Hussman: How QE Works

July 9, 2012 What if the Fed Throws a QE3 and Nobody Comes?

John P. Hussman, Ph.D.
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The financial markets were largely unresponsive to news of further easing by the European Central Bank, the Bank of England, and the People’s Bank of China last week. Notably, Spanish bonds plunged, while German short-term government bonds now yield -0.17%, indicating growing concern about sovereign default risk in the Euro area. Every few days will undoubtedly bring word of new “agreements” and “mechanisms” – arcane enough to mask their futility – that promise to solve the European crisis. The headwinds remain very strong. The key distinction here remains liquidity versus solvency. There is little doubt that liquidity will be provided at every opportunity, though the continual degrading of collateral standards by the ECB suggests that all the good collateral has been pledged already. More importantly, with a global recession visibly unfolding, solvency risk will only increase.

The odds remain against European countries agreeing to the surrender their national sovereignty to the extent needed to create a “fiscal union” and enable massive and endless transfers of public resources from stronger to weaker European countries. Barring a catastrophe severe enough to either prompt European countries to hand fiscal control to a central administrator, or to prompt Germany to agree to unconditional bailouts, the least disruptive move would be for Germany and a handful of stronger countries to leave the Euro first, and allow the remaining members to inflate as they wish.

With regard to the economy, I noted two weeks ago that the leading evidence pointed to a further weakening in employment, with an abrupt dropoff in industrial production and new orders. Mike Shedlock reviews the litany of awful figures we’ve seen since then, focusing on the new orders component of global purchasing managers indices: U.S. manufacturing new orders and export orders plunging from expansion to contraction, Eurozone new export orders plunging (only orders from Greece fell at a faster rate than those of Germany), and an accelerating decline in new orders in both China and Japan.

Recall that the NBER often looks for “a well-defined peak or trough in real sales or industrial production” to help determine the specific peak or trough date of an expansion or recession. From that standpoint, the sharp and abrupt decline we’re seeing in new orders is a short-leading precursor of output. As the chart below of global output suggests, I continue to believe that we have reached the point that delineates an expansion from a new recession.

On the employment front, Friday’s disappointing report of 80,000 jobs created in June may be looked on longingly within a few months, as we continue to expect the employment figures to turn negative shortly. That said, it remains important to focus on the joint action of numerous data points, rather than choosing a single figure as an acid test. I noted last week in Enter, the Blindside Recession, GDP and employment figures are subject to substantial revision. Lakshman Achuthan at ECRI has observed the first real-time negative GDP print is often seen two quarters after a recession starts. Earlier data is often subsequently revised negative. As for the June employment figures, the internals provided by the household survey were more dismal than the headline number. The net source of job growth was the 16-19 year-old cohort (even after seasonal adjustment that corrects for normal summer hiring). Employment among workers over 20 years of age actually fell, with a 136,000 plunge in the 25-54 year-old cohort offset by gains in the number of workers over the age of 55. Among those counted as employed, 277,000 workers shifted to the classification “Part-time for economic reasons: slack work or business conditions.”

What if the Fed throws a QE3 and nobody comes?

To date, the stock market has largely shrugged off the evidence of oncoming recession, in the confidence that the Federal Reserve will easily prevent that outcome and defend the market from any material losses. On that point, it is helpful to remember that the real economic effects of Fed actions in recent years have been limited to short-lived bursts of pent-up demand over a quarter or two. Not surprisingly, as interest rates are already low, and risk-premiums on more aggressive assets are already remarkably thin, the impact of quantitative easing around the globe continues to show evidence of diminishing returns.

With the help of some preliminary work from Nautilus Capital, the following charts present the market gains, in percent, that followed versions of quantitative easing by the Federal Reserve, the European Central Bank, and the Bank of England on their respective stock markets (measured by the S&P 500, the Dow Jones EuroStoxx Index, and the FTSE Composite, respectively). In order to give QE the greatest benefit of the doubt and account for any “announcement effects,” the advances in each chart are based on the 3-month, 6-month, 1-year and 2-year gains in each index following the initiation of the intervention, plus any amount of gain enjoyed by the market from its lowest point in the 2 months preceding the actual intervention. The effects of most interventions would look weaker without that boost.

Remember that quantitative easing “works” through central bank hoarding of long-duration government bonds, paid for by flooding the financial markets with currency and reserves that essentially bear no interest. As a result, investors in aggregate have more zero-interest cash, and feel forced to reach for yield and speculative gains in more aggressive assets. Of course, in equilibrium, somebody has to hold the cash until it is actually retired (in aggregate, “sideline” cash can’t and doesn’t “go” anywhere). Increasing the quantity simply forces yield discomfort on more and more individuals. The process of bidding up speculative assets ends when holders of zero-interest cash are indifferent between continuing to hold that cash versus holding some other security. In short, the objective of QE is to force risky assets to be priced so richly that they closely compete with zero-interest cash.

Understanding this dynamic, it follows that QE will have its greatest impact on financial markets when interest rates and risk-premiums have spiked higher. If interest rates are low already, and risky assets are already priced to achieve weak long-term returns (we estimate that the S&P 500 is likely to achieve total returns of less than 4.8% over the coming decade), there is not nearly as much room for QE to produce a speculative run. Leave aside the question of why this is considered an appropriate policy objective in the first place, given the extraordinarily weak sensitivity of GDP growth to market fluctuations. The key point is this – QE is effective in supporting stock prices and driving risk-premiums down, but only once they are already elevated. As a result, when we look around the globe, we find that the impact of QE is rarely much greater than the market decline that preceded it.

To illustrate, each of the Fed, ECB and BOE quantitative easing interventions since 2008 are presented below as a timeline. The shaded area shows the amount of market gain that would be required to recover the peak-to-trough drawdown experienced by the corresponding stock index (S&P for Fed interventions, EuroStoxx for ECB interventions, FTSE for BOE interventions) in the 6-month period preceding the quantitative easing operation. The lines plot the 3-month, 6-month, 1-year and 2-year market gain following each intervention, adding any gain from the low of the preceding 2 months, to account for any "announcement effects." Technically, the lines should not be connected, since they represent the gains following distinct actions of different central banks, but connecting the points shows the clear trend toward less and less effective interventions, with the most recent interventions being flops. Notice also that central banks have typically initiated QE interventions only when the market had somewhere in the area of 18% or more of ground to make up.

Of all the experiments with QE, the round of QE2 from late-2010 to mid-2011 was most effective, in that stocks recovered their prior 6-month peak, and even some additional ground. Yet even with QE2, the Twist and its recent extension, as well as liquidity operations such as dollar swaps and so forth, the S&P 500 is again below its April 2011 peak, and was within 5% of its April 2010 peak just a month ago (April 2010 is a particularly important reference for us, since that is that last point that the ensemble methods we presently use would have had a significantly constructive market exposure). The largely sideways churn since April 2010 reflects repeated interventions to pull a fundamentally fragile economy from the brink of recession, and recessionary pressures are stronger today than they were in either 2010 or 2011. Investors seem to be putting an enormous amount of faith in a policy that does little but help stocks recover the losses of the prior 6 month period, with scant evidence of any durable effects on the real economy.

In short, the effect of quantitative easing has diminished substantially since 2009, when risk-premiums were elevated and amenable to being pressed significantly lower. At present, risk-premiums are thin, and the S&P 500 has retreated very little from its April 2012 peak. My impression is that QE3 would (will) be unable to pluck the U.S. out of an unfolding global recession, and that even the ability to provoke a speculative advance in risky assets will be dependent on those assets first declining substantially in value.

OECD Slowdown Seen

Kudlow: Obama's Goose Is Cooked

Obama needed a filet mignon in the June employment report. Instead he got a rubber chicken.

Only 80,000 new jobs were created last month, way below Wall Street expectations. It’s the fourth consecutive monthly disappointment. For a few months last winter, jobs were rising at an average of 225,000 a month. But that has sloped way down to only 75,000. The unemployment rate continues at 8.2 percent, which is the forty-first straight month above 8 percent. The U6 unemployment rate, which includes discouraged workers, is just under 15 percent.
As voters finalize their election impressions this summer, all of this is bad news for the Chicago incumbent.
At a campaign stop in Ohio on Friday, Obama actually said we’re still “heading in the right direction.” Is he kidding? As a stagnant GDP drops below 2 percent, employment falters, retail sales decline, and the ISM index for manufacturing drops below 50 (signaling contraction)? No objective observer can deny that the economy is headed in the wrong direction.
I don’t like playing the pessimist, but the numbers are the numbers. This is exactly what former Clinton advisers James Carville, Doug Schoen, and Stanley Greenberg have been warning Obama about. People just don’t believe the economy is getting better. So he’s gotta change his message.

But what change? Taxing rich people won’t create jobs. Neither will bashing Bain Capital. Obama is surrounded by leftist campaign advisers. And it’s hard to see them shifting gears to something constructive like making a summer deal to extend the Bush tax cuts for a year, or heaven forbid backing off the 20-some-odd tax hikes embodied in Obamacare. In other words, Obama’s goose may already be cooked.
The Joint Economic Committee (JEC), spearheaded by Texas congressman Kevin Brady, put out a report saying that the Obama recovery now ranks dead last in modern times. That’s a real milestone in the post-WWII era. It’s ten out of ten for both jobs and economic growth. According to the Bureau of Economic Analysis, real GDP has expanded only 6.7 percent over the eleven-quarter recovery since the recession ended. The Reagan recovery at the same stage had increased by 17.6 percent. The Clinton recovery by 8.7 percent.
As for jobs, the Bureau of Labor Statistics reports that the number of private-sector jobs has grown by only 4.1 percent since the cyclical low point. Reagan’s record was 10.7 percent.
So much for Obamanomics. Didn’t work. Still isn’t working. As the JEC put it, spending stimulus, housing bailouts, auto bailouts, financial bailouts, cash for clunkers, cash for caulkers, and $5 trillion in deficit spending left the Obama recovery dead last in modern times.
Whatever happened to the great boom of the ’80s and ’90s, when the animal spirits were strong and the American economy wasn’t held hostage by Europe or China? In an odd twist, both Obama and his top economist Alan Krueger blame “problems built up over decades.” Does that mean they blame Clinton? Reagan?
For nearly 25 years — during those bad old decades — the economy increased 3.3 percent annually. Unemployment dropped from 11 percent to 6 percent to 5 percent to below 4 percent. Obama would swoon for numbers like that. But those statistics come from the era when big government was over, when pro-market forces stopped the expansion of Leviathan, and when marginal tax rates were slashed to grow the economy.
Now the question is, with Obama’s economic goose cooked, does Mitt Romney have what it takes to win the election and provide a pro-growth economic model that will restore prosperity at home and America’s number-one position around the world?
Some powerful figures — including Rupert Murdoch, Jack Welch, and even my brothers and sisters at the Wall Street Journal editorial page — have taken shots at Romney in recent days. But I am more optimistic. In response to his critics on the day of the bad June jobs report, Romney talked about expanding energy resources, approving the Keystone pipeline, cutting taxes, and increasing trade with Latin America. He reaffirmed his intention to cut federal spending and eliminate programs.
Basically, Romney is promising a return to free-market, supply-side policies on taxes, trade, regulation, and spending. Hopefully he will embrace a sound and stable dollar as well. I still believe Romney is the most underrated politician in America today, and that he’s the most conservative Republican standard-bearer since Ronald Reagan.
In other words, he’s some real filet mignon.
– Larry Kudlow, NRO’s economics editor, is host of CNBC’s The Kudlow Report and author of the daily web log, Kudlow’s Money Politic$.

Was There Ever Any Doubt...

...that this wouldn't "fix" anything?

The Obama Derecho

from the Washington Free Beacon

Column: The damage from Obama will be lasting

BY: Matthew Continetti - July 6, 2012 5:00 am

Safe to say most Washingtonians had never heard of a “derecho” before June 29, when one of these speedy and destructive windstorms ploughed through the capital, leaving behind dead bodies and battered homes and more than a million households without power. Now the storm is over, and one can expect this obscure meteorological term to pass just as swiftly into everyday speech. Exotic, vaguely menacing, and evoking senseless, abrupt calamity, “derecho” is an especially apt description of America in the age of Obama.
Like the homeowners in Fairfax County, Va., picking up felled tree branches and putting in insurance claims, Americans across the country are still recovering from the Obama derecho that struck the nation from 2009 to 2010. The damage from that whirlwind has been ugly. The cost has been enormous. And another one may form at any moment.
A spectacular confluence of events swept Obama into office. Seven years of war, almost a year of recession, and seven weeks of financial crisis pulled down the incumbent president’s approval rating on Election Day 2008 to an atrocious 25 percent. Obama’s opponent was a war hero and a courageous statesman who nevertheless seemed rather anachronistic, not to mention confused at the bewildering and frightening economic situation.
Obama, on the other hand, had a smooth and graceful and likeable character that appealed to America’s best hopes and dreams of racial and partisan conciliation. His running mate was a dolt, but a familiar one. They promised a new tone in Washington, sound economic management, lower health care premiums, cutting the federal deficit in half, and an end to the war in Iraq. This was the winning ticket, 53 percent to 46 percent.
The economy worsened after Obama’s election. Unemployment spiked. The government took over the financial system, nationalized mortgage giants Fannie Mae and Freddie Mac, consumed AIG, drew closer to buying GM and Chrysler, and drastically expanded the monetary base to prevent credit from dissolving further.
The economic and legal and political arrangements that had led to two decades of expansion were being re-written hastily and unthinkingly. A deluge of taxes and spending and regulations was let loose, with the stated aim of transforming the base of a system that had produced the most prosperous civilization in history. It turned out that when Obama spoke of putting America on “a new foundation,” he meant it.

AP

Unemployment was at 7.8 percent when Obama became president. It would rise to 10 percent in October 2009 and would not fall below 8 percent in over 30 months. Long-term unemployment became endemic. Participation in the work force fell to lows not seen in decades. Foreclosures mounted. Mortgages sank underwater. Obama’s response was to maintain the policies of the Paulson-Geithner-Bernanke troika: bail out financials and autos while engaging in massive fiscal and monetary stimulus, and hope for the best. Publicize every “green shoot.” Say, “Welcome to the recovery.”
The change in governing style that the president had promised never seemed to materialize. Relations with the domestic opposition was an area in which the administration seemed eager to adopt a “with us or against us” mentality. The White House targeted dissenting individuals and organizations for public rebuke and media-enforced shame: Rush Limbaugh, Dick Cheney, Fox News Channel, the Chamber of Commerce, Charles and David Koch, Paul Ryan, Sheldon Adelson. The list grows with each day.
Even as Obama said he would listen to the Republicans, he let archliberals Nancy Pelosi, Henry Waxman, and David Obey write the stimulus bill, ironically called “the Recovery Act.” They larded this legislation with handouts to public sector unions, the social services lobby, and green energy companies managed by Democratic contributors. They included tax rebates that history had shown to be ineffective at stimulating demand, and emergency aid to states that would delay but not resolve the governors’ budget issues. The cost: $862 billion. Read the papers, and then try to say the stimulus “worked” while keeping a straight face.
It was with glassy-eyed seriousness that the president and his allies in Congress turned from the economic crisis to the ambitious spending and regulatory agenda that they had waited years to enact. Having passed the stimulus, Pelosi, Waxman, and Ed Markey brought to the floor of the House a monstrosity of an energy bill that would have imposed a cap-and-trade system of carbon regulation on the nation in the middle of the worst economy since the Great Depression. It cleared the House by seven votes before coal-state Democrats and Republicans in the Senate spared us, in this instance, from the greens.
Then in July 2009 Congress authorized Obama’s first budget of $3.4 trillion, hilariously titled “A New Era of Responsibility.” Like all of the president’s budgets, this one was easy to summarize: Taxes and spending and debt went up.
Obama and Congress carefully designed their “crown jewel,” a health care overhaul that mandates insurance coverage for every American while turning health insurers into quasi-public utilities, raising taxes, and establishing manifold regulatory boards and bodies that will encroach ever more on institutional and personal liberties. The months spent debating Obamacare revealed the character of this president in an unforgettable way. He pushed for the legislation despite its unpopularity, despite his party losing elections in Virginia and New Jersey and Massachusetts, despite public protests and marches and threats to challenge the law’s constitutionality. What could be seen in these glimpses of the real Obama was a single-mindedness of intent. Obamacare became law in March 2010.
The final surge was the Dodd-Frank “Wall Street Reform and Consumer Protection Act,” which required more than 2,300 pages to delegate authority to new or established regulatory bodies that will issue more than 400 rulings on every sort of financial transaction. The president signed it into law in July 2010. The most obscure and arcane piece of legislation passed during the Obama derecho, Dodd-Frank may also come to be seen as the most harmful. It enshrines the Too Big To Fail bailout model that led to excessive leverage and risk-taking, and incentivizes consolidation in a banking sector already beset by cronyism and insider relationships between Wall Street and Washington.
This is the legislative horror-show that birthed the Xenomorph-like Consumer Financial Protection Bureau, an already politicized agency that is shielded from democratic accountability even as it runs amok in credit markets. The regulatory capture and other perverse consequences of Dodd-Frank will become clear only in hindsight. However, we already do know that it did nothing to reform Fannie and Freddie or housing in general, and that it won’t prevent the next financial crisis, which may soon be on us.
The clouds finally broke in November 2010 when Republicans had their best electoral performance in decades, and took the House of Representatives while gaining seats in the Senate and in governors’ mansions and in statehouses. The worst seemed to be over. Obama was forced to maintain the tax rates that have been operative since 2001. The congressional Republicans have checked his additional plans.
The economy still suffers, however. The legacy of the derecho years remains. We will be picking up after Obama’s debt and regulations and taxes for a long time to come. Even the current respite may turn out to be brief, for there are dark clouds on the horizon. Massive tax hikes on all levels of income, combined with crippling defense cuts, are set to take place on January 1, 2013. The health care mandate goes into effect the next year. The wind is picking up, and one can feel the first drops of rain. My advice: Take shelter.

Jobs Report Hits Stocks

Even Obama's Apologists Say Economy Is "Grim"

from CNBC:

"A slew of weak U.S. economic data is casting doubts over expectations of a pick-up in growth in the second half of the year.
From manufacturing to job growth to consumer spending, the numbers have been grim, and economists are wondering whether they need to dial down forecasts for the remainder of the year.

"Our sense was that of a gradual improvement. Now the sense is of muddling along at a low level of activity," said Adolfo Laurenti, deputy chief economist at Mesirow Financial in Chicago. "We went from seeing progress, though gradual and very uneven, to not seeing progress at all."

 The economy grew at a 1.9 percent annual pace in the first quarter and estimates for the April-June period are increasingly coming in around 1.5 percent.

A high level of uncertainty as Europe struggles with a debt crisis and as the United States stares at the prospect of a sharp budgetary tightening at the start of next year seem to have led businesses and ordinary Americans to watch their dollars carefully.

Drought, Heat Destroying Food Crops

Fired by fresh worries about drought, corn powered up 34 cents per bushel on the Chicago Board of Trade to $7.08, above $7 per bushel for the first time in a year.
Soybeans climbed 53 cents per bushel to an all-time high of $15.27.
The gains in Iowa’s mainstay crops have been breathtaking as farmers and traders factor in their fears that the heat and drought in Iowa and elsewhere in the corn belt will take yields down far below expectations.
As recently as June 1, corn traded for $5.20 per bushel and soybean at $12.50 per bushel on expectations of big crops that would increase U.S. domestic stocks and also moderate what has been a two-year record run of corn and soybean prices.
The U.S. Department of Agriculture has forecast a national corn yield of 166 bushels per acre and a soybean yield of 44 bushels per acre. Iowa’s yields historically are about ten percent above the national averages.
But private forecasters have cut their yield predictions for corn to as low as 148 bushels per acre and soybeans below the USDA projections.
Corn

 Soybeans -- new all-time record high

 Wheat

US Manufacturing Contracts

First contraction in three years!

But following early losses, stocks closed mixed, with the S&P closing higher!

Global Economic Outlook Worsens

But the S&P 500 closed up today!

from Zero Hedge:
Three weeks ago we noted that Goldman Sach's Global Leading Indicator (GLI) and its Swirlogram had entered a rather worrying contraction phase. Today's update to the June GLI data suggests things got worse and not better as momentum is now also dropping as well as the absolute level.

This continued deterioration in momentum suggests further softening in the global cyclical picture. Of particular concern is the broad-based deterioration in the GLI’s constituent components in June. 

Nine of ten components weakened last month, only the second time this has occurred since the depths of the recession in 2008Q4. The June Final GLI confirms the pronounced weakening in global activity in recent months. Goldman has found elsewhere (as we noted here) that this stage of the cycle, when momentum is negative and decelerating, is typically accompanied by deteriorating data and market weakness.

Stocks, Euro Scream Higher On Latest Bailout News

*EURO LEADERS RENOUNCE SENIORITY ON SPAIN LOANS -Bloomberg
Remember, after the European bailout a few weeks ago, the hitch was the the funds (to be provided by the ESM bailout fund) would be senior to existing sovereign debt, and this was seen as a problem for Spain keeping market access. Evidently Europe has agreed to not have this new money be senior to other sovereign debt, which is a minor pressure relief.

Proof -- Wall St Loves Tyranny!

U.S. Recession Imminent

One of the world's largest financial institutions, Deutsche Bank, this morning has declared that recession in the United States is imminent. They say that based upon history of 33 economic cycles over a period of the past 158 years, [b]"the next recession should start by the end of August."[/b] Yeah, that's August THIS YEAR!

Deutsche Bank, based in Germany, is one of Europe's largest financial powerhouses, with 100,000 employees in 70 countries, including the United States. It is THE largest currency dealer in the world.

Stocks, which had been trading choppy this morning, but had been in the black all morning, have tanked on this news and are now in the red.

And by the way, the Richmond Fed survey plunged and is now in the negative, which indicates economic contraction.

Real estate increased modestly last month. That's good, but its also seasonal. People tend to buy homes during the summer while the kids aren't in school.

Consumer confidence also declined -- for the fourth month in a row!

And this quote, by Art Cashin, UBS' floor manager on the NYSE, and one of Wall St's veterans, said this today in what seems like a timely statement for this topic:

"The frequency with which the world goes to hell in September seems hardly random... An interesting pattern emerges: banking crises tend to start in the second half of the year, with large September and December effects." The avuncular Art concludes with: "try to enjoy your summer".

More Bad Economic News

from MSNBC:
U.S manufacturing grew in June at its slowest pace in 11 months and hiring in the sector slowed as overseas demand for U.S. products waned, an industry survey showed on Thursday...
Financial information firm Markit said its U.S. "flash" manufacturing Purchasing Managers Index fell to 52.9 from 54.0 in May. The June reading was the lowest since last July although it stayed above 50, indicating expansion in activity.

For the second straight month, weaker demand from Europe and large emerging markets such as China dented sales. Markit said U.S. manufacturers reported the second largest decline in new export orders since September 2009.

The index's new orders component fell to 54.1 from 54.6.

And jobless claims rose to the highest level in 11 months.

Fed Extends Operation Twist through 2012

from Zero Hedge:

As always, Goldman Corzined anyone who listened to its call that an epic QE is coming. Fed did the worst possible outcome for risk- merely extended Twist, just as the credit market predicted it would 3 weeks ago:

• FED SAYS IT IS PREPARED TO TAKE FURTHER ACTION `AS APPROPRIATE
• FED TWIST EXTENSION TO SWAP $267 BLN OF TREASURIES BY END 2012
• FED TO SELL OR REDEEM `EQUAL AMOUNT' DEBT DUE 3 YEARS OR LESS
• FED TO BUY TREASURIES DUE IN 6 TO 30 YEARS AT `CURRENT PACE'
• FED SAYS EMPLOYMENT GROWTH `HAS SLOWED'
• FED SAYS INFLATION HAS DECLINED, REFLECTING OIL
• FED REITERATES ECONOMY `EXPANDING MODERATELY'
• LACKER DISSENTS FROM FOMC DECISION

This means that soon Primary Dealers' entire balance sheets will be filled with the entire inventory of Fed 1-3 year bonds. Market not happy. Full June statement here.

Greece' Continued Death Spiral

Spanish Version of Wash, Rinse, Repeat

Despite Recessionary Concerns, Commodities Back in Uptrend

This is the NYBOT Commodity Index, and like stocks, commodity prices have once again returned to an uptrend. Bubbles Bernanke has promised to resume printing money to help his Wall St friends! It's "risk on" again!

Obama -- Biggest Spender in World History!

Facts are still such stubborn things!

By Peter Ferrara at Forbes:
The U.S. has never before had a President who thinks so little of the American people that he imagines he can win re-election running on the opposite of reality. But that is the reality of President Obama today.
Waving a planted press commentary, Obama recently claimed on the campaign stump, “federal spending since I took office has risen at the slowest pace of any President in almost 60 years.”
Peggy Noonan aptly summarized in last weekend’s Wall Street Journal the take away by the still holding majority of Americans living in the real world:

“There is, now, a house-of-cards feel about this administration.  It became apparent some weeks ago when the President talked on the stump – where else? – about an essay by a fellow who said spending growth [under Obama] is actually lower than that of previous Presidents.  This was startling to a lot of people, who looked into it and found the man had left out most spending from 2009, the first year of Mr. Obama’s Presidency.  People sneered: The President was deliberately using a misleading argument to paint a false picture!  But you know, why would he go out there waiving an article that could immediately be debunked?  Maybe because he thought it was true.  That’s more alarming, isn’t it, the idea that he knows so little about the effects of his own economic program that he thinks he really is a low spender.”

What this shows most importantly is that the recognition is starting to break through to the general public regarding the President’s rhetorical strategy that I’ve have been calling Calculated Deception.  The latter is deliberately using a misleading argument to paint a false picture.  That has been a central Obama practice not only throughout his entire presidency, but also as the foundation of his 2008 campaign strategy, and actually throughout his whole career.
Rest assured, Ms. Noonan, that the President is not as nuts as he may seem at times.  He knows very well that he is not a careful spender.  His whole mission is to transform the U.S. not into a Big Government country, but a Huge Government country, because only a country run by a Huge Government can be satisfactorily controlled by superior, all wise and beneficent individuals like himself.  That is why he is at minimum a Swedish socialist, if not worse.  Notice, though, how far behind the times he and his weak minded supporters are, as even the Swedes have abandoned Swedish socialism as a failure.
The analysis by Internet commentator Rex Nutting on which Obama based his claim begins by telling us “What people forget (or never knew) is that the first year of every presidential term starts with a budget approved by the previous administration and Congress.”  Not exactly.
The previous administration, or President, proposes a budget.  The previous Congress approves a budget.  And what Congress approves can be radically different from what the President proposes.
As Art Laffer and Steve Moore showed in the Wall Street Journal on Tuesday, President Bush began a spending spree in his term that erased most of the gains in reduced government spending as a percent of GDP achieved by the Republican Congress in the 1990s led by former House Speaker Newt Gingrich, in conjunction with President Clinton.  But for fiscal year 2009, President Bush in February, 2008 proposed a budget with just a 3% spending increase over the prior year.  Fiscal year 2009 ran from October 1, 2008 until September 30, 2009.  President Obama’s term began on January 20, 2009.
Recall, however, that in 2008 Congress was controlled by Democrat majorities, with Nancy Pelosi as Speaker of the House, and the restless Senator Obama already running for President, just four years removed from his glorious career as a state Senator in the Illinois legislature.  As Hans Bader reported on May 26 for the Washington Examiner, the budget approved and implemented by Pelosi, Obama and the rest of the Congressional Democrat majorities provided for a 17.9 percent increase in spending for fiscal 2009!
Actually, President Obama and the Democrats were even more deeply involved in the fiscal 2009 spending explosion than that.  As Bader also reports, “The Democrat Congress [in 2008], confident Obama was going to win in 2008, passed only three of fiscal 2009’s 12 appropriations bills (Defense, Military Construction and Veterans Affairs, and Homeland Security).  The Democrat Congress passed the rest of them [in 2009], and [President] Obama signed them.”  So Obama played a very direct role in the runaway fiscal 2009 spending explosion.
Note as well that President Reagan didn’t just go along with the wild spending binge of the previous Democratic Congress for fiscal year 1981 when he came into office on January 20 of that year.  Almost no one remembers now the much vilified at the time 1981 Reagan budget cuts, his first major legislative initiative. Then Democrat Rep. Phil Gramm joined with Ohio Republican Del Latta to push through the Democratic House $31 billion in Reagan proposed budget cuts to the fiscal year 1981 budget, which totaled $681 billion, resulting in a cut of nearly 5% in that budget.  Obama could have done the exact same thing when he entered office in January, 2009, even more so with the Congress totally controlled by his own party at the time.
Reagan then ramped up the spending cuts from there.  In nominal terms, non-defense discretionary spending actually declined by 7.1% from 1981 to 1982.  But roaring inflation at the time actually masks the true magnitude of the Reagan spending cut achievement.  In constant dollars, non-defense discretionary spending declined by 14.4% from 1981 to 1982, and by 16.8% from 1981 to 1983.  Moreover, in constant dollars, this non-defense discretionary spending never returned to its 1981 level for the rest of Reagan’s two terms!  By 1988, this spending was still down 14.4% from its 1981 level in constant dollars.
Even with the Reagan defense buildup, which, remember, won the Cold War without firing a shot, total federal spending as a percent of GDP declined from a high of 23.5% of GDP in 1983 to 21.3% in 1988 and 21.2% in 1989.  That’s a real reduction in the size of government relative to the economy of 10%, a huge achievement.
In sharp contrast to Reagan, Obama’s first major legislative initiative was the so-called stimulus, which increased future federal spending by nearly a trillion dollars, the most expensive legislation in history up till that point.  We know now, as thinking people knew at the time, that this record shattering spending bill only stimulated government spending, deficits and debt.  Contrary to official Democrat Keynesian witchcraft, you don’t promote economic recovery, growth and prosperity by borrowing a trillion dollars out of the economy to spend a trillion dollars back into it.
But this was just a warm up for Obama’s Swedish socialism.  Obama worked with Pelosi’s Democratic Congress to pass an additional, $410 billion, supplemental spending bill for fiscal year 2009, which was too much even for big spending President Bush, who had specifically rejected it in 2008.  Next in 2009 came a $40 billion expansion in the SCHIP entitlement program, as if we didn’t already have way more than too much entitlement spending.
But those were just the preliminaries for the biggest single spending bill in world history, Obamacare, enacted in March, 2010.  That legislation is not yet even counted in Obama’s spending record so far because it mostly does not go into effect until 2014.  But it is now scored by CBO as increasing federal spending by $1.6 trillion in the first 10 years alone, with trillions more to come in future years.
After just one year of the Obama spending binge, federal spending had already rocketed to 25.2% of GDP, the highest in American history except for World War II.  That compares to 20.8% in 2008, and an average of 19.6% during Bush’s two terms.  The average during President Clinton’s two terms was 19.8%, and during the 60-plus years from World War II until 2008 — 19.7%.  Obama’s own fiscal 2013 budget released in February projects the average during the entire 4 years of the Obama Administration to come in at 24.4% in just a few months.  That budget shows federal spending increasing from $2.983 trillion in 2008 to an all time record $3.796 trillion in 2012, an increase of 27.3%.
Moreover, before Obama there had never been a deficit anywhere near $1 trillion.  The highest previously was $458 billion, or less than half a trillion, in 2008. The federal deficit for the last budget adopted by a Republican controlled Congress was $161 billion for fiscal year 2007.  But the budget deficits for Obama’s four years were reported in Obama’s own 2013 budget as $1.413 trillion for 2009, $1.293 trillion for 2010, $1.3 trillion for 2011, and $1.327 trillion for 2012, four years in a row of deficits of $1.3 trillion or more, the highest in world history.
President Obama’s own 2013 budget shows that as a result federal debt held by the public will double during Obama’s four years as President.  That means in just one term President Obama will have increased the national debt as much as all prior Presidents, from George Washington to George Bush, combined.
But this 2012 election is defined for the voters by the future, not the past.  And that future is fully revealed by the stark contrast between President Obama’s spending, deficits and debt projected under his proposed 2013 budget, and the projections under House Budget Committee Chairman Paul Ryan’s budget, adopted by the Republican House, and endorsed by presumptive Republican Presidential nominee Mitt Romney.
Despite all the controversy in Washington and in the media over Ryan’s budget, what it all adds up to is just to restore federal spending to its long term, postwar, historical average of 20% of GDP.  That stable level of federal spending, with some modest variance, prevailed for over 60 years after the end of World War II, until 2009.  Ryan’s budget reduces federal spending from an average of 24.4% of GDP during the Obama years to 20.1% after just 3 years, by 2015.
By contrast, under the budget policies supported by President Obama and Congressional Democrats, federal spending soars to 30% of GDP by 2027, 40% by 2040, 50% by 2060, and 80% by 2080.  Obama’s 2013 budget proposes to spend $47 trillion over the next 10 years, the most in world history by far, increasing federal spending by $1.5 trillion above the current CBO baseline.  Ryan’s budget proposes to cut that by $6.8 trillion.  By 2022, Ryan’s budget would be spending nearly a trillion dollars less per year than President Obama’s budget.
Ryan proposes tax reform to consolidate the current 6 individual income tax rates, ranging up to 35%, to just two rates of 10% and 25%.  His budget would otherwise retain the Bush tax rates of 15% for capital gains and 15% for corporate dividends, and repeal the Alternative Minimum Tax.  Ryan also proposes corporate tax reform, closing loopholes and reducing the federal corporate tax rate from 35% to 25%, which is roughly the international average.  CBO scores these reforms, even with the rate cuts, as again restoring federal revenues to their long term, postwar, historical average of 18.3% of GDP by 2015.
Obama’s budget, in sharp contrast, proposes to increase federal taxes by nearly $2 trillion over the next 10 years above the CBO baseline.  The budget projects that under Obama’s tax policies federal income tax revenues will double by 2020, federal corporate tax revenues will double by 2017, and federal payroll taxes will double by 2022.
Next year, under President Obama’s policies, the top tax rates of virtually every major federal tax are already scheduled to increase under current law.  That is because the Obamacare tax increases are scheduled to go into effect, and the Bush tax cuts expire, which President Obama proposes refuses to renew for singles making over $200,000 a year, and couples making over $250,000.  President Obama is now proposing on top of that the Buffett Rule, which would increase tax rates on capital gains and dividends even further.  Counting that, next year the top tax rate for capital gains would increase by 100%, the top tax rate on corporate dividends would increase by 100%, the top two income tax rates would increase by nearly 20%, and the Medicare payroll tax again for singles making over $200,000 and couples making over $250,000 would increase by 62% (under Obamacare).
This is all on top of the corporate income tax rate, which counting state corporate rates is nearly 40%, the highest in the world now, except for the socialist one party state of Cameroon.  Under the Buffett Rule, America’s capital gains tax rate would be the fourth highest in the industrialized world.  Based on historical precedent, these tax rate increases are unlikely to raise anywhere near the revenue projected by CBO, meaning even higher future deficits and debt.
Under Ryan’s budget, even with CBO’s static scoring, the federal deficit in actual nominal dollars would be reduced to $182 billion by 2017, the fifth year of the budget.  That compares to $1,327 billion, or $1.327 trillion, today.  So in just 5 years, the deficit would be reduced by at least 86%.  The deficit under Ryan’s budget would be less than 1% of GDP by 2017, at 0.9%, where it stabilizes for 6 years to the end of the 10 year budget window.  Most importantly, given the sharp tax rate cuts in Ryan’s budget, with dynamic scoring the budget would probably be balanced by 2017.  That is because in the real world the rate cuts will not lose nearly as much revenue as CBO scores.
Under President Obama’s budget, his own projections show the deficit never gets anywhere near balance.  Indeed, the deficit never gets below or anywhere near the former all time record in 2008.  By 2022, his own budget projects the deficit rising over the previous 5 years to $704 billion.  But if Obama’s comprehensive tax rate increases throw the country back into recession next year, the deficits will soar much higher for several years, to new all time records.
Even under CBO’s horse and buggy static scoring, Ryan’s budget does serve to get federal debt under control and avoid any debt crisis, putting federal debt held by the public on a declining path from 77% of GDP in 2013 to 62% by 2022.  That debt continues on a sharp decline from there, as the long term effects of Ryan’s structural entitlement reforms phase in.  Debt held by the public is reduced to 53% of GDP by 2030, 38% by 2040, and 10% by 2050.  That means the national debt is all but paid off by 2050, and would be soon thereafter.  In fact, under dynamic scoring it probably would be paid off by then.
In stark contrast, on our current course, under President Obama’s budget policies, federal debt held by the public rockets to 140% of GDP by 2030, 220%by 2040, and 320% by 2050, on its way to over 700% by 2080.  That would undoubtedly create a Grecian style sovereign debt crisis for America before that point.
So which course will you choose America?

Stocks Rise On Bad Economic Data

Inflation is down because demand and prices are slumping.

Unemployment claims rose more than expected.

Foreclosures are rising again.

But stocks are higher.

Wall St continues to see the bad data as transitory, temporary!

Government Jobs Rise, Private Jobs Plunge

This is why Obama is the Deceiver in Chief!

from Investors Business Daily:
President Obama’s statement Friday that the private sector is “doing fine” drew so much ridicule that he was forced to backtrack hours later. But it’s clear that Obama and many other Democrats see job problems — and solutions — starting and stopping with government employment.
A quick look at payroll stats shows that’s not the case.
Private-sector jobs are still down by 4.6 million, or 4%, from January 2008, when overall employment peaked. Meanwhile government jobs are down just 407,000, or 1.8%. Federal employment actually is 225,000 jobs above its January 2008 level, an 11.4% increase. That’s right, up 11.4%.
Private payrolls have been trending higher in the last couple of years while government has been shedding staff. But that’s because governments did not cut jobs right away. Overall government employment didn’t peak until April 2009, 16 months after the recession started. It didn’t fall below their January 2008 level until September 2010.
The recession was boomtime for federal employment, especially after Obama took office. Federal jobs kept rising (excluding a temporary Census surge in early 2010) until March 2011 — more than three years after overall payrolls peaked.
Obama’s 2009 stimulus did little to revive private jobs, but did funnel massive funding to state and local governments. That, however, only delayed the day of reckoning for states and cities to curb spending. They finally did significantly slash jobs in 2010 and 2011. But those layoffs have slowed to a crawl in recent months — averaging less than 3,500 job cuts a month since November.
It’s easy to argue that Obama’s tunnel vision on government employment reflects his complete lack of experience in the business world. But it’s also mainstream Democratic thinking.
The Wisconsin recall election was about liberals’ zeal to maintain government employees’ privileges far and above those of struggling private sector workers who pay their salaries.
Payroll change since January 2008
Total: -5.01 million  -3.6%
Private: -4.61 million  -4%
Government: -407,000  -1.8%
Federal Government: (excluding post office) +225,000  11.4%
Sources: Labor Department, Datastream
Update: Why does Obama think the private sector is "doing fine"? "We've seen record profits in the corporate sector." And high corporate profits are good for tax revenues to pay for government programs and government jobs. That's the main reason Obama cares about the private sector.

Americans' Wealth Plummets

The Heart of the Matter

John P. Hussman, Ph.D.
All rights reserved and actively enforced.
Reprint Policy

Over the past 13 years, the S&P 500 has underperformed even the depressed return on risk-free Treasury bills. Real U.S. gross domestic investment has not grown at all since 1999, and even as a share of GDP, real investment remains weak.

The ongoing debate about the economy continues along largely partisan lines, with conservatives arguing that taxes just aren't low enough, and the economy should be freed of regulations, while liberals argue that the economy needs larger government programs and grand stimulus initiatives.

Lost in this debate is any recognition of the problem that lies at the heart of the matter: a warped financial system, both in the U.S. and globally, that directs scarce capital to speculative and unproductive uses, and refuses to restructure debt once that debt has gone bad.

Specifically, over the past 15 years, the global financial system - encouraged by misguided policy and short-sighted monetary interventions - has lost its function of directing scarce capital toward projects that enhance the world's standard of living. Instead, the financial system has been transformed into a self-serving, grotesque casino that misallocates scarce savings, begs for and encourages speculative bubbles, refuses to restructure bad debt, and demands that the most reckless stewards of capital should be rewarded through bailouts that transfer bad debt from private balance sheets to the public balance sheet.

What is central here is that the government policy environment has encouraged this result. This environment includes financial sector deregulation that was coupled with a government backstop, repeated monetary distortions, refusal to restructure bad debt, and a preference for policy cowardice that included bailouts and opaque accounting. Deregulation and lower taxes will not fix this problem, nor will larger "stimulus packages." The right solutions are to encourage debt restructuring (and to impose it when necessary), to strengthen capital requirements and regulation of risk taken by traditional lending institutions that benefit from fiscal and monetary backstops, to remove fiscal and monetary backstops and ensure resolution authority over institutions engaging in more speculative financial activities, and to discontinue reckless monetary interventions that encourage financial speculation and transitory "wealth" effects without any meaningful link to lending or economic activity.

By our analysis, the U.S. economy is presently entering a recession. Not next year; not later this year; but now. We expect this to become increasingly evident in the coming months, but through a constant process of denial in which every deterioration is dismissed as transitory, and every positive outlier is celebrated as a resumption of growth. To a large extent, this downturn is a "boomerang" from the credit crisis we experienced several years ago. The chain of events is as follows:

Financial deregulation and monetary negligence -> Housing bubble -> Credit crisis marked by failure to restructure bad debt -> Global recession -> Government deficits in U.S. and globally -> Conflict between single currency and disparate fiscal policies in Europe -> Austerity -> European recession and credit strains -> Global recession.

In effect, we're going into another recession because we never effectively addressed the problems that produced the first one, leaving us unusually vulnerable to aftershocks. Our economic malaise is the result of a whole chain of bad decisions that have distorted the financial markets in ways that make recurring crisis inevitable.

Once we abandoned Glass-Steagall, removing the firewall between traditional banking and more speculative activities, and allowing those activities to have the effective protection of the U.S. government, it was only a matter of time until a credit crisis would unfold. My 2003 piece Freight Trains and Steep Curves detailed the problem: "So the real question is this: why is anybody willing to hold this low interest rate paper if the borrowers issuing it are so vulnerable to default risk? That's the secret. The borrowers don't actually issue it directly. Instead, much of the worst credit risk in the U.S. financial system is actually swapped into instruments that end up being partially backed by the U.S. government. These are held by investors precisely because they piggyback on the good faith and credit of Uncle Sam."

The ability to use the Federal government as a backstop for risk-taking was the central element in creating the housing bubble. As long as a borrower was physically breathing, you could make a mortgage loan without really worrying about whether the loan could be paid back. By the time it was packaged up, tranched out, and securitized either by a bank or by Fannie and Freddie, all of which had the government backstop, the loan was somebody else's problem. When the bubble crashed, our policy makers made their crucial mistake - first through the Bush Administration, and then continued by the Obama Administration - they failed to require bondholders to take losses on bad loans.

Every major bank is funded partially by depositors, but those deposits typically represent only about 60% of the funding. The rest is debt to the bank's own bondholders, and equity of its stockholders. When a country like Spain goes in to save a failing bank like Bankia - and does so by buying stock in the bank - the government is putting its citizens in a "first loss" position that protects the bondholders at public expense. This has been called "nationalization" because Spain now owns most of the stock, but the rescue has no element of restructuring at all. All of the bank's liabilities - even to its own bondholders - are protected at public expense. So in order to defend bank bondholders, Spain is increasing the public debt burden of its own citizens. This approach is madness, because Spain's citizens will ultimately suffer the consequences by eventual budget austerity or risk of government debt default.

The way to restructure a bank is to take it into receivership, write down the bad assets, wipe out the stockholders and much of the subordinated debt, and then recapitalize the remaining entity by selling it back into the private market. Depositors don't lose a dime. While the U.S. appropriately restructured General Motors - wiping out stock, renegotiating contracts, and subjecting bondholders to haircuts - the banking system was largely untouched.

The failure of our policy makers to restructure debt resulted in the worst of both worlds - an economy where banks were relieved of the need for transparency (thanks to accounting changes by the FASB), and yet homeowners strapped with bubble-sized mortgage obligations saw very little in terms of debt restructuring. The reason we never got any economic traction in this "recovery" is that these debt burdens remain in place. While we certainly don't advocate "freebie" principal writedowns - which would almost surely result in a tsunami of strategic defaults, we've long proposed what we've called Property Appreciation Rights as a way to partially substitute mortgage principal for a marketable claim on future appreciation. Failing any meaningful debt restructuring, however, we've got a financial system that continues to operate with a confident government backstop for risk taking, while aggregate demand remains suppressed by a burden of existing debt.

Economists define a standard of living as the amount of goods and services that people in the economy can consume as a result of the work they do. They define productivity as the amount of goods and services that people in the economy can produce as the result of the work they do. In the long run, a rising standard of living requires rising productivity, which in turn requires the economy to accumulate a stock of productive investments - factories, machines, inventions, education, and so forth. In the short run, the benefits of productivity growth can be retained through profits in a way that prevents those benefits from being enjoyed by workers, but even then, redistributing wealth can only achieve limited improvements in living standards. Over time, an economy that squanders its scarce savings will predictably suffer for it.

Tragically, nobody seems to have learned a thing from the dot-com crash, or the tech crash, or the housing crash. Wall Street continues to beg for monetary interventions to reward speculative trading, even though these rewards have repeatedly proved to be short-lived. What investors don't seem to appreciate is how much of our nation's scarce savings have been burned to ashes as a result.

I really don't mean to pick on Facebook. It's a neat company, a neat platform, and I respect Mark Zuckerberg's charitable initiatives. But the example is too instructive to miss, so let's think about it as a business and as a major recipient of investment capital. If you go on Amazon or Ebay, you want to stay in order to buy something. That's a fine business model, and network effects work in your favor because there are a lot of sellers on the other side. If you go on Google, you want to find what you're looking for and then leave, which is a situation where advertising is welcome, and has also worked as a business model (though with a surprising lack of competition given that the business is based largely on a single eigenvector calculation). But consider Facebook. If you go on Facebook, your whole intention is to stay on Facebook for a while, but not to buy something. Here, network effects work against advertising because responding to the ad pulls you away from the network. On that platform, advertising is a nuisance, and if you're forced to tolerate advertising, you'll eventually migrate to a platform without it, so retention will be challenging. And yet, somehow the investment bankers were able to price the company at $100 billion on offering day. Perhaps the IPO proceeds will bring us more games, more  photo apps, and more ways our kids can pass their time online, instead of developing some useful knowledge or skill. I'm all for down-time and social networks in moderation, but it's discouraging when this is the stuff that historic IPOs are made of - that this is where massive amounts of savings are allocated on the basis of a "wait and see" business model. Thanks to speculative hype, coupled with intentionally suppressed returns on less speculative but better understood investment choices, we continue to allocate the nation's scarce savings in ways that are ultimately unproductive, and that error will return to bite us over time.

How do we change course? To restore the economy to the path of long-term growth, we need to allocate capital better. This requires the willingness to allow bad investments to work out badly, without being bailed out or otherwise rescued. It would also help to detach the global economy from the burden of bad loans that can't be serviced. The first order of business is to restructure debt burdens. This requires lenders and bondholders to take partial losses (rather than transferring those losses to the public through bailouts) and requires debt repayments to be restructured - ideally swapping part of the principal for some form of equity claim. A return to growth will require regulatory structures that protect depositors but fully remove government protection from investment banking and trading activities. A return to growth will require monetary policy that stops distorting financial markets by simultaneously suppressing the incentive to save and encouraging speculative investment.

Over the long run, economic growth really means the introduction of new products and services, new methods and technologies, and indeed whole new industries. These aren't the result of stimulus programs, but are instead the result of productive investment, education, creativity, and frankly time. Of course, stimulus programs can have important short-term effects, but even here, we can't talk meaningfully about "stimulating aggregate demand" unless we also restructure the debt burdens on individuals, primarily on the mortgage side. Next to nothing has been done in on this front in recent years. A sharp "fiscal cliff" would be very disruptive here, but we shouldn't overestimate the ability of deficit spending to produce meaningful or sustained economic progress, however "enlightened" a given stimulus package seems to be.

Meanwhile, we can't imagine that the European crisis can be addressed by piling up excessive government debt to bail out troubled banks, and then relying on troubled banks to buy the excessive government debt. Unless we want a world where public services are cut to the bone in order to make bank bondholders whole, and where recession (or in some countries depression) is forced onto citizens in order to make government bondholders whole, the world's leaders will eventually have to wake up and recognize that bad debt requires bondholders who willingly took the risk to also take the loss.

The latest item in the ongoing European crisis is the news that Spain has been promised loans from the EU in order to bail out its banking system. The promise to bail out Spain may provide a burst of positive market sentiment, though I suspect there are some wrinkles ahead before any of that funding will actually be forthcoming. It's a little depressing to reflect on the fact that Spain is one of the four largest European nations, so it's effectively being called on to lend to itself. Somehow, this is seen as Europe "doing the right thing." But what is really happening is that a continent that is already excessively in debt is promising funds so that Spain can increase its government debt, and then needlessly protect the bondholders of Spanish banks, who should be subject to orderly restructuring instead. This is interesting because the new debt will be senior to existing Spanish bonds, much to the chagrin of existing Spanish bondholders, and the bailouts will put the claims of Spanish bank bondholders ahead of the claims of the Spanish citizens who are funding the "recapitalizations." The only way Spain could make a more explicit gift to bank bondholders would be to include wrapping paper and a bow.

If it seems as if the global economy has learned nothing, it is because evidently the global economy has learned nothing. The right thing to do, again, is to take receivership of insolvent banks and wipe out the stock and subordinated debt, using the borrowed funds to protect depositors in the event that the losses run deep enough to eat through the intervening layers of liabilities (which is doubtful), and otherwise using the borrowed funds to stimulate the economy after the restructuring occurs. We're going to keep having crises until global leaders recognize that short of creating hyperinflation (which also subordinates the public, in this case by destroying the value of currency), there is no substitute for debt restructuring.

Finally, on the subject of a Greek exit, bank runs, and general Euro-area stress, the always observant guys at ZeroHedge noted the following news item last week:

VANCOUVER, BRITISH COLUMBIA--(Marketwire - June 7, 2012) - Fortress Paper Ltd. ("Fortress Paper" or the "Corporation") (TSX:FTP), announces that its wholly-owned subsidiary, Landqart AG, a leading manufacturer of banknote and security papers, has had a material banknote order reinstated. This order was unexpectedly suspended in the fourth quarter of 2011 which negatively impacted the financial results of Landqart's operations in the first half of 2012. The Company operates its security paper products business at the Landqart Mill located in Switzerland, where it produces banknote, passport, visa and other brand protection and security papers, and at its Fortress Optical Facility located in Canada, where it manufacturers optically variable thin film material.

We'll add that De La Rue PLC, a British company involved in the design and production of over 150 national currencies, registered a new 52-week high last week, despite steep recent losses elsewhere in foreign stock markets.

Economic Wizardry

Once upon a time (today), in a land not so far away (USA), there lived a trio of economic wizards (economists), whose names shall remain anonymous (Paul Krugman, Greg Mankiw, Ben Bernanke).

A fourth wizard, Murry Rothbard, is no longer among the living but resides in the netherworld.

The above wizards seldom agree with each other because they come from competing schools of wizardry.

Three Schools of Economic Wizardry

1. Keynesian School of Fiscal Voodoo and Witchcraft
2. Monetarist School of Monetary Voodoo and Witchcraft
3. Austrian School of Sound Money, Sound Economic Principles and Common Sense.

"Dark Arts" Wizardry

The first two wizardry schools belong to a class of wizardry promoted to aspiring wizards as the "Dark Arts".

Philosophical Beliefs

• Keynesian wizards believe governments can spend their way to economic health and although fiscal deficits may matter at some point in time, they never matter now, in practice.
• Monetarist wizards believe money will cure any and every problem if enough is dropped from helicopters and interest rates held low.
• Austrian wizards believe that economic problems are created by unsound money, haphazard loans, excessive debts, and government manipulations.
• Keynesian and Monetarist wizards believe in the voodoo principle "the problem is the solution if only you do more of it". The former relies primarily on fiscal voodoo, the latter relies primarily on monetary voodoo.
• Austrian wizards do not believe "the problem is the solution", no matter how many times it is repeated.

Grand Poobahs

1. Paul Krugman is the economic "Grand Poobah" of the Keynesian wizards.
2. The "Grand Poobah" of Monetarist Voodoo is Fed chairman Ben Bernanke.
3. Murray Rothbard, no longer alive, was the last great proponent of  school of Sound Money, Sound Economic Principles, and Common Sense.

"Dark Arts" Schools Overflowing With Students

The "Dark Arts" are very enticing to modern day wizards-in-training because nearly everyone likes money from helicopters and deficit spending (even when they claim they don't).

In response to demand for voodoo economists, the "Dark Arts" schools for voodoo economics are overflowing with young wizards all hoping to win a Nobel Prize in Voodooism with "fresh thinking" and new voodoo proposals.

Voodoo Proposal Example - Purposely Make Money Go Worthless

Aspiring Grand Poobah Greg Mankiw (Professor of Economic Wizardry at Harvard University) put forth a proposal that caused a stir in both the real world and the world of wizards.

Mankiw proposed that purposely making money go worthless money over time would be of great economic benefit.

No Demand for Common Sense

The average non-wizard, living in the real world, with an education level beyond 2nd grade, would quickly see the ridiculousness of making money go worthless.

However, at the highest political levels, there is virtually no demand for common sense, and shockingly high demand for voodoo wizardry.

For example, if you ever expect to make chairman of the president's Council of Economic Advisers or become an economic adviser to Mitt Romney (Wizard Mankiw did both), then common sense must go out the window.

Aspiring wizards hoping for careers in politics better quickly learn that politicians never want to hear they cannot spend money. Instead, politicians want to hear economic voodoo.

"Dark Arts" Feuds

Given Keynesian and Monetarist wizards both believe in voodoo, one might think the two schools would get along reasonably well. One would be wrong.

There have been numerous public squabbles between Mankiw and Krugman but the mother of all verbal wizardry battles came when Krugman went so deep into fiscal voodoo theory that Bernanke Called Krugman "Reckless"

Ivory Towers and Academic Wonderland

Unlike non-wizards, modern-day economic wizards do not live in the real world, in real cities. Instead, they live in ivory towers in secret villages for wizards only, typically tucked away in obscure corners of major U.S. universities.

Collectively, these secret villages are known as "Academic Wonderland".

"Academic Wonderland" is strictly off limits to non-wizards with the exception of "Dark Arts" wizards-in-training. It is even off limits to those few aspiring wizards who believe in Sound Money, Sound Economic Principles, and Common Sense.

Real World Experience

"Dark Arts" wizards of the Keynesian and Monetarist schools generally have never worked in the real world. Instead, they sit in their ivory towers and devise empirical formulas as to how they expect the real world to behave.

Occasionally the "Dark Arts" wizards surface in the real world, primarily to explain their mathematical formulas as to how the world functions.

It is seldom of concern to economic wizards if the real world does not follow their mathematical formulas.

Decision Making at Night

"Dark Arts" wizards are very concerned about such nebulous concepts as the "Decision Making at Night". Here is set of equations from an aspiring wizard-in-training.



"Decision making at night" is of course different from "decision making in the day". Both are distinctly different than "decision making with no news".

Voodoo Wizards Like Secrecy

The voodoo wizard-in-training making the above proposal is big proponent of secrecy, believing that Grand Poobahs need to keep what they are doing a big secret lest it change real-world decision making process of non-wizards during the day or night.

Austerity

Non-wizards understand that "austerity" is a very bad word to both Keynesian and Monetarist wizards. No "Dark Arts" wizard worth his weight in salt would ever propose that any country live within its means.

For a recent example, Paul Krugman, the Grand Poobah of the Keynesian School of Fiscal Voodoo and Witchcraft writes about Estonian Rhapsody.

Since Estonia has suddenly become the poster child for austerity defenders — they’re on the euro and they’re booming! — I thought it might be useful to have a picture of what we’re talking about. Here’s real GDP, from Eurostat:



So, a terrible — Depression-level — slump, followed by a significant but still incomplete recovery. Better than no recovery at all, obviously — but this is what passes for economic triumph?

Left Unsaid

Here's what Grand Poobah Krugman failed to say about the Booming Estonia Economy.

Sixteen months after it joined the struggling currency bloc, Estonia is booming. The economy grew 7.6 percent last year, five times the euro-zone average.

Estonia is the only euro-zone country with a budget surplus. National debt is just 6 percent of GDP, compared to 81 percent in virtuous Germany, or 165 percent in Greece.

Shoppers throng Nordic design shops and cool new restaurants in Tallinn, the medieval capital, and cutting-edge tech firms complain they can’t find people to fill their job vacancies.

Estonia’s achievement is all the more remarkable when you consider that it was one of the countries hardest hit by the global financial crisis. In 2008-2009, its economy shrank by 18 percent. That’s a bigger contraction than Greece has suffered over the past five years.

How did they bounce back? “I can answer in one word: austerity. Austerity, austerity, austerity,” says Peeter Koppel, investment strategist at the SEB Bank.

Estonia vs. Fantasyland

Estonia is not Nirvana. Estonia is not "Academic Wonderland" either.

In contrast, Krugman is in "Academic Wonderland". The Grand Poobah clearly believes Estonia would be in better shape with helicopter drops of fiscal stimulus than a very nice partial recovery and no debt, in spite of the fact the eurozone in general is going to hell in hand basket.

Debt Never a Problem

In modern-day ivory towers, with voodoo economics, debt is never a problem. The only thing that matters is GDP.

One might think that a Nobel prize winner would figure out that government spending will make GDP rise by definition (government spending is part of the equation) and the debt must be paid back. However, one would be wrong.

Bear in mind, Japan has tried both Keynesian voodoo and Monetarist voodoo for over 20 years. The result is a nearly unfathomable debt-to-GDP ratio of 220% and rising. Krugman would have you believe still more spending is the answer. Monetarists like Mankiw would propose making the Yen worthless.

Remember the Voodoo Motto!

Please remember the voodoo motto: If it doesn't work, keep doing more of it, even if that is what got you in trouble in the first place!

Anyone with an ounce of common sense would realize that artificial stimulus will always end, but the debt will remain, hanging like the Sword of Damocles over the economy.

Sadly, these modern-day economic wizards do not have the common sense of the average 6th grader who inherently knows that you cannot keep spending what you do not have.

Invalid Comparisons

No doubt Krugman will point to the misery in Spain and Greece. The comparison is invalid. Estonia is booming not solely because of austerity but rather because it did a number of common-sense things that Spain and Greece did not fully do.

1. Slashed public sector wages
2. Raised the pension age
3. Reduced job protection
4. Made it more difficult to claim health benefits

Keynesian wizards would be against all those things!

Was Krugman a Housing Bubble Proponent?

In a 2002 New York Times editorial Krugman said "To fight this recession the Fed needs…soaring household spending to offset moribund business investment. [So] Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble."

Krugman claims "that wasn't a piece of policy advocacy, it was just economic analysis."

For further discussion please see Krugman's Intellectual Waterloo

When wizards get into trouble they claim they were misquoted, someone did too much, someone did not do enough or any number of other excuses.

No, it was not "policy advocacy", it was simply economic voodoo that that Krugman condoned.

Krugman a Panderer to Public Unions

One of the reasons Estonia is recovering is it had the common sense to slash public sector wages.

In contrast, Krugman is a strong backer of public unions as noted in Wisconsin Power Play.

The reasons Krugman supports unions should be obvious:

1. Krugman wants to waste as much money as possible (because that is what Keynesian voodoo economics is all about).
2. There is no better way to waste taxpayer money than overpay for services from public unions.

Wizards in ivory towers have not completely figured out that money to pay public unions has to come from somewhere (namely taxpayers in general). Of course liberal Keynesian wizards (the worst kind) have an answer for that as well: take from productive members of society and slosh it around to public unions.

Never mind that public unions have bankrupted numerous cities and even in economic la-la land (otherwise known as California), backlash against unions is justifiably high and rising.

Moral of the Story

The average non-wizard non-union employee has long ago figured out the moral of this story. Those in ivory towers in "Academic Wonderland" have not, so I need to spell it out.

It is indeed possible to have a genuine economic debt-free recovery, along with austerity, as long as other sound economic measures are incorporated at the same time.

Yes, there will be some short-term pain. However, any attempt to avoid pain via heaps of fiscal and monetary stimulus is nothing but voodoo economics and can-kicking witchcraft.

How Bad Is the Labor Market

From David Rosenberg:
One Sick Labor Market
There were so many disturbing elements to the May jobs data that we're not sure we can do justice to the litany of disappointments (with some help from our friends at the Investor's Business Daily):

• The share of long-term unemployment is at its highest level since the Great Depression (42%).
• Fully 54% of college degree graduates under the age of 25 are either unemployed or underemployed.
• 45 million Americans are on food stamps — one in seven residents.
• 47% of Americans are on some form of government assistance.
• The employment-to-population ratio for 25-54 year olds is now 75.7%, lower than it was when the recession supposedly ended in June 2009.
• The number of people not in the labour force has swelled eight million since the recession ended; absent that effect, the unemployment rate would be 12% right now (about the same as President Obama's election chances would be).
• The number of people confident enough to leave their jobs fell 11% in May
  for the second month in a row to 891k, the lowest since November 2010.
• The ranks of the unemployed who have been looking fruitlessly for work for at least 27 weeks jumped 310k in May, the sharpest increase since May 2011.
• The unemployment rate for males aged 16-19 is 27% and for males between 20 and 24 it is 13%. Draw your own conclusions from a social (in)stability standpoint.
• One in seven Americans are either unemployed or underemployed.
• Only one in six of the youth are working full-time and three-in-five are living with their folks or another relative (as per the NYT).
• A mere 16% of the 2009-2011 graduating class has found full-time work, while 22% are working part-time. Even those hired from 2006-08, just 23% are working full-time.
• According to a poll cited in the NYT, just 14% of high-school grads today believe they will have a more successful financial future than their parents Line of the day, as depressing as it is, comes from an 18-year old: "Thank God I had a buddy at Burger King who could help me out". Fast-food has emerged as the fast-growing industry in a country once led by technology. Even tech now is fuelled more by companies that produce nifty consumer gadgets and feed our narcissistic needs than those who focus on improving the nation's capital stock which is the ultimate trailblazer for productivity growth and durable gains in our standard-of-living.

Fed Begins New Round of Quantitative Easing (Destroying the Currency)

"...contrary to what purists may believe, the only way to inflate away unsustainable debt in a growth-free economy is by destroying the currency" Tyler Durden, Zero Hedge

Hussman Renews Recession Warning

"I expect that the U.S. economy is presently entering a recession, which is global in nature. It is unlikely to respond meaningfully to monetary stimulus, which has already gone well past the point of diminishing returns, and on to the point of recklessness.

"At present yields, a further round of QE would essentially amount to fiscal policy, subsidizing bond market speculators and banks, and ultimately producing near-certain losses for the Fed, after interest, and at public expense." John Hussman, Ph.D.

Spain Loses Market Access

I'm surprised stocks aren't down more, but I think there is a growing expectation of more QE and greater faith than there should be in its benefits. Here is the headline from WSJ:

In the longer run, over the course of the next few months, I expect that this will only get much worse. We have much further to go in this debt crisis.

China's Economy Falters

from Bloomberg:
"Bad tidings for manufacturing and services, and weakening consumer confidence: China sure packed a lot of disappointing economic news into just a few days. And it’s certain to strengthen recent calls in China for renewed stimulus measures, including through rapid approvals of new infrastructure projects and more credit easing."

But stocks are shaking off the news, beginning to ally this morning. 

World Bank Warning