of the New Deal.  Some hoped that 9/11 would be the “Pearl Harbor of the twenty-first century” to produce a similar result but it clearly didn’t.  The banking bailouts showed us how the government spends our money:  it distributes it according to the existing income distribution, with most going to the richest Americans.  And America now has a greater aggregate debt load than it did in 1929 (see this). 

As regular readers know, I propose giving a livable workfare and health coverage to the unemployed and involuntarily working part-time, now 25 million people, before spending a nickel on anything else.  They will spend the money wisely; research has shown that the bang for the buck is highest from direct income transfers like this (reference). 

The social contract is broken, Paul.  I’d like to hear your thoughts on how to remedy a broken social contract.  My proposal is hardly revolutionary, as it can be viewed as a way of keeping the people most likely to want wholesale change happy with their lot—but it addresses immediate human need and is better than validating the debt “death spiral” that you seem to be advocating, and that is much more likely to lead to revolutionary change—and war. 

Till Debt Does Its Part


So new budget projections show a cumulative deficit of $9 trillion over the next decade. According to many commentators, that’s a terrifying number, requiring drastic action — in particular, of course, canceling efforts to boost the economy and calling off health care reform.

The truth is more complicated and less frightening. Right now deficits are actually helping the economy. In fact, deficits here and in other major economies saved the world from a much deeper slump. The longer-term outlook is worrying, but it’s not catastrophic.

The only real reason for concern is political. The United States can deal with its debts if politicians of both parties are, in the end, willing to show at least a bit of maturity. Need I say more?

Let’s start with the effects of this year’s deficit.

There are two main reasons for the surge in red ink. First, the recession has led both to a sharp drop in tax receipts and to increased spending on unemployment insurance and other safety-net programs. Second, there have been large outlays on financial rescues. These are counted as part of the deficit, although the government is acquiring assets in the process and will eventually get at least part of its money back.

What this tells us is that right now it’s good to run a deficit. Consider what would have happened if the U.S. government and its counterparts around the world had tried to balance their budgets as they did in the early 1930s. It’s a scary thought. If governments had raised taxes or slashed spending in the face of the slump, if they had refused to rescue distressed financial institutions, we could all too easily have seen a full replay of the Great Depression.

As I said, deficits saved the world.

In fact, we would be better off if governments were willing to run even larger deficits over the next year or two. The official White House forecast shows a nation stuck in purgatory for a prolonged period, with high unemployment persisting for years. If that’s at all correct — and I fear that it will be — we should be doing more, not less, to support the economy.

But what about all that debt we’re incurring? That’s a bad thing, but it’s important to have some perspective. Economists normally assess the sustainability of debt by looking at the ratio of debt to G.D.P. And while $9 trillion is a huge sum, we also have a huge economy, which means that things aren’t as scary as you might think.

Here’s one way to look at it: We’re looking at a rise in the debt/G.D.P. ratio of about 40 percentage points. The real interest on that additional debt (you want to subtract off inflation) will probably be around 1 percent of G.D.P., or 5 percent of federal revenue. That doesn’t sound like an overwhelming burden.

Now, this assumes that the U.S. government’s credit will remain good so that it’s able to borrow at relatively low interest rates. So far, that’s still true. Despite the prospect of big deficits, the government is able to borrow money long term at an interest rate of less than 3.5 percent, which is low by historical standards. People making bets with real money don’t seem to be worried about U.S. solvency.

The numbers tell you why. According to the White House projections, by 2019, net federal debt will be around 70 percent of G.D.P. That’s not good, but it’s within a range that has historically proved manageable for advanced countries, even those with relatively weak governments. In the early 1990s, Belgium — which is deeply divided along linguistic lines — had a net debt of 118 percent of G.D.P., while Italy — which is, well, Italy — had a net debt of 114 percent of G.D.P. Neither faced a financial crisis.

So is there anything to worry about? Yes, but the dangers are political, not economic.

As I’ve said, those 10-year projections aren’t as bad as you may have heard. Over the really long term, however, the U.S. government will have big problems unless it makes some major changes. In particular, it has to rein in the growth of Medicare and Medicaid spending.

That shouldn’t be hard in the context of overall health care reform. After all, America spends far more on health care than other advanced countries, without better results, so we should be able to make our system more cost-efficient.

But that won’t happen, of course, if even the most modest attempts to improve the system are successfully demagogued — by conservatives! — as efforts to “pull the plug on grandma.”

So don’t fret about this year’s deficit; we actually need to run up federal debt right now and need to keep doing it until the economy is on a solid path to recovery. And the extra debt should be manageable. If we face a potential problem, it’s not because the economy can’t handle the extra debt. Instead, it’s the politics, stupid.

Wednesday, August 26, 2009

How can change come?

For me the litmus test of whether Bernanke will ultimately fail and lead the country into deeper depression—or whether he will reform the financial system—begins with this:  now that the immediate crisis is averted, over coming months does he weed out the bad debts and bad banks, letting the losses fall where they should according to law, or will he attempt to sweep them under the carpet as I suggested yesterday, to try to make them disappear into the black hole of the Fed?  The latter would complete the massive transfer of wealth from ordinary Americans to the financial elite that Hank Paulson initiated.  If Bernanke temporizes and “lets zombie banks run” we are assured a prolonged liquidity trap, more asset bubbles as the Goldman Sachs’s and other trading banks take advantage of free money from the Fed, and a grinding immiseration of the national psyche. 

My proposal for fiscal policy is to provide livable workfare and health benefits to the unemployed before spending a nickel on anything else.  Ron Paul suggests bringing troops home to pay for national health insurance—that at this moment in history to cut everyone loose as his libertarian principles would require would be inhumane.  If the fiscal stimulus is distributed anything like the financial bailouts were, it will go to the richest Americans.  The political system has been corrupted by money and serves moneyed interests above all others. 

Let’s forget macroeconomic models, “fiscal stimulus” and “quantitative easing.”  Let’s concentrate on the American people.  The nation is a fiscal basket case—and the people don’t trust the government to spend their money any more.  They didn’t agree with the bailouts and no one listened to them.  They’re right to be concerned with the deficits.  They don’t trust the financial markets any more.  They have no idea how to invest their growing savings.

Let’s stop all the academic nonsense and help out the American people.  The American empire is showing all the classic signs of elitist, hubristic collapse.  It never ceases to amaze me how even commentators on the left can ignore what’s going on right under their noses while debating macroeconomic figments.  In this context the way that most of academic economics has circled its wagons to support Bernanke is particularly pathetic.  They did the same for Greenspan, while it was the “tinfoil hats” who were critical.

How does change come when the President and Congress are so clearly compromised?

Tuesday, August 25, 2009

The Fed as black hole into which losses disappear?

Via:  Slate  When all this bad debt that the Fed is taking in begins to default, and the Fed has to write down the loss, are the “selling” bank’s reserves reduced accordingly?  Or is this really a sale?  Does the Treasury have to come up with the scratch, or do the losses disappear forever in the black hole that is the Fed? 

The Next Credit Bubble Is Now
Are you ready for a replay?
By Heidi N. Moore
Posted Tuesday, August 25, 2009 - 1:07am

Mortgage-backed securities—and the bankers who loved them—wreaked havoc last year, helping to pitch us into the deepest downturn since the Great Depression. Are you ready for a replay?

Gird your loins. The signs are growing that there's a new Wall Street gold rush under way—for those complex bundles of mortgage loans that fueled banks' profits between 2005 and 2007. This year, prices for mortgage-backed securities are rocketing as federal stimulus dollars flood the market. But the difference with this "boom" is the center of gravity has shifted: from giddy, cowboy bankers to the Federal Reserve. The Fed is so eager to save banks, create a demand for these securities, and stabilize the housing market that it's taking troubled loans and mortgages onto its own books. The problem is the Fed may be in well over its head.

The Fed is cleaning up the old mortgage securities in the market—mostly old residential mortgage loans backed by Fannie Mae and Freddie Mac. But it will soon be on the hook for new ones, too, as troubled commercial mortgages are expected to fail en masse in a crash. The institution has already received $2.3 billion in requests to buy commercial mortgages. Indeed, investors are so eager to dump their commercial mortgage-backed securities on the Fed that they have spurred an outcry against Standard & Poor's, which has said it may tighten its ratings requirements to keep the more problematic loans out of government hands. Put simply, the holders of such securities don't want anything to stand in the way of getting on the federal gravy train.

Both types of assets are creating a shadow boom in unworthy debt, based on the same excessive leverage and questionable financial judgment of the last credit bubble. Plus the Fed is making some of the same mistakes as banks did in 2005-07. The banks forgot they were in the "moving" business-of underwriting mortgage-backed securities—and got into the "storage" business of keeping those securities on their books. That's where the Fed is now. It has not yet articulated an exit strategy to dump up to $800 billion of mortgages from its balance sheet.

And if you thought U.S. banks holding all those sketchy mortgages was a bad idea, wait until you see what happens when the center of our country's money supply is saddled with bad debt. The Fed could bail out the banks; no one can bail the Fed out.

It's partly a matter of sheer dollars. The Fed has dug itself in deep, spending $64 billion over the last four weeks and $741 billion this year as it plans to purchase $1.25 trillion of securities backed by agencies like Fannie Mae and Freddie Mac.

At the same time, prices for some residential mortgage-backed securities have jumped 40 percent or more this year to as high as 85 cents on the dollar, even though 9.24 percent of all U.S. mortgages are now delinquent. Analysts have warned that mortgage prices are overvalued. And when about one in every nine is heading for delinquency, buyers have to question the quality of all the bundles they are buying, no matter how highly rated. That is especially true as fewer and fewer homeowners manage to catch up on missed payments. Fitch Ratings, for instance, found that only 6.6 percent of homeowners holding prime loans managed to catch up on late payments as of July. As the Wall Street Journal noted, "That compares to an average of 45% for the years 2000 through 2006."

While the mortgage market is getting worse, the Fed is getting in deeper. In fact, the Fed never owned a Fannie-or-Freddie-backed mortgage before 2009 and now controls about 15 percent of that market, according to Credit Suisse (CS). No wonder Fannie and Freddie shares pitched precipitously upwards in Monday trading, by as much as 50 percent.. Perhaps investors are getting wise that the agencies are in for a long and very lucrative ride as the federal government supports their debt.

Plus, the Fed's buying spree has attracted the attention of investors looking to cash out on mortgage-backed securities: Everyone from Beijing to veteran investors is getting in on the action. Financial firms are forming real estate investment trusts—or pools of capital that buy mortgages-to buy distressed mortgages fast. Investors like hedge fund Third Point entered the market with a $160 million investment in the second quarter and quickly made a $20 million profit. John Costas, a former UBS employee who founded a fund that nearly took down the Swiss bank with bets on subprime mortgages, has just started a new firm to trade mortgages again. Of course, what Wall Street wants is a replay of the early 1990s, when savvy buyers of troubled mortgage-backed securities made a fortune by holding onto the toxic assets until the market came roaring back.

But the Fed should be driving a harder bargain instead of paying richly enough to create a boom. Not surprisingly, the hype for mortgage-backed securities is all in classic bubble language: Wall Street is just happy to have some business to do. Analysts goad on "vulture" investors in distressed mortgage securities by predicting returns of "several hundred percent" for savvy buyers who jump into the market now. Like many bubbles, however, those returns won't last forever. Eventually, supply and demand will fall out of whack again.

If the Fed wants to save banks and consumers by buying these securities, Wall Street is happy to play along. This boom will be hard to stop—and impossible to regulate—because it is spurred by the Fed. On the surface, everyone wins: Banks get to dump some bad assets and gain fees for selling them to the Fed. The Fed gets to enact a stimulus that helps the banks and gets the mortgage markets moving. Politicians can be delighted that Fannie and Freddie are getting some love, because they lend to consumers and that in turn wins votes. But, as we found out during the last boom, something that feels great at first can feel terrible later.

Must read links 8/25

Monday, August 24, 2009

The Wile E. Coyote moment for the U.S. economy

Via:  Business Wire  While there is a natural tendency for “animal spirits” to buoy the business cycle for a couple of years here, I do not see an immediate double dip (see “animal spirits” update).  However, we are only part-way through our deflationary collapse in my analysis, as evidenced by the article below (see also this). 

We are living through the “Wily Coyote moment” for the United States economy, where the economy has gone off the cliff but hasn’t realized it.  America is a basket case:  give us a livable workfare and health benefits for the unemployed before the country becomes a humanitarian disaster area.

Fitch: Delinquency Cure Rates Worsening for U.S. Prime RMBS

NEW YORK--(BUSINESS WIRE)--While the number of U.S. prime RMBS loans rolling into a delinquency status has recently slowed, this improvement is being overwhelmed by the dramatic decrease in delinquency cure rates that has occurred since 2006, according to Fitch Ratings. An increasing number of borrowers who are 'underwater' on their mortgages appear to be driving this trend, as Fitch has also observed.

Delinquency cure rates refer to the percentage of delinquent loans returning to a current payment status each month. Cure rates have declined from an average of 45% during 2000-2006 to the currently level of 6.6%. It is important not only to observe total roll rates, but delinquency cure rates as well, according to Managing Director Roelof Slump.

'Recent stability of loans becoming delinquent do not take into account the drastic decrease in delinquency cure rates experienced in the prime sector since the peak of the housing market,' said Slump. 'While prime has shown the most precipitous decline, rates have dropped in other sectors as well.'

In addition to prime cure rates dropping to 6.6%, Alt-A cure rates have dropped to 4.3%, from an average of 30.2%, and subprime is down to 5.3% from an average of 19.4%. 'Whereas prime had previously been distinct for its relatively high level of delinquency recoveries, by this measure prime is no longer significantly outperforming other sectors,' said Slump.

The general deterioration in home prices appears to be a key driver in the worsening cure rate behavior. Due to home price declines, loans that have recently become delinquent have an effective loan to value ratio that is on average approximately 23% higher than those loans that are current on their payments, and are typically over 100%. Since home price declines have been relatively more severe in certain areas such as California and Florida, these areas tend to have a higher degree of representation in the non-current category. While California and Florida represent 49% of the remaining outstanding balance of currently performing prime loans, these states make up 62% of the non-current category and are under-represented in the 'cured loan' category as well. Furthermore, up to 25% of loans counted as cures are modified loans, which have been shown to have an increased propensity to re-default.

Recent data shows prime current-to-delinquency rates at 89% of the December 2008 levels, though new rolls-to-delinquency are still elevated when compared to historical standards. Recently observed three-month average roll rates of 1.1% are nearly twice the level seen from the 2000 through current averages for prime. Additionally, the gross roll rates do not reveal some additional important information relating to prime loan performance.

Other stresses may also be playing a part in the worsening cure rates. Although current credit score information is not generally available for all borrowers, some significant differences are noted between the original credit profiles of the current and delinquent prime loans. On average, current prime loans had credit scores at origination that are seen to be 25 points higher than the delinquent loans. Also, the loans that are current have shown a higher percentage of full income documentation than those that have recently become delinquent. 'As income and employment stress has spread, weaker prime borrowers become more likely to become delinquent in their loan payments and are less likely to become current again,' said Slump.

Regardless of aggregate roll-to-delinquent behavior, it will be difficult to argue that the market has stabilized or that performance has improved, until there is a concurrent increase in cure rates. This is especially true in the prime sector, which remains performing many times worse than historic averages. Prime 60+ delinquencies have more than tripled in the past year, from $9.5 billion to $28 billion total, or roughly $1.6 billion a month.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

Saturday, August 22, 2009

Quantitative easing and fiscal stimulus are both fool’s games

Via:  Daily Finance

It is still the pathetic wet dream of neo-Keynesians and neo-conservatives alike that inflation is going to accomplish the debt jubilee that they think is going to “reflate” our deflationary economies.

PIMCO: Fed needs to 'be irresponsible' if deflation appears
Joseph LazzaroJoseph

To borrow a phrases from the late, great Jimi Hendrix, wrap your mind around this one: would you root for an "irresponsible" Fed?

PIMCO's Managing Director Paul McCulley is doing exactly that. McCulley, in a PIMCO commentary, said that, if the U.S. economic recovery does not begin as expected in Q3/Q4, the Federal Reserve should push inflation above its long-term target to encourage U.S. consumers to spend money.

"The way to make monetary policy effective is for the central bank to promise to be irresponsible," McCulley wrote, citing a 1998 paper written by Nobel Prize-winning Princeton University economist and New York Times (NYT) columnist Paul Krugman.

My primary objection to this line of thinking is that it ignores the primary cause of deflationary depressions, too much debt on a highly unequal income distribution.  Simply put, some people have too much money while everyone else has very little money and too much debt—not enough money to spend to keep the circular flow of income and product going, let alone service their debt.  This is where we are today.  America is a rich country compared to most others and compared to ourselves a generation ago—there’s plenty to go around, but since Reagan the game has been tilted toward capital and rich folks.

But what qualifies Krugman’s remarks as obtuse, in the sense of biting off his own nose to spite his face (and I apologize for getting wonky a bit here, it’s something I’ve sworn off of since leaving academic economics, but every once in a while fall back into) is that the Fed can’t at once be credible in its stated policies of monetary control and at the same time promise to be irresponsible by igniting inflation.  That is incredible, literally.

It’s the debt, stupid, and the income distribution, the fact that the game is rigged by social conventions accepted by—or imposed upon—folks up to now.  Bad debts don’t get repaid by reflation, the cash flow coverage on the loans was never right and won’t be made right by inflation.  And not to get wonkish again, but you introduce all kinds of inefficiencies into the economy when you cause uncertainty about relative prices—because as Hayek pointed out, he who raises his price first wins—and given the state of our social contract, that’s not likely to be the people who need help the most.

What to do?  Follow William Black’s example in the S&L crisis and bust bad bankers, close their banks, write off their crap, break up Goldman Sachs (bring back Glass Steagall—there’s no way Goldman should be getting free money from the Fed), and provide a livable workfare-style dole and health benefits to the unemployed, who are going to be with us for a while. 

Quantitative easing and fiscal stimulus are both fool’s games, blind to the true nature of the problem, the broken distribution.  Fiscal stimulus will be distributed as unequally as the banking bailouts were.  The social contract needs to be renegotiated.

Reference: Income inequality, debt, crisis and depressions

Friday, August 21, 2009

Computers playing chicken

Warning:  This is research, not investment advice.  You invest at your own risk.

Via:  Chart of the Day  This is apparently month-end data to July, as the producers say the ratio has dropped to 129 from a high of 144.  It would take almost a 50 percent pull-back with earnings constant just to get back into the channel… or a doubling of earnings, prices constant.



Data monthly to July.  Consumption spending is collapsing and will continue to be under pressure from housing and wage deflation and unemployment, increased saving, and at some point, taxes.  Given the public’s distrust of Washington and New York, it is doubtful that a big honking second fiscal stimulus is coming.  (Can you see the effect of the first one?)  I wouldn’t support it anyway—we’ve seen that government “solutions” (viz., the financial bailouts) merely validate the current highly unequal income distribution.  Plus ça change, plus c'est la même chose.  And even if our current account deficit is down and we don’t (seem to) need the Chinese as much as before, we are hardly going to turn into an export-led economy… unless, of course, the dollar tanks dramatically soon.  America is still the world’s foremost manufacturing power, a fact that recent media coverage of manufacturing has chosen to ignore.  With the government increasingly hogging the debt markets, it’s hard to see how a domestic investment boom is going to get going.

Thursday, August 20, 2009

Fear still close to generational highs


With fear still close to generational highs there is a danger of getting stuck in a self-reinforcing loop of repeating the same behavior patterns over and over again… as our policymakers seem to be doing. 

Via:  NYT

Brain Is a Co-Conspirator in a Vicious Stress Loop


If after a few months’ exposure to our David Lynch economy, in which housing markets spontaneously combust, coworkers mysteriously disappear and the stifled moans of dying 401(k) plans can be heard through the floorboards, you have the awful sensation that your body’s stress response has taken on a self-replicating and ultimately self-defeating life of its own, congratulations. You are very perceptive. It has.

As though it weren’t bad enough that chronic stress has been shown to raise blood pressure, stiffen arteries, suppress the immune system, heighten the risk of diabetes, depression and Alzheimer’s disease and make one a very undesirable dinner companion, now researchers have discovered that the sensation of being highly stressed can rewire the brain in ways that promote its sinister persistence.

Reporting earlier this summer in the journal Science, Nuno Sousa of the Life and Health Sciences Research Institute at the University of Minho in Portugal and his colleagues described experiments in which chronically stressed rats lost their elastic rat cunning and instead fell back on familiar routines and rote responses, like compulsively pressing a bar for food pellets they had no intention of eating.

Moreover, the rats’ behavioral perturbations were reflected by a pair of complementary changes in their underlying neural circuitry. On the one hand, regions of the brain associated with executive decision-making and goal-directed behaviors had shriveled, while, conversely, brain sectors linked to habit formation had bloomed.

In other words, the rodents were now cognitively predisposed to keep doing the same things over and over, to run laps in the same dead-ended rat race rather than seek a pipeline to greener sewers. “Behaviors become habitual faster in stressed animals than in the controls, and worse, the stressed animals can’t shift back to goal-directed behaviors when that would be the better approach,” Dr. Sousa said. “I call this a vicious circle.”

Robert Sapolsky, a neurobiologist who studies stress at Stanford University School of Medicine, said, “This is a great model for understanding why we end up in a rut, and then dig ourselves deeper and deeper into that rut.”

The truth is, Dr. Sapolsky said, “we’re lousy at recognizing when our normal coping mechanisms aren’t working. Our response is usually to do it five times more, instead of thinking, maybe it’s time to try something new.”

And though perseverance can be an admirable trait and is essential for all success in life, when taken too far it becomes perseveration — uncontrollable repetition — or simple perversity. “If I were to try to break into the world of modern dance, after the first few rejections the logical response might be, practice even more,” said Dr. Sapolsky, the author of “Why Zebras Don’t Get Ulcers,” among other books. “But after the 12,000th rejection, maybe I should realize this isn’t a viable career option.”

Happily, the stress-induced changes in behavior and brain appear to be reversible. To rattle the rats to the point where their stress response remained demonstrably hyperactive, the researchers exposed the animals to four weeks of varying stressors: moderate electric shocks, being encaged with dominant rats, prolonged dunks in water. Those chronically stressed animals were then compared with nonstressed peers. The stressed rats had no trouble learning a task like pressing a bar to get a food pellet or a squirt of sugar water, but they had difficulty deciding when to stop pressing the bar, as normal rats easily did.

But with only four weeks’ vacation in a supportive setting free of bullies and Tasers, the formerly stressed rats looked just like the controls, able to innovate, discriminate and lay off the bar. Atrophied synaptic connections in the decisive regions of the prefrontal cortex resprouted, while the overgrown dendritic vines of the habit-prone sensorimotor striatum retreated.

According to Bruce S. McEwen, head of the neuroendocrinology laboratory at Rockefeller University, the new findings offer a particularly elegant demonstration of a principle that researchers have just begun to grasp. “The brain is a very resilient and plastic organ,” he said. “Dendrites and synapses retract and reform, and reversible remodeling can occur throughout life.”

Stress may be most readily associated with the attosecond pace of postindustrial society, but the body’s stress response is one of our oldest possessions. Its basic architecture, its linked network of neural and endocrine organs that spit out stimulatory and inhibitory hormones and other factors as needed, looks pretty much the same in a goldfish or a red-spotted newt as it does in us.

The stress response is essential for maneuvering through a dynamic world — for dodging a predator or chasing down prey, swinging through the trees or fighting off disease — and it is itself dynamic. As we go about our days, Dr. McEwen said, the biochemical mediators of the stress response rise and fall, flutter and flare. “Cortisol and adrenaline go up and down,” he said. “Our inflammatory cytokines go up and down.”

The target organs of stress hormones likewise dance to the beat: blood pressure climbs and drops, the heart races and slows, the intestines constrict and relax. This system of so-called allostasis, of maintaining control through constant change, stands in contrast to the mechanisms of homeostasis that keep the pH level and oxygen concentration in the blood within a narrow and invariant range.

Unfortunately, the dynamism of our stress response makes it vulnerable to disruption, especially when the system is treated too roughly and not according to instructions. In most animals, a serious threat provokes a serious activation of the stimulatory, sympathetic, “fight or flight” side of the stress response. But when the danger has passed, the calming parasympathetic circuitry tamps everything back down to baseline flickering.

In humans, though, the brain can think too much, extracting phantom threats from every staff meeting or high school dance, and over time the constant hyperactivation of the stress response can unbalance the entire feedback loop. Reactions that are desirable in limited, targeted quantities become hazardous in promiscuous excess. You need a spike in blood pressure if you’re going to run, to speedily deliver oxygen to your muscles. But chronically elevated blood pressure is a source of multiple medical miseries.

Why should the stressed brain be prone to habit formation? Perhaps to help shunt as many behaviors as possible over to automatic pilot, the better to focus on the crisis at hand. Yet habits can become ruts, and as the novelist Ellen Glasgow observed, “The only difference between a rut and a grave are the dimensions.”

It’s still August. Time to relax, rewind and remodel the brain.

The New York Times on class; Pinochiobama

h/t Mark Thoma

It is so painful to watch the shredding of our social contract that I’m having trouble posting much.  When I read Mish Shedlock complaining that the healthy will subsidize the sick in a health care program as if this is a proper indictment of “government,” I become very sad that the old right wing meme “government is evil” will be used to complete the neo-feudalization of America.  Much as I admire Peter Schiff for his prescient economic analysis (see for example this) I would be very unhappy to see him in the Senate.  Even Ron Paul has said he would provide health care to the poor and fund it by bringing troops home.

The American people are being snookered again by the right into voting against their own interests.  It is very sad.

Those who voted for Obama thinking they were going to get real change rather than a executive facsimile of Alan Greenspan (I used to irritate liberal friends in the ‘Nineties by calling Alan “The Great Accommodator”—liberals can be so blind to the persuasions of money, too—easy money was good for the people, no?) those who voted for Obama are perhaps the most devastated by the way things are going, now that we see that Obama is just a puppet, an appeaser of Wall Street, a politician who knows his place. 

Tuesday, August 18, 2009

William Black is always worth watching

This is making the rounds and is worth watching.  I’ve posted William Black videos before.  He speaks clearly and with tremendous authority about the financial fraud that our government is enabling, aiding and abetting so cavalierly.  Once the American people glean the slightest understanding of what is considered normal protocol in Washington and New York, I expect we’ll witness great social change.

Monday, August 17, 2009

Take Goldman, please!


“The great, unreported story in globalization is about power, not ideology. It's about how finance and business regularly, continuously insert their own self-interested deals and exceptions into rules and agreements that are then announced to the public as ‘free trade.’”

-- William Greider


"Le secret des grandes fortunes sans cause apparente est un crime
oubli, parce qu'il a été proprement fait."

-- Honoré de Balzac

Translation:  "The secret of a great fortune for which you are at a loss to account
is a crime that has never been found out, because it was properly

Downdraft: stress testing “animal spirits”

Warning:  This is research, not investment advice.  You invest at your own risk.

With the coming wave of foreclosures (see Mish and T2 under Worthwhile Reading on left) and the worldwide market plunge this morning, I thought it would be worth considering what kind of unemployment increase it would take to drive confidence down.  More than is likely to occur, it turns out:


Even assuming unemployment (U3) goes to 18 percent, after a jag down confidence will crawl upward, the next outright collapse due in about 2013 or 2014. 

The Feds can be expected to panic about now and inject untold amounts of liquidity into the market.  As I pointed out in Animal spirits in the stock market, the Big Mo in the stock market is very positive.  And if you believe Tyler Durden and other close-in observers, there is ample manipulation of the market taking place, so we might expect this downdraft to be allowed to go a while to achieve verisimilitude, setting the stage for a miraculous rally.

Preconditions by my lights for a double-dip recession (as opposed to simply a severe “underemployment equilibrium” in slow-or-no growth mode) are (1) an inversion of the 1/10 Treasury yield curve (that could be accomplished by a currency crisis in short order with collapse to follow a year later) and (2) some level of perceived unemployment that would push the U – UMEAN spread wider; this could happen if people start considering U6 to be the “true” unemployment rate (reference); or (3) the overall level of macroeconomic and world volatility and instability overwhelms people’s ability to adapt and feel at all confident. 

Sunday, August 16, 2009

True or False: “Consumption is 70 percent of GDP”?

Via:  Business Week via CR

An article in Business Week declares that “consumption is not 70 percent of GDP.”


Yes, 70 percent of GDP in recent years has been “consumption” as the government defines it.  And yes, if the saving rate out of disposable income goes up four to eight percent, the consumption part of “consumption” (or some part of “consumption,” anyway, could be discretionary health care spending) will go down. 

So the point has no material bearing on the collapse of consumption spending.

Saturday, August 15, 2009

Will the pulse of the postwar business cycle stop?

Warning:  this is research not investment advice.  You invest at your own risk.

This site is dedicated to the proposition that “animal spirits” or confidence levels are a prime—if not the prime—driver of the business cycle.  My models have not sent a false signal of recession in over a decade in real time, and in over fifty years in back testing.  So while the markets made a pretty big deal of the drop in the Michigan consumer sentiment series on Friday, the reported number is well within the range of random variation around a rising trend. 

Click on graph for larger image in new window.


Why might the pulse of the postwar business cycle stop?  The ongoing collapse of effective demand that so many of us have written about (see this and this).  Briefly, if consumption returns to a long-term trend share of about 65 percent from over 70 percent of GDP, that’s a ~5 percentage point drop.  Private investment demand has fallen ~20 percent year-over-year recently, and the residential portion of that is not going to return to previous levels any time soon.  Capacity utilization is still quite low.  The government’s stimulus falls far short of replacing this lost demand. 

Anticipation of a deflationary collapse might invalidate the Big Mo in the stock market (which is “discounting a V-shaped robust recovery”).  Short rates would rise as T-bill auctions are crowded with refugees from the long end, and the 1/10 yield curve would invert, the reliable recession signal I use in my recession forecasting model.  Unemployment would shoot up even further, and “animal spirits” would collapse. 

All this may happen, but turning the macro economy is like turning a supertanker, it takes time.  Even if the yield curve inverted this fall, history suggests the collapse would not come until a year or so later in 2010.  In the meanwhile we are likely to see a stabilization and perhaps weak growth of real output in absolute terms although the percentages might seem high.  Industrial production ticked up for the first time in nine months, often a sign of recession’s end.

Of course, a natural catastrophe or a hot war might break the mould immediately, probably in the direction of hyperinflation.

So we will probably witness yet another act of our long-running national drama, “Fake Democracy,” or “Money Gets What Money Wants.”  The President has already gutted the health care “reform” bill by giving away price negotiation with the drug companies and the possibility of a public option.  Wall Street continues to defecate in the faces of the American people paying themselves outsized bonuses while accepting welfare from the Feds… yada yada yada

Abject failure of the existing system would be consistent with our over-arching hypothesis of Strauss and Howe of a revolutionary change in the American social contract within the next two decades (see this and links for an introduction.  However, as a previous post indicates, we could as easily go toward neo-feudalism as toward a reformed democracy.

Big recessions and depressions tend to happen at the beginning of decades:  the Great Depression, the recessions of 1973-1974 and 1980-1982.  We may see one last hurrah from a stock market bid up by computers playing chicken while the insiders sell all they can—or the stock market may begin to discount the deflationary collapse before the yield curve inverts.  Why not have a sucker’s rally on free Fed money and a carry trade that Wall Street may find too good to pass up?  If the dollar rallies as Bob Prechter forecasts, it might bring in international hot money.

Hang on, we’ve only just begun this rollercoaster ride.

Friday, August 14, 2009

I’m on the pavement, thinkin’ ‘bout the governeent

Via:  AP

You're Bob Dylan? NJ police want to see some ID

By WAYNE PARRY, Associated Press Writer Wayne Parry, Associated Press Writer 24 mins ago

Rock legend Bob Dylan was treated like a complete unknown by police in a New Jersey shore community when a resident called to report someone wandering around the neighborhood.

Dylan was in Long Branch, about a two-hour drive south of New York City, on July 23 as part of a tour with Willie Nelson and John Mellencamp that was to play at a baseball stadium in nearby Lakewood.

A 24-year-old police officer apparently was unaware of who Dylan is and asked him for identification, Long Branch business administrator Howard Woolley said Friday.

"I don't think she was familiar with his entire body of work," Woolley said.

The incident began at 5 p.m. when a resident said a man was wandering around a low-income, predominantly minority neighborhood several blocks from the oceanfront looking at houses.

The police officer drove up to Dylan, who was wearing a blue jacket, and asked him his name. According to Woolley, the following exchange ensued:

"What is your name, sir?" the officer asked.

"Bob Dylan," Dylan said.

"OK, what are you doing here?" the officer asked.

"I'm on tour," the singer replied.

A second officer, also in his 20s, responded to assist the first officer. He, too, apparently was unfamiliar with Dylan, Woolley said.

The officers asked Dylan for identification. The singer of such classics as "Like a Rolling Stone" and "Blowin' in the Wind" said that he didn't have any ID with him, that he was just walking around looking at houses to pass some time before that night's show.

The officers asked Dylan, 68, to accompany them back to the Ocean Place Resort and Spa, where the performers were staying. Once there, tour staff vouched for Dylan.

The officers thanked him for his cooperation.

"He couldn't have been any nicer to them," Woolley added.

How did it feel? A Dylan publicist did not immediately return a telephone call seeking comment Friday.

Further results on income inequality

Now, is it really plausible that the top 0.01 percent got that much more productive in recent decades?  Or the top 1.0 percent?  Or could it have something to do with a clubby sort of atmosphere at the top in which one scratches another’s back in return for board seats, the right CEO job at the right time, and oh, don’t you know, it’s a small world up there and we are all very true to our class.  See Income inequality, debt, crisis and depressions for a sketch of the larger picture of how income inequality effects other social changes, especially the distribution of debt, and On the coming neo-feudalism for a rant I wrote in a bad mood about where the country might be going, a concern that Emmanual Saez, who is still in academia, shares while expressing himself in the sedate academic manner.  This a must read.  Hat tip Financial Armageddon.

How to change this?  Let’s start by raising tax rates on tippy-top incomes.  These people have taken enough.  There is no economic rationale for this kind of pay that is not laughable.  Saez addresses the issue of extreme income inequality creating great wealth inequality that is the essence of feudalism as America saw in the Gilded Age just over a hundred years ago.  We raise marginal tax rates on the super-rich not to raise revenue, because that hole is much too deep to fill that way, but to bring these high-rollers down to earth.  Look at the arrogance of Goldman Sachs and the other financial oligarchs paying themselves some of the biggest bonuses ever on the taxpayers’ tab—letting the Fed guarantee their debt! 

And the American people need to tell their politicians that they’ll see the “death tax” done away with over their dead bodies.  Little else stands between today’s extreme income inequality and a Gilded Age tomorrow.  An exclusion (non-taxable portion) of, say, $5 million in today’s dollars of any estate would enable a wealthy family to pass on a large amount to support to following generations.  A few fortunes of hundreds of millions or billion or more allowed to pass untaxed might pass a tipping point of wealth concentration, supporting untold generations of trust fund waste products, and depriving everyone else of income.

saez-UStopincomes-2007 -

Wednesday, August 12, 2009

Animal spirits in the stock market

This is research, not investment advice.  You invest at your own risk.

Below are the graph of the venerable Coppock Guide and my “animal spirits of the SPX” indicator (SPXAS2) that is calculated the same way as the “animal spirits” indicator for the unemployment rate (with a sign change).

Both indicators suggest that the stock market wants to continue to rally, sheerly on emotion and easy money.  I expect, along with Bob Prechter, for the market to break below the March lows in time.  However, this reading is consistent with the July 26 “buy” signal from the Dow theory.  This rally is testament to the power of easy money, even when most consumers are broke.  Buying into this market in these economic conditions may be damaging to your digestion.

Also, the Coppock gave a false signal in 2002 and might well do again.


The latest Fed bubble

Via:  Fortune  The answer to the question below is “yes.”  And this is appearing in the mainstream financial press!  That’s cause for some hope, although it’s doubtful the prostitutes in Congress will have the courage to sacrifice their rich financial donor dollars to do the right thing.  Can there be any doubt that “activist monetary policy” accompanied by complete ignorance of financial intermediary management skills can do no more than cause continuous consumer price inflation until consumers are tapped out, and then blow serial asset price bubbles?  The Federal Reserve System, our systemic risk Creator….  Alan Greenspan created the pre-conditions for this depression, Ben Bernanke will destroy our currency “fixing” it using his magic hammer.  Worse yet is that central banks throughout the world are imitating our idiots.  Monetary chaos looms.

Stocks: The latest Fed bubble

Are the government programs supporting the financial sector reinflating global stock markets even as economies stumble?

By Colin Barr, senior writer

Last Updated: August 12, 2009: 3:52 AM ET

NEW YORK (Fortune) -- The Federal Reserve has spent the past year cleaning up after a housing bubble it helped create. But along the way it may have pumped up another bubble, this time in stocks.

To head off the worst downturn since the Great Depression, the central bank has slashed interest rates while funneling money to banks.

The Fed has mostly won praise for its efforts. The pace of job losses has slowed, and there has been a modest recovery in output.

At the same time, stocks have bounced back with startling speed. Since global markets hit their bottom in March, the S&P 500 has jumped 51% -- even as the outlook for economic recovery remains dim.

"This is the most speculative momentum-driven equity market since the early 1930s," Gluskin Sheff economist David Rosenberg wrote in a note to clients Monday.

Of course, stocks have rallied in part because investors perceive the worst-case scenario -- a 1930s-style Depression -- is off the table. And while the gains have been remarkable, they come after an even bigger decline. The S&P is still down 16% since Lehman Brothers collapsed in September.

But while most people take the rise in stocks as a hopeful sign for the economy, some see evidence that the Fed has been financing a speculative mania that could end in another damaging rout.

Recent weeks have brought huge rallies in some of the lowest-quality stocks -- including firms such as AIG (AIG, Fortune 500), Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) that are being propped up by the government and are unlikely to return to health any time soon.

What's more, this year has brought an 80% surge in emerging market stocks, while the dollar has posted a 10% decline since March. A declining dollar and surging emerging markets were the hallmarks of the credit-fueled bull run earlier this decade.

"We have put the band back together on a lot of this," said Howard Simons, a strategist at Bianco Research in Chicago. "That couldn't have happened without liquidity."

Though liquidity is admittedly a nebulous concept, there's no question that central bankers around the globe have poured huge amounts of money into the markets to ease the financial crisis. Given free money, investors' appetite for risk shoots higher and they gobble up stocks.

That's good, except when the outlook for economic growth doesn't seem to support the higher stock values.

"Many observers are wondering whether the strong stock market rebound since mid-March is already a forerunner of the next recovery or simply driven by a reflux of liquidity into riskier asset markets," Deutsche Bank Research analyst Sebastian Becker wrote in a report last month.

Rosenberg, who notes that consumer credit has dropped an unprecedented five straight months, said it's far from clear the recession is over. He says the risk of a market relapse later this year is high.

Simons said another factor that could work against recovery is that short-term interest rates could soon head higher, judging by action in futures markets. That could raise companies' borrowing costs at a time when policymakers have committed to holding rates near zero to restore economic growth.

Fed officials have stressed that they will start to unwind their financial support programs at the earliest sign of inflation. Given the cost of cleaning up after the last bubble, Becker writes that "this time, policymakers are unlikely to remain inactive should they suspect the formation of another asset price bubble."

But it's clear that bankers are loath to pull back on their support for the financial system before it's clear the economy has staged a stronger recovery. And the Fed has a long and painful history of ignoring asset price inflation.

"The central bankers have this textbook belief that the only inflation is the kind that appears in consumer price indexes," said Simons. "They don't believe what they're doing could cause an asset price bubble."

For now, Fed chief Ben Bernanke and other central bankers can console themselves for now with stable consumer price inflation readings in major economies.

But comparing the bankers with a driver pulled over for speeding for the umpteenth time, Simons said, "At some point, you have to say maybe your speedometer's broken."

The FDIC is in trouble

Via:  The Daily Reckoning   Nothing succeeds like failure in disciplining a financial system, an inconvenient fact that we’ve forgotten in our age of unlimited moral hazard or financial fascism.  The current administration could be called “The Dukes of Moral Hazard…,” with Tim Geithner as their poster boy.

As we all know, the Federal Deposit Insurance Corporation (FDIC) guarantees depositors that they'll get their money back if a bank fails, at least up to a certain amount. To fund its operations, the FDIC collects small fees from the banks that are held in reserve for the purpose of taking over troubled banks and paying off depositors.

Since the Great Depression, a period marked by widespread runs on banks, the FDIC has done a good job of fulfilling its mandate. So how are they doing in this crisis?

In a nutshell, they are in trouble.

The FDIC insures 8,246 institutions, with $13.5 trillion in assets. Not all of them are going bankrupt, of course. Yet as of late July, a disturbing 64 banks had gone belly up this year - the most since 1992 - costing the FDIC $12.5 billion. At the end of Q1, the agency was already asking for emergency funding.

And worse, much worse, is likely yet to come. The following chart shows the total assets on the books of the FDIC's list of 305 troubled banks. The list doesn't include the biggest banks that are considered too big to fail, as they are being separately supported with bailouts. By contrast, if the banks on this list fail, the FDIC is on the hook to have to step in and take them over and, of course, make depositors whole.

Other measures of how serious the losses at banks are becoming can be seen in the chart below, which shows charge-offs and non-current loans at all banks. You can see that the Net Charge-offs remain stubbornly high, with banks charging off almost $40 billion in bad loans in the last two quarters alone. And the number of non-current loans - loans where payments are not being kept up - is soaring.

Together, these measures indicate the potential for more big failures and more big bailouts coming down the pike.

Into the battle against bank insolvency the Fed brings a level of reserves that can best be described as paper-thin. From almost $60 billion last fall, the FDIC's reserves have been drawn down to only about $13 billion today, a 16-year low. A quick look at the FDIC's own data shows us how inadequate those reserves are compared to the deposits they are now insuring.

The chart below says it all:

As you can see, the Federal Deposit Insurance Corporation currently covers each dollar on deposit with a trivial 2/10ths of a penny.

And even that understates the seriousness of the situation: the $4.8 trillion in deposits the FDIC is providing coverage on doesn't include the expansion that now extends insurance coverage from $100,000 to $250,000 for normal bank accounts. That likely brings the exposure of the FDIC closer to $6 trillion. But that's pretty inconsequential at this point: using any reasonable accounting method, the FDIC is already bankrupt and will require hundreds of billions of dollars in government bailouts just to keep the doors open.

So, given the dire shape of its finances, what measures is the FDIC taking, you know, to batten down the hatches and all that?

For starters, they are expanding their mandate by guaranteeing bank loans - $350 billion and counting at this point. And the government has tapped the FDIC to play a pivotal role in guaranteeing the loans issued to buy toxic waste through the government's highly problematic and fraud-prone new Private Public Investment Partnership (PPIP). The FDIC's commitment to the PPIP is and may become limited based on its resources.

It is hard to draw any other conclusion but that hundreds of billions in new funding will be required to keep the FDIC operating. Given the catastrophic consequences of the FDIC failing, starting with a bank run of biblical proportions, there's no question it will get whatever funding it needs. By loading the new loan guarantee responsibilities and the PPIP onto the FDIC's back, the administration will go back to Congress and ask for the next large bailout.

Of course, in the end, all of this falls on the taxpayer, either directly in the form of more taxes or indirectly via the destruction of the dollar's purchasing power. Another bale of straw on the camel's back, and another reason to be concerned about holding paper dollars for the long term.

Tuesday, August 11, 2009

Troubled assets may still pose risk; dollar bottoming?

  • Robert Prechter calls a bottom in the USD – Yahoo Finance  Prechter was early in calling the crash, but got it right.  Jesse has the opposite prediction.  I would guess Prechter is right.  This is not investment advice, but simply my opinion.  You invest at your own risk.

Via:  NYT  True or false:  the TARP program never actually bought any bank assets?

Troubled Assets May Still Pose Risk


Published: August 11, 2009

WASHINGTON — The Treasury Department’s $700 billion bailout program has stabilized the banking system, but it has done little to prod banks to fully deal with the troubled loans on their books, a Congressional oversight panel said in a report to be released Tuesday.

The Troubled Asset Relief Program was originally conceived as a program for the government to buy troubled and unsalable mortgages and mortgage-backed securities.

But the Treasury has never actually used the program to buy assets, in part because it was faster to invest money directly into the nation’s banks and in part because banks have not wanted to sell their problem loans and book the loss in their value.

“The nation’s banks continue to hold on their books billions of dollars in assets about whose proper valuation there is a dispute and that are very difficult to sell,” the panel said in its latest monthly report.

As a result, it warned, many banks could find themselves short of capital if the economy suffered another downturn and their losses on troubled loans soared.

In an encouraging note, the panel said 18 of the 19 biggest bank holding companies would probably have enough capital even if economic and financial conditions deteriorated more than they have already. That conclusion essentially backed up the results of the Federal Reserve’s stress tests in April.

But it warned that thousands of small and medium-size banks, which it defined as those with assets of $600 million to $100 billion, might find themselves short a total of $21 billion if the conditions matched its worst-case assumptions.

The panel noted that other institutions had already estimated the amount of troubled assets on bank balance sheets that had yet to be written down. The Federal Reserve estimated in May that American banks still had about $599 billion in assets to write down. Goldman Sachs and the International Monetary Fund estimated the total at about $1 trillion. And RGE Economics, headed by Nouriel Roubini, has estimated the total at $1.27 trillion.

The panel urged the Treasury to either expand its current program to soak up troubled assets, the Public-Private Investment Program, “or consider a different strategy.”

The five-member oversight panel is headed by Elizabeth Warren, a professor at Harvard Law School. But one member, Representative Jeb Hensarling, Republican of Texas, dissented from the report.

The recommendations seem to advocate another bailout of a failed federal program with involuntary taxpayer capital, Mr. Hensarling said in a statement.

The Treasury, in a statement, said its efforts had already helped stabilize the banking system and that programs to buy problem assets could be expanded quickly if necessary.

Monday, August 10, 2009

Obama’s deal with big pharma


The United States government has agreed not to negotiate prices with Big Pharma in exchange for support of a health bill.

Here’s what Robert Reich, a Democratic team player, has to say about that.

We’ve got a liberal friend from Minnesota visiting who is still arguing that it’s going to be better under Obama because he’s not a Republican.  And I do agree that Bill Clinton and a Republican Congress did the best job in recent memory of managing the economy.

I keep trying to tell her there’s only one party in American politics, the Money Party, and it always wins because it owns the government. 

Sadly, it wasn’t enough that Obama could beat the system (and he really did, and beat the Clintons, too) by raising his own money over the Internet.  What must the man be feeling, if he actually believes anything like his campaign rhetoric?  He’s gone back on what he represented as his basic values, ramping up a stupid war and providing massive welfare for the rich and now caving in to Big Pharma.  Or was it all an act?  I don’t think so.

Head’s up people:  you got to support Congressional candidates with money who will honor your will.  

First, we have to figure out how to get them on the ballot…. I still like the idea of voting out all incumbents until they get the idea….

Sunday, August 9, 2009

It’s the debt, stupid (reprise)

Via:  Comstock Partners 

Check out the charts.  Only when viewed in the this context can one understand the scale of the criminality of the financial institution bailouts that put the bad debt (bad bets) of financial speculators on the backs of the American taxpayers.  This is all stuff regular readers have heard before, but Comstock does a really nice job on it.

I expect this house of cards to collapse within five or so years in unprecedented defaults that will of necessity be upon private debts.  This implies further asset price deflation in the U.S., probably of both real estate and stock prices. 

The monetary and fiscal authorities can be expected to “panic” again (really, they just realize that they have no choices, that all their moves are forced moves, forced by the financial-military-industrial complex and its ownership of the government).  It might well be agreed that, historically, the quickest way to get an inflation going to reduce the government’s debt is to have a hot war.  The chances of a U.S.-initiated war starting in the next decade are pretty good.  A rapid inflation could ignite.  So could a world war, over oil resources, perhaps. 

God save us from our leaders, and our greed.

Deleveraging the U.S. Economy
Total Credit Market Debt as a % of GDP
H/H Debt relative to Disposable Income
Savings Rate
Personal Consumption vs. GDP
H/H Debt vs. GDP
Credit Conditions
Capacity Utilization
Net Worth

We are in the process of deleveraging the most leveraged economy in history.  Many investors look at this deleveraging as a positive for the United States.  We, on the other hand, look at this deleveraging as a major negative that will weigh on the economy for years to come and we could wind up with a lost couple of decades just as Japan experienced over the past 20 years.  It is true that Japan didn't act as quickly as we did but our debt ratio presently is much worse than Japan's debt ratios throughout their deleveraging process. 

Presently, the stock market is exploding to the upside, which you could say argues against the case we are attempting to make in this special report.  However, if you step back and look at the larger picture, you can see that the stock market is still down over 35% from the highs reached in 2007 and also down over 33% from the highs reached in early 2000.  In fact, the market now is acting in the same manner as it did in early 2000 at the peak of the dot com bubble and again in 2006 & 2007 at the combined housing and stock market bubble. 

This seems to us to be a "mini bubble" of stocks reacting to an abundance of "money printing" by governments all over the world since stocks are rising worldwide.  Of course, if the U.S. doesn't recover there will be no worldwide recovery since the rest of the world is still dependent upon the U.S. consumers' appetite for their goods and services (despite the so called growth of domestic consumption in China and India).   We, however, don't believe that the U.S. massive stimulus programs and money printing can solve a problem of excess debt generation that resulted from greed and living way beyond our means.  If this were the answer Argentina would be one of the most prosperous countries in the world.  This excess debt actually resulted from the same money printing and easy money that we are now using to alleviate the pain.

Most investors believe the bailouts, stimulus plans, and quantitative easing will lead to inflation.  In fact, almost all of the bearish prognosticators are negative because of the fear that interest rates will rise once the inflation starts to work its way into the economy.  They point to the doubling of the monetary base which they believe will soon lead to rising prices as more dollars are created chasing the same amount of goods.  We, on the other hand, are not as concerned about the doubling of the monetary base because we believe the excess money will need the money multiplier and increases in velocity in order to increase aggregate demand and eventually inflation.  As long as velocity (turnover of money) is stagnant we expect the increases in the monetary base and all the quantitative easing will lead to a stagnant economy and deflation until the consumer goes into the same borrowing and spending patterns that was characteristic of the 1990s through 2007.  

Remember, over the past decade (when we believe the secular bear market started) the total debt in the U.S. doubled from $26 trillion in 2000 to just over $52 trillion presently (peaking a few months ago at $54 trillion).  This consists of $14 trillion of gross Federal, State and Local Government debt and $38 trillion of private debt.  We expect the private debt to continue declining in the future as the deleveraging of America unfolds, while the government debt will very likely explode to the upside as the government tries to slow down the private deleveraging by helping out the entities and individuals in the most trouble with debt (such as over-extended homeowners).    

We wrote a special report in January of this year titled "Substituting Debt for Savings and Productive Investment" in which we explained why the U.S. economy historically prospered because of hard working Americans saving a substantial amount of their income which was used for productive investment.  Unfortunately, all of this changed over the past few decades and got worse over the past decade.  In fact, we stated in the report that it took $1.50 of debt to generate $1 of GDP in the 1960s, $1.70 to generate $1 of GDP in the '70s, $2.90 in the '80s, $3.20 in the '90s, and an unbelievable $5.40 of debt to generate $1 of GDP in the latest decade.  Over the past two decades, while most investors thought this trend could continue indefinitely, we have been warning them of the catastrophic problems associated with this ballooning debt. 

The attached chart of total debt relative to GDP shows exactly how much debt grew in this country relative to GDP (it is now 375% of GDP).  The total debt grew to over $52 trillion relative to our current GDP of approximately $14 trillion.  This is worse than the debt to GDP relationship in the great depression (even when the GDP imploded) and greater than the debt to GDP that existed in Japan in 1989.  Even if you took the debt to GDP when the U.S. entered the secular bear market in early 2000 and compared that to 1929 and Japan in late 1989, our debt to GDP still exceeded both (by a substantial margin relative to 1929).  The approximate numbers at that time were about 275% in the U.S. in early 2000, 190% in 1929, and about 270% in Japan in 1989. 

In fact, the similarities between Japan's deleveraging and the U.S. presently are eerie.  Japan's total debt to GDP increased from 270% when their secular bear market started to just about 350% 7 years later (1998) before declining to 110% presently.  The U.S. increased their total debt to GDP from 275% of GDP when our secular bear market started (in our opinion) to 375% presently (10 years later), and we suspect the total debt to decline similar to Japan's even though the Japanese government debt tripled during their deleveraging.  The government debt relative to GDP was about 50% in both the U.S. and Japan when the secular bear market started.  We also suspect that our government debt will grow substantially just like it did in Japan as the private debt collapses.  Also, the Japanese stock market doubled during the three years preceding their secular bear market in 1987, 1988, and 1989 while the U.S. market also doubled during the three years preceding the beginning of our secular bear market in 1997, 1998, and 1999. 

There also a few significant differences between the U.S. and Japan.  The private debt in Japan was almost the reverse of the U.S. where most of our excess debt was in the household sector and most of the excess debt in Japan was in the corporate sector.  The debt to GDP figures in Japan were not easy to come by from the typical sources until the mid 1990s and had to be estimated, but should be pretty close to the numbers used above.  Our sources on the above Japanese debt figures came from Ned Davis Research and the Federal Reserve Bank of San Francisco. NDR's report, "Japan's Lost Decade-- Is the U.S. Next?" have great statistics and information and the Fed's report "U.S. Household Deleveraging and Future Consumption Growth" is well worth reading.

The Fed study charted the peak of the debt related bubble of the stock and real estate assets in Japan in 1991 (1989 for stocks and 1991 for real estate) and overlaid it with the peak of U.S. debt associated with the same assets in 2008.  They concluded that if we are able to liquidate our debt at the same rate as Japan we would have to increase our savings rate from the present 6% (artificially high due to the recent stimulus paid to households) today to around 10% in 2018.  If U.S. households were to undertake a similar deleveraging, the collective debt-to-income ratio which peaked in 2008 at 133% (H/H debt vs. Disposable Personal Income) would need to drop to around 100% by 2018, returning to the level that prevailed in 2002.

If the savings rate in the U.S. were to rise to the 10% level by 2018 (following the Japanese experience), the SF Fed economists calculate that it would subtract ¾ of 1% from annual consumption growth each year.  We did a weekly comment about this very subject on June 25 of this year and came to a similar conclusion.  In that same report we showed that from 1955 to 1985 that consumption accounted for around 62% of GDP.  Because of the debt driven consumption over the past few years at the end of March 2009 consumption accounted for over 70% of GDP.  If the percentage dropped to the normal low 60% area of GDP it would subtract about $1 trillion off of consumption (or from $10 trillion to $9 trillion).  We also showed in that same report that H/H debt averaged 55% of GDP over the past 55 years and was 64% as late as 1995.  It has since soared to over 100% of GDP giving a big boost to spending that will be reversed as the deleveraging takes place over the next few years.

Other problems we have in the U.S. that will exacerbate the deleveraging are excess capacity, unemployment rates skyrocketing (putting a damper on wages), credit availability contracting, and dramatic declines in net worth.  The attached chart of capacity utilization is self evident that excess capacity in the U.S. has just dropped to record lows with the manufacturing capacity dropping to under 65% and total capacity utilization is just a touch better at 68%.  It is very hard to imagine corporations adding fixed investment at this time.  With unemployment rates close to 10% and rising, it is unlikely that wages will grow anytime soon.  The charts on credit availability and net worth reductions are self explanatory and will also put a damper on consumer spending rising anytime soon.

We expect that the U.S. deleveraging will follow along the path of Japan for years as real estate continues to decline and the deleveraging extracts a significant toll from any growth the economy might experience.  We also expect that, just like Japan, the stock market will also be sluggish to down during the next few years as the most leveraged economy in history unwinds the debt.   

Saturday, August 8, 2009

No double-dip recession in sight, risk premia falling

To continue the “animal spirits” update:

There is no double-dip recession in sight.  There is a natural pulse to the economy, and it is stabilizing.  The damage done to effective demand is huge, however, and there is a chance that the natural pulse has been stopped.  However, without an inversion of the yield curve a further pronounced downturn is exceedingly unlikely.  The yield curve was inverted in 1928-1929 and before every postwar slump (and there never failed to be a slump after an inversion; if anyone can provide me with Treasury yield curve data for the 1920s and 1930s I would appreciate it).  Also, before every postwar recession the unemployment rate has risen toward its adaptation level and crossed it almost exactly at the onset of the recession.  Currently, the “animal spirits” variable is forecast to rise even with rising unemployment.  Here is the recession “probability” for the coming year:


As I have been forecasting all year, the RP = Baa – Aaa risk premium has fallen sharply in the past month, so this trade has worked out nicely.  This is research, however, not investment advice.  Risk premia may fall more slowly for several years, until the next slump.


From my perspective, the two things that will signal the next collapse will be an inversion of the 1/10 Treasury yield curve, and the unemployment rate rising toward its adaptation level from below.  Currently the adaptation level is 6.1 while the print unemployment rate is 9.4.  This process is forecast to take several years.  See the last “animal spirits” update for details.