Declining Economic Forecasts Cast a Pall Over Markets

from CNBC:

A drumbeat of disappointing data about consumer behavior, factory sales and weak hiring in recent weeks has prompted economists to ratchet down their 2011 economic forecasts to as little as half what they expected at the beginning of the year.

Two months ago, Goldman Sachs projected that the economy would grow at a 4 percent annual rate in the quarter ending in June. The company now expects the government to report no more than 2 percent growth when data for the second quarter is released in a few weeks.

Macroeconomic Advisers, a research firm, projected 3.5 percent growth back in April and is now down to just 2.1 percent for this quarter.

Both these firms, well respected in their analysis, have cut their forecasts for the second half of the year as well. Then this week, the Federal Reserve downgraded its projections for the full year, to under 3 percent growth. It started the year with guidance as high as 3.9 percent.

Two years into the official recovery, the economy is still behaving like a plane taxiing indefinitely on the runway. Few economists are predicting an out-and-out return to recession, but the risk has increased, with the health of the American economy depending in part on what is really “transitory.”

During the first press conference in the central bank’s history two months ago, Federal Reserve Chairman Ben S. Bernanke used the word to describe factors — including supply chain disruptions after the earthquake and tsunami in Japan and rising oil prices — that were restraining economic growth in the first half of the year.

Earlier this week, Mr. Bernanke confessed that “some of these headwinds may be stronger and more persistent than we thought,” adding, “we don’t have a precise read on why this slower pace of growth is persisting.”

Economists say the unexpected shocks from Japan and the Middle East in the first half of the year go only partway toward explaining the deceleration. Many worries remain: housing prices have continued to fall, hiring is weak, wages are flat, growth in emerging economies like China and India is slowing and the debt crisis in Europe could have ripple effects.

What’s more, government stimulants like the payroll tax cut and the extension of unemployment benefits are scheduled to expire at the end of this year. With the underlying economy undeniably tepid, economists are concerned that further shocks to the system could knock the country off its slow upward trajectory.

“The likelihood of a negative surprise is bigger than the likelihood of a positive surprise,” said Jerry A. Webman, chief economist at OppenheimerFunds.

There was a glimmer of hope on Friday when the government reported that orders for appliances and other equipment from manufacturers were higher than expected in May. And the Commerce Department edged up its estimate of growth in the first three months of the year to 1.9 percent, from 1.8 percent.

The slow place of the economy’s expansion is not entirely surprising, though it is clearly painful for those who are out of work and whose homes are worth far less than a few years ago. Many economists, most prominently Kenneth S. Rogoff and Carmen M. Reinhart, have emphasized that recovering from a financial crisis takes much longer than from a normal cyclical recession.

Jan Hatzius, the chief United States economist at Goldman Sachs, said that in fact, households appeared to be paying down debt largely as expected. “Most of the things that looked like they were improving six months ago still look like they are improving,” he said.

Analysts generally expect the economy to pick up in the second half as supplies from Japan come back and car production resumes at some temporarily idled plants. “Parts producers are getting back online a lot quicker than anybody had thought,” said Ben Herzon, a senior economist at Macroeconomic Advisers. The firm is forecasting 3.5 percent overall economic growth in the second half of the year, though that is down from its projection at the beginning of the year of 4 to 4.5 percent.

Consumer spending has been lukewarm as people have cut back elsewhere to cover for higher prices at the pump. Although gas prices have eased in the wake of the International Energy Agency’s announcement that it would release some emergency stockpiles of oil, there is no guarantee prices won’t climb again as turmoil in the Middle East continues. In the meantime, customers remain wary.

“A lot of the factors that will give us a boost in the second half are largely temporary and will run their course at some point,” said David Greenlaw, chief United States economist at Morgan Stanley.

How the Strategic Petroleum Reserve Works

Bernanke's Catastrophe

Interview with Lee Adler of Wall Street Examiner
Introduction by Ilene
Elliott, of PSW’s Stock World Weekly, and I began a series of interviews with Lee Adler, chief editor and market analyst at the Wall Street Examiner, on May 11, 2011. This is part 2. Lee's Wall Street Examiner is a unique, comprehensive investment newsletter that covers subjects such as the Fed’s open market operations, the impact of the Fed and the US Treasury on the markets, the housing market, and investment strategies. We often cite Lee’s analysis in Stock World Weekly and on Phil’s Stock World--his research provides invaluable information for formulating an overall market outlook.
(Here's part 1 of our interview: The Blinking Idiot & the Banking System)

Part 2: Bernankenstein's Monster 

Elliott: How should we invest in this environment - when we take into account the Fed’s huge interference in the markets?
Lee: Think like a criminal. Look, it’s a matter of knowing what the Fed’s next move is going to be, and knowing the investment implications.  You have to stay with the trend until the Fed sends signals that it is going to reverse. We’re at that inflection point. The issue is how much front running will there be? You definitely have to be out of your longs by now. When support fails after having succeeded, succeeded, succeeded, and every other previous retracement has held, then suddenly one doesn’t, it’s a huge signal.
Ilene: If the Fed wants oil and metal to go down, and the dollar to go up, is that saying it wants the stock market to go down as collateral damage? If pattern continues, the stock market will go down with the commodities.

Lee: No, the stock market is the center. Bernanke came out in November, the day they announced QE2, and did an Op-ed in the Washington Post saying exactly what he expected. He’s going to manipulate the stock market higher, and that’s going to create economic confidence and everyone’s going to be happy. His goal was to manipulate the stock market. The collateral damage, the stupidity of their policy, was that they didn’t take into account the inflationary effects on commodities. They kept denying it.  And Bernanke kept saying over and over, well, look the stock market is going up, QE2’s having the desired effect. He was willing to take credit for the stock market going up, but he refused to take responsibility for the same exact move in commodities. It’s the same, they move together. It’s just that one was an intended consequence (stocks going higher), and the other (inflation in commodities) was the unintended consequence. They took credit for the intended consequences, but wouldn’t take responsibility for the unintended consequences.
Ilene: What in the Fed’s creation gives it the power to manipulate the stock market? That wasn’t one of its dual mandates (maximum employment and price stability). Isn’t that beyond its scope?
Lee: Of course, but QE2 was a direct manipulation of the stock market.
Ilene: So the Fed knew the money they gave to the Primary Dealers would end up in the stock market. Do they have an agreement with Goldman Sachs, like “hey we’re going to print you this money and we want you to buy stocks?”

Lee: Look, Brian Sack, the head trader for the Fed, sits down with the Primary Dealer traders every morning before the NY markets open, and they have a conference call. Every morning. The Fed makes no secret of this, it’s all on the NY Fed website, the “Fed points.” They describe the whole thing. They discuss the dealers’ “positions and what their financing needs are”, but that’s code. The Fed decides what it wants, and the PDs execute the Fed’s wishes. So while government securities are usually the Fed’s focus, the dealers can trade whatever they want. Bernanke made it absolutely clear that stocks were his focus in that November 4 editorial in the Washington post.

Ilene: Even though manipulating stocks is not a legitimate focus of the Fed?
Lee: That’s what they get away with. The mainstream views pushing stocks higher as a legitimate policy. People want the stock market higher. But they don’t want to see oil prices over $100 a barrel, and gas prices over $4 a gallon, they don’t want that.

The Fed does not control what the dealers do with the money, they can only make their wishes clear. The Fed can make it difficult for the dealers, and now they are, because they finally got fed up with the commodity speculation. But the Fed does not control what Goldman Sachs does completely. In fact, it might be the other way around. There’s clearly collusion, it’s no secret.

Ilene: Why doesn’t anyone do anything to stop this?
Lee: Well, most of the FOMC members want stock prices higher. They believe the trickle down theory crap. They want to inflate, so it costs less to service our debt. But the kind of inflation we have is devastating. It impoverishes the middle class and makes the middle class unable to pay its debts to the banking system, which is a time bomb in itself.
The banks are not increasing their loss reserves at all. They’re shrinking their reserves so they can show profits when they should be going in the other direction because the ability of the public to service the debt is decreasing.
The Fed gets into these post-hoc crisis management modes where they will make another huge blunder. QE2 was a massive blunder. It did not achieve its desired goal. It got stock prices up but it didn’t get the economy turned around, and it made inflation much worse. They fucked up and the blunder will only be recognized after the fact. Mainstream media won’t get it until after the stock market collapses. By then it’s too late. But the blunder won’t be manifest till stock prices collapse, and then everyone will recognize what a damn idiot Bernanke is.

And now they’re going to sacrifice the stock market, because another problem is that they can’t afford to allow long-term bond yields to go up. The government can’t afford higher interest rates. They will sacrifice the stock market at the alter of the Treasury market. They will do whatever they can to support Treasury prices at high levels. That means they’ll force the liquidation of stocks, and once the wave of liquidation hits the stock market, the knee jerk reaction is for the money to flow towards Treasuries. Someday that’s not going to work, and I think that day may be coming pretty soon.

Ilene: What do you think about Bill Gross shorting Treasuries, is that going to work out for him?
Lee: William the Gross. Watch what he does, not what he says. The guy is a world class card player. For any public pronouncement he makes, generally, you have to consider the opposite. Think like a criminal. He’s the Godfather. When Gross comes on TV, I hear the Godfather music playing in the background. His track record of public pronouncements isn’t very good, yet he consistently makes more money than anyone else trading the bond market, so obviously you can’t be wrong all the time and make money all the time.
Ilene: So he’s front running?
Lee: If he’s making a pronouncement on CNBC, he probably has another reason for saying what’s he’s saying other than what it appears to be. He’s got a direct pipeline to the Fed. The Fed sends these coded messages. It’s not that hard to figure out by watching the data. The massive spike in bank reserve deposits at the Fed, starting right after the January Fed meeting, means something is happening there.
Ilene: You’ve concluded this game is going to stop in June?
Lee: Well, I always figured it would because commodity prices were getting out of control. The more Bernanke denied it, the more troubling it seemed he knew it was. It’s the old “[he] doth protest too much, methinks.”  Every time Bernanke claimed the inflation was transitory, the more clear it became that he knew it was a serious problem. But they didn’t do anything about till recently.
Ilene: So what is going to happen with the stock market? Will it sell off as QE ends? At what point will the Fed start a QE3 to stop the stock market from dropping - would it let stocks drop 10%, 20%...?
Lee: Oh yeah. The Fed’s job one is to preserve the Treasury market. With this enormous mountain of debt which the government is on the hook for, they can’t afford to pay 5% interest, or even 4%. They can’t afford any increase in Treasury yields. So, if necessary, they’re going to force a liquidation of stocks and spark a “flight to safety” panic again, as they did in 2008. Then, they needed to get the yields down, and they were also thinking it would help the housing market.
Ilene: But it didn’t really get to the housing market.

Lee: The problem in the housing market had nothing to do with mortgage rates but they didn’t understand that. It’s amazing how when you put all these smart people together how stupid they can be. It’s the problem with group think. When the FOMC gets together, it’s like having all these geniuses in the room coming up with idiotic decisions. They all have the same motivation - to become the next Fed Chairman. The way to do that is to comply with the mad scientist running the show. Bernanke’s whole life has been an ongoing doctoral dissertation in which he tries one experiment after another, based on the crap he wrote when working on his PhD.
The problem we’re experiencing now is that the system is imploding. It’s a slow motion implosion.
Elliott: When QE2 ends in June, will the pain of that ending be extreme enough cause the Fed to resume some form of QE3?
Lee: Yep. I don’t think it will take long.  We’re in bad shape, as bad as Greece. The only way we can pay our bills is if other countries and investors continue to lend us $100 Billion every month, and that could jump to $150 Billion a month in the summer. So we can’t pay our bills unless people lend us more money. That’s not paying bills. That’s creating a bigger problem.

Bernanke Is Making Things Worse

Elliott, writer of PSW’s Stock World Weekly, and I recently began a series of interviews with Lee Adler, chief editor and market analyst at the Wall Street Examiner. (The interview was on May 11, 2011.) The Wall Street Examiner is a unique and very comprehensive investment newsletter. Lee Adler’s work covers subjects such as the Fed’s open market operations, the impact of the Fed and the US Treasury on the markets, the housing market, and investment strategies. We often cite Lee’s analysis in Stock World Weekly and on Phil’s Stock World -- his research into the Fed’s and the Treasury’s activities – the money flows – provides invaluable information for formulating an overall market outlook. 

Part 1: A Blinking Idiot & the Banking System 

Ilene: Lee, I’ve gathered from reading your material lately that you think it’s time to be out of speculative trades, such as oil, now?
Lee: Yes, the Fed is serious about stopping speculation, and they are not waiting till the end of QE2. Bernanke wants to break the back of this thing. So if you want to trade the long side now, you’re playing with fire. The powers that be have put out the message that they won’t keep tolerating speculation in the oil and commodities markets.
Ilene: Because of the inflation that Bernanke denies exists?
Lee: Yes, the inflation is disastrous. They’ve known all along that inflation is real. You know it when you’ve got this situation in Libya with people getting killed. It started with food riots in Tunisia, but then it morphed into something else. People are starving all over the world because of these commodity prices, and the idea that it is not affecting Americans is crap because 80% of the people are affected by gas prices at these levels. They have to cut back on other spending, and the top 10% can’t carry the ball. If you’re spending an extra $100 – $200 to fill up your car and put groceries on the table, that affects your ability to service your debts, and that affects the banking system. This inability to pay back loans is showing up in mortgage delinquencies and credits card delinquencies.
Ilene: You also have written that the Dollar and commodities have an inverse relationship, why is that?
Lee: Because commodities, such as oil, are traded in Dollars. Commodities are basically a cash substitute at this point. The players don’t want to hold Dollars because the Fed is trashing the Dollar. If you’re a trader outside the U.S., and your native currency is the yen, for example, and you want to buy oil or gold futures, you need to sell Dollars in exchange for the gold or oil futures contracts you’re buying. So your action of buying the commodities in Dollars is in effect creating a short position in the Dollar.
So if commodities collapse and you’re forced to sell your positions, you’ll reverse that short position in the Dollar – trading the commodities back for Dollars. That creates demand for the Dollar. That’s why commodities and the Dollar definitely do have an inverse relationship.
With the margin increases that were implemented in the last month or so, the Fed is beginning to reverse the commodities price run up.  This is the precursor to the end of QE2. The Fed is sending warning shots across the bow. After the Jan 26 FOMC meeting, banks’ reserves began to skyrocket. Why did bank reserves suddenly skyrocket? There’s no overt reason. Something was going on behind the scenes.  I think banks and Primary Dealers (PDs) got the back channel message that it’s time to start building reserves because they’re really going to end QE in June – they really, really are. I give it six weeks to two months until the whole thing collapses and they have to start printing money again.
Ilene: Why do commodities and the Dollar have a more persistent relationship than the Dollar and the stock market, for which there is an inverse relationship now, but this is not always the case?
Lee: The Dollar/stock market inverse relationship is a correlation due to a common cause – essentially the actions of the Fed.  It’s not a cause and effect relationship.
Elliott: Will the Fed defend the Dollar?
Lee: They are starting to, but not officially. They’re doing it behind the scenes. That’s my theory. I’m a tinfoil hat guy…. I didn’t start out this way. I arrived at my tinfoil hat after paying careful attention to the data for 8 or 9 years. After a while I realized it’s kabuki theater. 
Elliott: As you say it is kabuki theater, and as Phil says, we don’t care if the markets are rigged, we just need to know HOW the market is rigged so we can place our bets correctly.
Lee: Exactly. All you need to know is what the Fed is doing. That’s my bread and butter. I watch what the Fed is doing every day.  I’m so familiar with the data that stuff jumps out and screams at me. The margin increases were not an accident. They were completely out of character, and they followed Bernanke’s press conference where he claimed he couldn’t stop speculation. He’s so manipulative. He says one thing and does another.
Elliott: But being Chairman of the Fed, doesn’t he have to lie? If he came out and said exactly what he’s planning to do, wouldn’t everyone and his dog get on the right side of the trade?
Lee: That’s what he does though – he lies, but in his backchannel way. He tells the favored groups exactly what he’s going to do. You have to read between the lines. The meeting minutes are pure propaganda. That is how they send coded messages to the market. 
In the last meeting minutes, or maybe the one before, the Fed said that wage increases were to be eradicated. I went ballistic when I saw that.
Elliott: Especially because they create all this inflation, and it trickles it’s way down. This is trickle down inflation. It’s gotten to the point where the people trying to make a living and ultimately buy things are being told that although prices are going up, we can’t allow you to earn anymore money…
Lee: It’s a moral outrage and a terrible policy. But that’s what they want. Their purpose is to keep the bankers in business. The Fed serves the banking system. That’s why it’s there, to make sure the banking system is profitable.
Ilene: So they are accomplishing their goal.
Lee: For the time being. In the end they cannot fulfill their purpose because the banking system is dead. This is Frankenstein’s monster. This is another one of Bernanke’s economic science experiments, Dr. Bernankenstein.  And the result of his policies is bernankicide – the financial genocide of the elderly in America.
Elliott: Then if Dr. Bernanke is Dr. Frankenstein, then what exactly is his monster?
Ilene: The banking system?
Lee: Yes, it’s got these screws coming out of its head, and stitches across its forehead. It’s the walking dead. The banks don’t make any money, the only way they appear to make money is by lying about it.
Ilene: But the people running the banks make money.
Lee: It’s a criminal syndicate for god’s sake.

Another Oops! Fed MIA?

Here It Comes, Right on Time!

Stocks: Oops!

Is Reality Setting In?

Tyler Durden at Zero Hedge calculates that the next Non-Farm Payroll report is going to be very disappointing in July. Is reality finally setting in on Wall Street that the Pollyanna Party is coming to an end?

Durable Goods Mixed

Index increases, but core disappoints.

News of Greece Austerity Hits Market

Stocks Bounce Off 200-Day Moving Average Again

This is the second time in less than 2 weeks that we have bounced at this indicator. The moving average continues to rise, making each bounce ever more risky and difficult. Eventually, negative news will send us plummeting through the 200-day. I wouldn't be surprised if it occurs in the next few weeks.

What to Expect Over the Next Few Years

Debt Defaults and a U.S. Economic Crisis

By Simon Hunt

The global economy is facing a difficult period. The US Federal Reserve’s QE2 program ends at the end of the month. Europe’s debt issues continue to roll on as no party wants to pull the plug on Greece. The Middle East is in turmoil and high oil prices, together with food, are a tax on global consumers. Japan’s reconstruction has yet to get into full gear; and there are new concerns about the durability of China’s economy. Any significant slowdown there will send ripples of fear around the world.
The Federal Reserve is likely to sit pat for some months to see how the US economy will be able to perform without the steroids provided by them. Foreign central banks have largely been absent from Treasury auctions. In quarter 1 this year, foreign central banks bought just 16% of the issuances while the Federal Reserve acquired almost 200%, according to Russell Napier. In other words, the Fed’s activities have masked the exodus of foreign central banks including China from these auctions.
If foreign central banks continue to abstain from purchasing US Treasuries, the private sector will have to fund the fiscal deficit, implying quarterly remittances to the US Treasury of some $370bn. The private sector will be able to fund these auctions but at a price. They will demand a higher return on treasury paper and the funding will mean that the free-flow of funds into equity and commodities will come to an end. Many institutions are taking risk off the table.
On our associate’s, WaveTrack International technical work, 10-year US Treasuries should be yielding around 4% later this summer and 6% a year or so later. The repercussions of such a change in the yield structure will have global consequences, not least on stock and commodity markets.
Debt has woven a dangerous spider’s web in Europe. The basic truth is that Greece can never repay its debt; the ECB, the IMF and Euro governments are merely buying time by granting new loans, hoping that the problem goes away. Future stability, however, does not depend on what these institutions and governments do, but on how the electorates will react. In their view, austerity can be accepted only on a one or two year view, not as an ongoing way of life.
This is especially true of Greece whose national pride will find the sale of assets to foreigners wholly unacceptable. The same is true in other debt-laden Euro countries. All, apart from Italy, have seen their economies contract significantly over the past two years with little hope of any imminent improvement. The next major move could emanate from Ireland; the Irish government wants to renegotiate its ECB and other loans.
In fact, nearly all the conventional forward looking indicators (PMIs, OECD leading indicators etc.) are suggesting that global growth is slowing and rolling over. The US ISM data for May was universally awful with every component from New Orders to Imports down significantly. This is a view shared by industry mills we talk to and visit regularly.
The USA does not only have a cyclical problem, but a structural one also. The fundamental issue is that sooner rather than later government will be forced to introduce measures that will allow the country to live within its means. It will take a deep crisis before such policies can be put together and passed by the country’s politicians. For instance, a run on the US dollar sometime next year or early in 2013 might do the trick.
Unemployment amongst teenagers has become a serious structural and social problem for the USA in an economy that is becoming dominated by skilled workers. The number of unemployed teenagers (16-19) now totals almost one in four. However, the number of African-American, not seasonally adjusted U-3 unemployment, including both sexes, in the same age group has risen to a stunning 41%, almost every other teenager.
Once Washington puts its act together, (it will have to or else the crisis will get so deep that US markets will become dysfunctional), America will find a large number of companies which had vacated the shores of the USA for China and other parts of Asia returning to their homeland.
There are two main reasons for this change, what we call reverse globalisation. First, manufacturers want their supply chains located close to the market, not on the other side of the world. And second just as important is the cost differential trend which is narrowing together with the increasing logistical costs. It is not only the wage profile looking 10 years forward, but the other costs, such as land, electricity, taxes together with the indirect supply chain cost increases. There is also the reluctance of the system in China to allow foreign companies to gain access to government contracts.
Within a decade, the USA could supplant China as the manufacturing hub of the world. To repeat, big changes will be needed in Washington for this historic development to occur. The changes will not just be on the fiscal side, but the need to offer businesses the right incentives to produce in the USA rather than abroad, the permitting procedures to allow the development of the country’s resources, including oil (the USA could become self-contained), making government less intrusive in households and businesses and so on.
In short, it is putting back in place the principals that made America the great country it once was. Crises produce opportunities and this one is as big as they have been since the USA entered WW11. What is noteworthy is that should America grab its opportunity, it will become self-contained in energy and of course food. What other major power has those valuable twin assets?
China and the rest of Asia are no exception to this slowing economic trend. In the former, government’s focus on CPI inflation and the housing market together with its concerns on the degree of speculative or hot money circulating within the economy will almost ensure that the tight monetary policy will continue for some months yet. In these circumstances, further hikes in interest rates and Reserve Requirements are likely to be seen before the end of the year.

Chart 1: Shanghai Composite Index

Such a scenario fits the political cycle. Some of the country’s excesses can be cleaned out by end 2011, much to the delight of the incoming leadership, whilst monetary policy remains tight. The chief economist of the State Information Centre, who is well regarded in Beijing, said at a recent conference in Shanghai that “China has a serious inflation”. He concluded his speech by saying that China had to endure some short term pain for the longer term benefit of the economy. Early in 2012, monetary policy will start to be loosened and should continue to do so throughout that year. The economy should recover so allowing the outgoing leadership to depart on a high note. Post 2012, we guess that the incoming leadership will want to put the economy on a firmer long-term footing, meaning more tightening. This may well coincide with the real estate sector seeing major falls in prices and, externally, the global economy starting to suffer from the breakout of its second global credit crisis. Oil prices in the $150-200 will be a disaster for China as one senior government economist said to us. China may well go through two odd years of real recession in 2013-14 years, in our view. The impact of an effective recession in China on the rest of the world will be serious and widespread.

Chart 2: The Demographics of the Middle East

Some of the underlying causes for MENA countries’ youth to rebel against their autocratic governments are common with China. The youth in these countries don’t care about democracy or who governs: they want freedom of expression, for governments to uphold their rights and the right to work. It is why Beijing has become so sensitive to the Jasmine movement and ongoing developments in MENA. Workers’ protests appear to be on the rise. The ability to communicate via computers and mobile phones (Facebook etc.) increasingly makes government powerless to control the flow of information.
As the Financial Times wrote on 20th July, “the perception that local protests might be gaining a broader national coherence is deeply threatening to China’s Communist Party....That is the conclusion of the government itself. A report by the State Council Development Research Centre blamed protests on the marginalisation of about 150M migrant workers...

Graph 1: Global Food Prices

Global food prices have risen by 37% in the past year according to the FAO. It was higher food prices plus the high level of unemployment in MENA countries that sparked so much rioting in the region. China’s government is highly sensitive to rising food prices. They may well rise further over the coming months due to the hog cycle so ensuring that pork prices increase further followed by corn and in due course even wheat. But, China’s agricultural base is deteriorating. Top soil is collapsing to dangerous levels; its fertility is being destroyed by acidification; water is being consumed way beyond sustainable levels; and aquifers are being exhausted. These are structural issues, not short term cyclical ones.
The demographics of the rural areas of China imply that the pool of active workers in the age group 15-30 is fast diminishing. It means that productivity will decline to a rate closer to the Asian Tigers ex. China or down to the 2% a year level from its historic 5% rate. The above remarks also imply that China will be importing more foodstuffs over the coming decade. Unlike the USA, China is becoming increasingly dependent on imports of food and energy.
The above is a more likely scenario to evolve than the benign outlook postulated by so many. The world is not back to the 1990s sustainable growth, but its fragility is being patched up by unsustainable fiscal and monetary excesses. In fact, as Charles Gave wrote recently in GaveKal Five Corners, these policies have had the opposite effect than those intended (the unintended consequences of policy actions!), “Capitalism cannot work without a proper cost of capital. Capitalism needs the process of creative destruction, and if real rates are negative or abnormally low, the destruction part of the process cannot happen, zombie companies are kept on perpetual life support and growth flags.”
This is exactly what is happening nearly everywhere. Politicians won’t bite the bullet (perhaps with the exception of the UK) without a crisis. That crisis is coming, certainly by early 2013 if not sooner, to be followed by years of recession and deflation, a period when the down years will outnumber the up ones. It will be accompanied by a serious deflation of assets, both equities and commodities, perhaps excepting food. This period of austerity is likely to last until around 2018; a generation of debt should by then have been worked off so laying the foundations for a long period of sustainable growth.

Chart 3: Historical Sovereign Default/Restructuring Events

The truth is that the lessons of history have been conveniently forgotten or ignored, as illustrated by Carmen Reinhardt and Kenneth Rogoff in their epic work “Growth in a Time of Debt”. Those lessons are simple: credit crises are followed by years of sub-par growth and sovereign defaults.

The Big Bounce

Crude Oil Plunge Suggests Cracks in Global Economy

It's Just Gets Worse

Dow down about 180 points!

Stocks Plunge at the Open

It's ugly!

Why We'll Never Be Able to "Grow" Our Way Out of Debt

Submitted by Charles Hugh Smith from Of Two Minds
"Growing Your Way Out of Debt" Is A Fantasy 
Add rising interest payments and higher taxes to declining assets and incomes and you don't get "growth," you get insolvency.
The Status Quo consensus is that "kicking the can down the road" a.k.a. "extend and pretend" will work because "Greece, Spain, Ireland et al. are going to "grow their way out of debt." That is a fantasy.

Here's why.

1. There's a funny little feature of debt called interest. The Status Quo solution for Ireland, Greece, Portugal, Spain et al. is A) increase their debt load with more loans and B) roll over their old debt into new loans, without the old lenders taking any "haircut" on the principal.

Both of these "solutions" add more interest costs. That means more of the national income stream must be diverted to pay the lenders their pound of flesh. That means there is less money in the national economy to buy goods and services, which means the economy must shrink to pay the higher interest costs.

This is why unemployment in Spain and Greece has skyrocketed and why 100,000 small businesses have closed in Greece in the past year.

2. A funny little feature of interest is that when people see you're at risk of default, they start charging you more to borrow their money. And it isn't a tiny bit more interest, it's a lot. Think subprime teaser loan at 3% shooting to 8%, or 28% if you're trying to sell new debt on the open market.

For the E.U. to "help" Greece and Ireland by rolling over their already crushing debt loads into new, higher interest loans is like "helping" a sick patient by sticking a knife into their back.

3. Governments over-promise future benefits to win elections in the here and now. This makes sense, of course, because you win the elections and power now and the problem of paying for these excessive benefits is left to future politicos and taxpayers.

But when the phony "growth" (think metasticizing cancer) fueled by rapidly rising debt is finally cut off, then the government has no choice but to raise taxes, and keep raising them, to pay for the extravagant past promises made to citizens.

That means more of the national income is diverted to taxes, only part of which flow through as cash benefits to consumers. Much of the tax revenues flow to cronies, fiefdoms and of course those higher interest payments on the ballooning debt.

4. Cheap abundant credit has a funny little consequence: asset bubbles. When everybody can borrow vast sums of nearly-free money at costs much lower than the outlandish gains being reaped by real estate speculators and punters pouring cash into stocks and commodities, then of course it is a perfectly rational decision to leverage yourself to the max, borrow as much as you can and join the speculative frenzy.

So assets bubble up to frothy levels, and McMansions sprout by the thousands on Irish and Spanish soil. The "demand" is not for shelter; it was all speculative demand for something to flip and churn.

So when the debt bubble pops, so too do all the asset bubbles.

5. Leverage has a funny little feature called collateral and that other peculiar feature, interest. The land and house are the collateral for a mortgage (debt). As the real estate bubble popped, then the value of the collateral plummeted. Now the collateral is worth less than the loan--the borrower is "underwater."

The lender foolishly reckoned this would never happen, and now taking the collateral when the borrower defaults is an unsavory option because the lender will have to absorb a huge loss ("haircut") if they take the property.

So they choose to "extend and pretend," offering the borrower new terms, lower payments, etc., anything to keep the loan value on the books at 100%.

All of this is just artifice, of course; the borrower is insolvent, and so is the lender. As long as the borrower has to pay interest and principal, then there is not enough income left to "grow" anything. As long as the lender keeps the impaired loan on the books at the bogus valuation, then the lender is treading on the thin ice of insolvency.

6. As the national income and asset valuations both decline, the government imposes "austerity" programs which further cut incomes. A funny little feature of government "austerity" is the cuts come from the citizen's side of the expense ledger, not from the crony/fiefdom side.

Here in the U.S., for example, the library hours are slashed and the parks are closed to save $22 million in a $100 billion annual budget (those are the numbers in California) while various favored fiefdoms continue to get their swag. The "pain" of austerity is anything but evenly distributed.

7. People facing financial uncertainty and duress have a funny little habit called saving. As the reality of instability becomes crystal-clear to all, then people rather naturally rally round and circle the wagons, i.e. start saving money to cushion them through the hard times. Trusting in future benefits and bubbles is obviously foolish, and the only avenue of relative safety is cash (or equivalent) in hand.

As people save more of their declining income, there is even less national income left to be spent on goods and services.

8. These forces are self-reinforcing. The worse times get, the more people save. the lower the national income, the more taxes will be raised. The more visible these trends become, the more interest lenders demand as they see the positive feedback loops leading to insolvency.

Once a household or nation is burdened with stupendous debt loads and stagnating earnings, "growing your way out of debt" is impossible. The E.U. may succeed in strong-arming Greece into swallowing even more debt, more austerity and higher interest payments, but that will only speed up the self-reinforcing dynamics of insolvency, and guarantee the losses kicked down the road for a few months will be even more devastating.

Stocks Continue Plunge After Hours

CBO Report Sends Stocks Tumbling to Close Down 80 Points

This was the impact of the CBO report today. The Dow had been slightly higher than yesterday's close, but collapsed 100 points upon this news.

CBO Warns of "Sudden Fiscal Crisis"

WASHINGTON (AP) — A new report says that the national debt is on pace to equal the annual size of the economy within a decade, levels that could provoke a European-style debt crisis unless policymakers in Washington can slam the brakes on spiraling deficits.
The Congressional Budget Office study released Wednesday offers a fresh reminder of what’s at stake in ongoing talks led by Vice President Joe Biden that are aimed at slashing more than $2 trillion from the federal deficit over the coming decade as the price for permitting the government to take on more debt to pay current obligations.
CBO says the nation’s rapidly growing debt burden increases the probability of a fiscal crisis in which investors lose faith in U.S. bonds and force policymakers to make drastic spending cuts or tax hikes.
“As Congress debates the president’s request for an increase in the statutory debt ceiling, the CBO warns of a more ominous credit cliff – a sudden drop-off in our ability to borrow imposed by credit markets in a state of panic,” said House Budget Committee Chairman Paul Ryan, R-Wis.
The findings aren’t dramatically new, but the CBO analysis underscores the magnitude of the nation’s fiscal problems as negotiators struggle to lift the current $14.3 trillion debt limit and avoid a first-ever, market-rattling default on U.S. obligations. The Biden-led talks have proceeded slowly and are at a critical stage, as Democrats and Republicans remain at loggerheads over revenues and domestic programs like Medicare and Medicaid.
With the fiscal imbalance requiring the government to borrow more than 40 cents of every dollar it spends, CBO predicts that without a change of course the national debt will rocket from 69 percent of gross domestic product this year to 109 percent of GDP – the record set in World War II – by 2023.
Economists warn that rising debt threatens to devastate the economy by forcing interest rates higher, squeezing domestic investment, and limiting the government’s ability to respond to unexpected challenges like an economic downturn.
But most ominously, the CBO report warns of a “sudden fiscal crisis” in which investors would lose faith in the U.S. government’s ability to manage its fiscal affairs. In such a fiscal panic, investors might abandon U.S. bonds and force the government to pay unaffordable interest rates. In turn, CBO warns, Washington policymakers would have to win back the confidence of the markets by imposing spending cuts and tax increases far more severe than if they were to take action now.
“Earlier action would permit smaller or more gradual changes and would give people more time to adjust to them, but it would require more sacrifices sooner from current older workers and retirees for the benefit of younger workers and future generations,” CBO Director Douglas Elmendorf said in a blog post.