The Chicago PMI (whose early release to subscribers pushed the market lower as usual), dropped by the biggest amount so far in 2010: at 59.7, it saw its largest decline YTD, at -6.4%. The only item that rescued the PMI was the ongoing surge in inventories as end demand collapses. How much longer can the inventory rebuild continue?
Aside from the inventory "junk food" restocking, all other PMI components tumbled, with the Prices Paid, Order Backlogs and Employment all coming in at 2010 lows, in signs that the fiscal stimulus benefits are all virtually over. Once the inventory inversion begins, look for the overall business barometer to make a sharp correction to the downside as the sugar high is on its last fumes.
Saturday, May 29, 2010
More Details on Yesterday's Chicago PMI
Quotes from Road to Serfdom, compiled by Mike Krieger
great quotes from Road to Serfdom by Von Hayek, by Mike Kieger:
I recently finished reading F.A. Hayek’s classic work The Road to Serfdom and quite frankly I was completely blown away. Its author is one of the greats in Austrian economic thought and he won the Nobel Prize in Economics in 1974. The Road to Serfdom was first published in Britain in 1944 and in the United States the following year. I found the book to hold such significant lessons about the dangers of concentrated political and economic organization that I was compelled to write down many of my favorite quotes and passages in the email below. Where I have found the need to comment I have added “my two cents.” I suggest everyone on this list buy this book and read it if you have not already and to reread it if you had in the past. It’s almost scary how he seems to be describing many of the exact same things that are happening today. I guess that is because as much as things change, human nature never really does. So we create the same disasters over and over.
I am about to head out on the road (not to serfdom hope!) and before I do I want to issue a rallying cry to everyone that craves freedom both politically and economically. We must all at once stop identifying ourselves as Democrats and Republicans. The elites use these definitions as part of a divide and conquer strategy. In any event, Bush and Obama seem pretty similar to me anyway. Two thugs. We must get back to our roots and what made this country great. The enemy is not someone from a different political party or a “capitalist” or a “socialist.” The enemy is collectivist thought imposed on humanity from the top down. Top down collectivist thought has taken on many forms whether it is Communism or Fascism but in the end what happens is a small ruling elite run the lives of 99% of the population. Those that resist are killed or imprisoned. I certainly do not think I have all the answers. What I do know is that freedom loving people the world over must shed their prior false political identities and together agree on certain key principles. There is a battle going on between a small highly organized group that wants a collectivist top down structure of world government and they are rushing to put these plans into action. This is not conspiracy theory it’s very obvious if you open your eyes. Get your money into real assets and get prepared so that you are not destitute when it comes time to stand up and rebuild. We can make this world a better place but it’s not going to be easy. I will be in touch.
The Road to Serfdom: Favorite Passages and Quotes
What in the future will probably appear the most significant and far-reaching effect of this success is the new sense of power over their own fate, the belief in the unbounded possibilities if improving their own lot, which the success already achieved created among men. With the success grew ambition – and man had every right to be ambitious. What had been an inspiring promise seemed no longer enough, the rate of progress far too slow; and the principles which had made this progress possible in the past came to be regarded more as obstacles to speedier progress, impatiently to be brushed away, than as the conditions for the preservation and development of what had already been achieved.
- Chapter One “The Abandoned Road”
My Two Cents: Basically as mankind advanced and become more free and standards of living advanced, a trend toward idealist and impossible to achieve utopian concepts became increasingly prevalent and the attempts to implement these have actually cause immense suffering and in the process many forgot the actual methods by which the prior progress had actually been achieved. I think this is a great parallel to the modern United States where we have forgotten the roots of that which made this country great. An attempts to rediscover those roots is burgeoning with the current Constitutional movement, which I fully endorse.
The complete collapse of the belief in the attainability of freedom and equality through Marxism has forced Russia to travel the same road toward a totalitarian, purely negative, non-economic society of unfreedom and inequality which Germany has been following. Not that communism and fascism are essentially the same. Fascism is the stage reached after communism has proven an illusion, and it has proved as much an illusion in Stalinist Russia as in pre-Hitler Germany.
- Quote by Peter Drucker used by Hayek in Chapter Two “The Great Utopia”
Many people, on the other hand, who value the ultimate ends of socialism no less than the socialists refuse to support socialism because of the dangers to other values they see in the methods proposed by the socialists.
- Chapter Three “Individualism and Collectivism”
Or, to express it differently, planning and competition can be combined only by planning for competition but not by planning against competition.
- Chapter Three “Individualism and Collectivism”
My Two Cents: Planning an entire economy doesn’t work! Look at the mess China is in. Believe me, they have a major mess on their hands and if they don’t either appreciate the yuan or back their currency by gold soon I expect a total collapse there.
It should be noted that, moreover, that monopoly is frequently the product of factors other than the lower costs of greater size. It is attained through collusive agreement and promoted by public policies.
- Chapter Four “The ‘Inevitability’ of Planning”
My Two Cents: Can you say the modern U.S. corrupt and rigged economy.
While there is nothing in modern technological developments which forces us toward comprehensive economic planning, there is a great deal in them which makes infinitely more dangerous the power a planning authority would possess.
- Chapter Four “The ‘Inevitability’ of Planning”
My Two Cents: And this was written in Hayek’s time. We must be more vigilant than ever to protect against an authoritarian government since the technology available to them to enforce tyranny is beyond nightmarish. Why anyone has any trust in the Federal government of virtually any nation to do the right thing is beyond me.
From the saintly and single-minded idealist to the fanatic is often but a step.
- Chapter Four “The ‘Inevitability’ of Planning”
That in a planned system we cannot confine collective action to the tasks on which we can agree but are forced to produce agreement on everything in order that any action can be taken at all, is one of the features which contributes more than most to determining the character of a planned system…It is important clearly to see the causes of this admitted ineffectiveness of parliaments when it comes to a detailed administration of the economic affairs of a nation. The fault is neither with the individual representatives nor with the parliamentary institutions as such but with the contradictions inherent in the task with which they are charged.
- Chapter Five “Planning and Democracy”
Yet agreement that planning is necessary, together with the inability of democratic assemblies to produce a plan, will evoke stronger and stronger demands that the government or some single individual should be given power to act on their own responsibility…Hitler did not have to destroy democracy; he merely took advantage of the decay of democracy and at the critical moment obtained the support of many to whom, though they detested Hitler, he seemed the only man strong enough to get things done.
- Chapter Five “Planning and Democracy”
My Two Cents: As if dealing with the current inept and corrupt administration is not bad enough. What we get in the backlash to this administration could be worse. We must all agree on the Constitution so that we do not put in a demagogue after Obama or in a “crisis” that makes us afraid.
It may well be true that our generation talks and thinks too much of democracy and too little of the values which it serves…Democracy is essentially a means, a utilitarian device for safeguarding internal peace and individual freedom…and it is at least conceivable that under the government of a very homogenous and doctrinaire majority democratic government might be as oppressive as the worst dictatorship…The fashionable concentration on democracy as the main value threatened is not without danger. It is largely responsible for the misleading and unfounded belief that, so long as the ultimate power is the will of the majority, the power cannot be arbitrary. The false assurance which many people derive from this belief is an important cause of the general unawareness of the dangers which we face…Democratic control may prevent power from becoming arbitrary, but it does not do so by its mere existence. If democracy resolves on a task which necessarily involves the use of power which cannot be guided by fixed rules, it must become arbitrary power.
- Chapter Five “Planning and Democracy”
My Two Cents: So prescient. Don’t fall for the propaganda that because we are in a “democracy” all is ok. Just look at how the Congress rams through extremely unpopular bills and refuses to pass a real Audit the Fed bill when 80% of the population wants it. America was founded as a REPUBLIC. There is a difference. Look it up.
The more the state plans, the more difficult planning becomes for the individual.
- Chapter Six “Planning and the Rule of Law”
It is the Rule of Law, in the sense of the rule of formal law, the absence of legal privileges of particular people designated by authority, which safeguards that equality before the law which is the opposite of arbitrary government…To produce the same result for different people, it is necessary to treat them differently.
- Chapter Six “Planning and the Rule of Law”
My Two Cents: There is no rule of law in America. Obama basically suspended it during the financial crisis. Remember, rights and the rule of law are always removed by autocratic leadership in a crisis. Think 9/11 and the financial crisis.
It may well be that Hitler has obtained his unlimited powers in a strictly constitutional manner and that whatever he does is therefore legal in the juridical sense. But who would suggest for that reason that the Rule of Law still prevails in Germany?
- Chapter Six “Planning and the Rule of Law”
Nothing would at first seem to affect private life less than a state control of the dealings in foreign exchange, and most people will regard its introduction with complete indifference. Yet the experience of most Continental countries has taught thoughtful people to regard this step as the decisive advance on the path to totalitarianism and the suppression of individual liberty.
- Chapter Seven “Economic Control and Totalitarianism”
My Two Cents: This is HUGELY important. Once the FX controls really kick in you will know deep trouble lies ahead. I expect this within 1-2 years at the latest.
The reader may take it that whoever talks about potential plenty is either dishonest or does not know what he is talking about.
- Chapter Seven “Economic Control and Totalitarianism”
My Two Cents: Potential plenty is a myth used by collectivists since the beginning to market their ideas to a naive public. It is still used today. It’s a sham.
To believe that the power which is thus conferred on the state is merely transferred to it from others is erroneous. It is a power which is newly created and which in a competitive society nobody possesses.
- Chapter Eight “Who, Whom?”
My Two Cents: Decentralized power is always inherently less dangerous than centralized power. Nothing is more dangerous than a “global centralized power.” This is the direction the elite and oligarchs are attempting to take us in to create a neo-feudalism with them and their progeny as the aristocracy.
It is not rational conviction but the acceptance of a creed which is required to justify a particular plan. And, indeed, socialists everywhere were the first to recognize that the task they had set themselves required the general acceptance of a common Weltanschauung, of a definite set of values.
- Chapter Eight “Who, Whom?”
There is a great deal of truth in the often heard statement that fascism and National Socialism are a sort of middle-class socialism –only that in Italy and Germany the supporters of these new movements were economically hardly a middle class any longer. It was to a large extent a revolt of a new underprivileged class against the labor aristocracy which the industrial labor movement had created…They were quite ready to take over the methods of the older socialism but intended to employ them in the service of a different class.
- Chapter Eight “Who, Whom?”
In a society used to freedom it is unlikely that many people would be ready deliberately to purchase security at this price. But the policies which are now followed everywhere, which hand out the privilege of security, now to this group and now to that, are nevertheless rapidly creating conditions in which the striving for security tends to become stronger than the love of freedom. The reason for this is that with every grant of complete security to one group the insecurity of the rest necessarily increases. If you guarantee to some a fixed part of a variable cake, the share left to the rest is bound to fluctuate proportionately more than the size of the whole. And the essential element of security which the competitive system offers, the great variety of opportunities, is more and more reduced.
- Chapter Nine “Security and Freedom”
My Two Cents: This is the real reason the welfare state is so dangerous. It ultimately collapses and then in the chaos and vacuum that follows freedom is often sacrificed. We must never allow this in the United States.
Just as the democratic statesman who sets out to plan economic life will soon be confronted with the alternative of either assuming dictatorial powers or abandoning his plans, so the totalitarian dictator would soon have to choose between disregard for ordinary morals and failure. It is for this reason that the unscrupulous and uninhibited are likely to be more successful in a society tending toward totalitarianism.
- Chapter Ten “Why the Worst Get on Top”
My Two Cents: Look at how we reward failure. The Treasury Secretary couldn’t pay his taxes. What a clown he is and what a clown Obama is for keeping this clown around.
He will be able to obtain the support of all the docile and gullible, who have no strong convictions if their own but are prepared to accept a ready-made system of values if it is only drummed into their ears sufficiently loudly and frequently. It will be those whose vague and imperfectly formed ideas are easily swayed and whose passions and emotions are readily aroused who will thus swell the ranks of the totalitarian party.
- Chapter Ten “Why the Worst Get on Top”
My Two Cents: We must all work as hard as possible to inform the largest number of people as possible ahead of the collapse so that some when we rebuild the demagogues do not come out on top in the battle of ideas.
Collectivism on a world scale seems to be unthinkable –except in the service of a small ruling elite.
- Chapter Ten “Why the Worst Get on Top”
My Two Cents: G20, Bilderberg Group. Any secretive group of elites must be examined much more closely by the populace. Time to grow up.
To split or decentralize power is necessarily to reduce the absolute amount of power, and the competitive system is the only system designed to minimize by decentralization the power exercised by man over man.
- Chapter Ten “Why the Worst Get on Top”
The principle that the end justifies the means is in individualist ethics regarded as the denial of all morals. In collectivist ethics it becomes necessarily the supreme rule; there is literally nothing which the consistent collectivist must not be prepared to do if it serves “the good of the whole” because to him the “good of the whole” is to him the only criterion of what ought to be done…There is always in the eyes of the collectivist a greater goal which these acts serve and which to him justifies them because the pursuit of the common end of society can know no limits in any rights or values of any individual.
- Chapter Ten “Why the Worst Get on Top”
The moral consequences of totalitarian propaganda which we must now consider are, however, of an even more profound kind. They are destructive of all moral because they undermine one of the foundations of all morals; the sense of and respect for truth.
- Chapter Eleven “The End of Truth”
My Two Cents: If you haven’t noticed the mainstream media is full of lies and trite stories. The government is the most consistent liar I have ever encountered.
It is not difficult to deprive the great majority of independent thought. But the minority who will retain an inclination to criticize must also be silenced. We have already seen why coercion cannot be confined to the acceptance of the ethical code underlying the plan according to which all social activity is directed. Since many parts of this code will never be explicitly stated, since many part of the guiding scale of values will exist only implicitly by the plan, the plan itself in every detail, in fact every act of the government, must become sacrosanct and exempt from criticism.
- Chapter Eleven “The End of Truth”
In particular, they all (totalitarian systems) seem to have in common an intense dislike of the more abstract forms of thought –a dislike characteristically also shown by many of the collectivists among out scientists.
- Chapter Eleven “The End of Truth”
In any society freedom of thought will probably be of direct significance only for a small minority. But this does not mean that anyone is competent, or ought to have power, to select those to whom this freedom is to be reserved…The tragedy of collectivist thought is that, while it starts out to make reason supreme, it ends by destroying reason because it misconceives the process on which the growth of reason depends.
- Chapter Eleven “The End of Truth”
Still less was the cause (of the rise of National Socialism in Germany), as so many people wish to believe, a capitalist reaction against the advance of socialism. On the contrary, the support which brought these ideas to power came precisely form the socialist camp. It was certainly not through the bourgeoisie, but rather through the absence of a strong bourgeoisie, that they were helped to power.
- Chapter Eleven “The Socialist Roots of Nazism”
My Two Cents: There is nothing more dangerous than a society where a vibrant middle class is destroyed. This is happening in America right now and is far and away the most concerning thing I see. Obama’s polices, intentionally or unintentionally are consolidating power and wealth into a small elite of government officials and corporate oligarchs that want to run your life.
“Conservative Socialism” (and, in other circles, “Religious Socialism”) was the slogan under which a large number of writers prepared the atmosphere in which “National Socialism” succeeded.
- Chapter Eleven “The Socialist Roots of Nazism”
My Two Cents: George W’s “Compassionate Conservatism” comes to mind. There was nothing compassionate or conservative about it. That administration ran America like a bunch of thugs using the “war on terror” as a cover. Unfortunately, Obama is doing the same thing.
In past ages intellectuals engaged in a disinterested search for universal truths; they searched for ideals that transcended the need of the state or society in which they lived. In recent times, however, intellectuals have become more and more the handmaiden of political and national causes. As a result of this betrayal of the intellectuals, extremist political passions had recently become more universal, coherent, continuous, and preponderant.
- Quote by Julien Benda from her book La Trahison des Clercs used by Hayek in Chapter Twelve “The Totalitarians in our Midst”
My Two Cents: This is a total tragedy and has clearly accelerated in modern times.
The impetus of the movement toward totalitarianism comes mainly from the two great vested interests: organized capital and organized labor. Probably the greatest menace of all is the fact that the policies these two most powerful groups point in the same direction.
- Chapter Twelve “The Totalitarians in our Midst”
My Two Cents: Obvious parallel to today. Look who has benefited the most under Obama. The elite use a divide and conquer strategy to keep the serfs bickering on issues away from the big picture. The truth of the matter is much of big business (especially the large banks) and big unions are so corrupt they are both the enemy of the middle class. We must step out of the left-right paradigm and see who is really screwing us!
The movement is, of course, deliberately planned mainly by the capitalist organizers of monopolies, and they are thus one of the main sources of this danger. Their responsibility is not altered by the fact that their aim is not a totalitarian system but rather a sort of corporative society in which the organized industries would appear as semi-independent and self-governing “estates…”But while the entrepreneurs may well see their expectations borne out during a transition stage, it will not be long before they will find, as their German colleagues did, that they are no longer masters but will in every respect have to be satisfied with whatever power and emoluments the government will concede them.
- Chapter Twelve “The Totalitarians in our Midst”
My Two Cents: The big banks and many of our corporate leaders (Warren Buffett in particular comes to mind. He is such a good actor he should win an Oscar) sold us out to “team up” with a corrupt government in the aftermath of the financial crisis. They think they will be “winners” with the government. I have my doubts. When this thing collapses and the administration needs a scapegoat they will go down and in an epic fashion.
But if the place of the opposition, in public discussion as well as in Parliament, should become lastingly the monopoly of a second reactionary party, there would, indeed, be no hope left.
- Chapter Twelve “The Totalitarians in our Midst”
My Two Cents: This is precisely what we have today with the Republican and Democratic fake choice system. We are offered coke or pepsi. We must stand up and say neither. We want the Constitution.
Though it is natural that, as the world around us becomes more complex, our resistance grows against the forces which, without our understanding them, constantly interfere with individual hopes and plans, it is just in these circumstances that it becomes less and less possible for anyone to fully understand these forces…But they are mistaken when they carry the comparison further to argue that we must learn to master the forces of society in the same manner in which we have learned to master the forces of nature, This is not only the path to totalitarianism but the path to the destruction of our civilization and a certain way to block further progress. Those who demand it show by their very demands that they have not yet comprehended the extent to which the mere preservation of what we have so far achieved depends on the coordination of individual efforts by impersonal forces.
- Chapter Thirteen “Material Conditions and Ideal Ends”
We must now return to the crucial point –that individual freedom cannot be reconciled with the supremacy of one single purpose to which the whole society must be entirely and permanently subordinated. The only exception to the rule that a free society must not be subjugated to a single purpose is war and other temporary disasters when subordination of almost everything to the immediate and pressing need is the price at which we preserve our freedom in the long run.
- Chapter Thirteen “Material Conditions and Ideal Ends”
My Two Cents: His observation about war is extremely important. Our leaders understand this. This is why we have been sold a never-ending “war on terror.” That way you can always be reminded we are at war so you have to give up this right and that right because someone went on a plane with a firecracker in his underwear. If someone wants to blow something up they will find a way. We can’t let fear take us over so much that the government can just poke and prod us like animals everywhere we go. Freedom in the number one priority in my opinion.
As the glib phase runs, it must be accomplished “at any price.” It is, in fact, in this field (the reduction of unemployment) that the fascination of vague but popular phrases like “full employment” may well lead to extremely shortsighted measures, and where the categorical and irresponsible “it must be done at all cost” of the single-minded idealist is likely to do the greatest harm.
- Chapter Thirteen “Material Conditions and Ideal Ends”
My Two Cents: Amazing that he used these exact phrases that you now hear so often from the administration and its minions. These phrases are not new and we must understand that as well as the dangers those that use them pose to us.
It should never be forgotten that the one decisive factor in the rise of totalitarianism on the Continent, which is yet absent in England and America, is the existence of a large recently dispossessed middle class.
- Chapter Thirteen “Material Conditions and Ideal Ends”
Outside the sphere of individual responsibility there is neither goodness nor badness, neither opportunity for moral merit nor the chance of proving one’s desires to what one thinks right…A movement whose main promise is the relief from responsibility cannot but be anti-moral in its effect, however lofty the ideals to which it owes its birth.
- Chapter Thirteen “Material Conditions and Ideal Ends”
My Two Cents: Morals only exists with the freedom to make such choices. If the government imposes morals and makes the whole of humanity acts in a way the rulers deem “moral” there are no morals and the concept is dead.
It is one of the most fatal illusions that, by substituting negotiations between states or organized groups for competition for markets or for raw materials, international friction would be reduced. This would merely put a contest of force in the place of what can only metaphorically be called the “struggle” of competition and would transfer to powerful and armed states, subject to no superior law, the rivalries which between individuals had to be decided without recourse to force.
- Chapter Fourteen “The Prospects of International Order”
My Two Cents: Such an amazing quote. This is precisely why we face a major war right now. Too much power is concentrated at the top and when the elites of one nation sell out the elites of another nation which always happens at times like this, they start a war. The elites don’t suffer the people do. Let’s not let them do this to us.
But one has only to visualize the problems raised by economic planning of even an area such as western Europe to see that the moral bases for such an undertaking are completely lacking.
- Chapter Fourteen “The Prospects of International Order”
My Two Cents: Western Europe would have been difficult enough! I can’t help but think of the Euro. What an absurd concept it was. Be aware that the elite would like to use this crisis to bring in a global currency managed by a global central bank. You thought the euro was bad. This is would be the end of all economic and individual freedom on a global scale. SDRs are just another fiat scam joke. We must never ever agree to it.
If most people are not willing to see the difficulty, this is mainly because, consciously or unconsciously, they assume that it will be they who will settle these questions for others, and because they are convinced of their own capacity to do this justly and equitably.
- Chapter Fourteen “The Prospects of International Order”
My Two Cents: The most dangerous people are those that think they “know best.” This attitude is the DNA of dictators.
Planning on an international scale, even more than is true on a national scale, cannot be anything but a naked rule of force, an imposition by a small group on all the rest of that sort of standard and employment which the planners think suitable for the rest.
- Chapter Fourteen “The Prospects of International Order”
What these dangerous idealists do not see is that where the assumption of a moral responsibility involves that one’s moral views should by force be made to prevail over those dominant in other communities, the assumption of such responsibility may place one in a position in which it becomes impossible to act morally.
- Chapter Fourteen “The Prospects of International Order”
My Two Cents: This is the ultimate contradiction of the idealistic planners. Their good intentions end up creating the highest of degrees of human suffering.
It is significant that the most passionate advocates of a centrally directed economic New Order for Europe should display, like their Fabian and German prototypes, the most complete disregard for of the individuality and of the rights of small nations.
- Chapter Fourteen “The Prospects of International Order”
My Two Cents: Any leader that talks of a “New Order” must be seen as potentially very dangerous. It was used by Hitler and others often back in Hayek’s days.
We shall all be gainers if we can create a world fit for small states to live in.
- Chapter Fourteen “The Prospects of International Order”
Neither an omnipotent superstate nor a loose association of “free nations” but a community of free men must be our goal.
- Chapter Fourteen “The Prospects of International Order”
Have a great long weekend,
Mike
U.S. Government Bonds -- The Mother of All Bubbles
from Expected Returns Blog:
What follows will read like an indictment on our entire economic system. But underlying my (relatively mild) harangue is an observation that people are ignoring the most obvious bubble out there; that is, the bubble in U.S. government bonds. The following is my attempt to figure out why.
What follows will read like an indictment on our entire economic system. But underlying my (relatively mild) harangue is an observation that people are ignoring the most obvious bubble out there; that is, the bubble in U.S. government bonds. The following is my attempt to figure out why.
Efficiency Market Theory
Let's face it, markets are inefficient. The efficient market theory, manufactured from the ivory towers of academia, poses perhaps the greatest threat to the stability of our system. Here's why.
False assumptions produce false conclusions. The efficient market theory posits that bubbles aren't recognizable before they pop. The natural consequence of this misguided belief is that government officials will never act to preempt bubbles since they are, by definition, impossible to identify. This is one of the reasons why supposedly "efficient" markets are consistently marked by fat tails, outright panics, and "once in a lifetime" events.
Let's face it, markets are inefficient. The efficient market theory, manufactured from the ivory towers of academia, poses perhaps the greatest threat to the stability of our system. Here's why.
False assumptions produce false conclusions. The efficient market theory posits that bubbles aren't recognizable before they pop. The natural consequence of this misguided belief is that government officials will never act to preempt bubbles since they are, by definition, impossible to identify. This is one of the reasons why supposedly "efficient" markets are consistently marked by fat tails, outright panics, and "once in a lifetime" events.
The efficient market theory currently extends to U.S. government debt. In a circular manner, the strength of U.S. bonds is justified by low yields, which is evidence of the strength of U.S. bonds. But take a step back and remember that current yields are a product of government intervention. Stability, especially artificial stability, breeds instability. U.S. bonds are a bubble, and it's pretty damn recognizable at the present time.
Psychology and Cognitive Dissonance
I love incorporating psychology to economics because this dual framework explains the world a whole lot better than pseudo-scientific economic models that are consistently wrong. I'm convinced that one of the biggest barriers to investment success is cognitive dissonance.
To briefly explain, cognitive dissonance is a phenomenon by which people attempt to reconcile two opposing views. When faced with seemingly contradictory facts or opinions, most people will defend their existing framework by explaining away anything that refutes it. To understand why this human tendency is important in the context of a U.S. debt default, we must understand the framework most Americans currently carry.
Most Americans cling to a framework that goes something like this: The U.S. is the biggest economic power the world has ever seen. We are the engine of global growth. We are immune to panics that characterize "less developed" countries. Our debt is rated Triple-A. Therefore, we can never default on our debt.
Any evidence contrary to pre-existing frameworks will be explained away- this is human nature. So when gold goes to record highs, instead of recognizing that it is the free market's indictment of the monetary system, people will say "gold is a bubble." When Greece experiences a debt crises engendered by factors indistinguishable from ours, people say "we're not Greece- we can print our own money." Utter nonsense.
Psychology and Cognitive Dissonance
I love incorporating psychology to economics because this dual framework explains the world a whole lot better than pseudo-scientific economic models that are consistently wrong. I'm convinced that one of the biggest barriers to investment success is cognitive dissonance.
To briefly explain, cognitive dissonance is a phenomenon by which people attempt to reconcile two opposing views. When faced with seemingly contradictory facts or opinions, most people will defend their existing framework by explaining away anything that refutes it. To understand why this human tendency is important in the context of a U.S. debt default, we must understand the framework most Americans currently carry.
Most Americans cling to a framework that goes something like this: The U.S. is the biggest economic power the world has ever seen. We are the engine of global growth. We are immune to panics that characterize "less developed" countries. Our debt is rated Triple-A. Therefore, we can never default on our debt.
Any evidence contrary to pre-existing frameworks will be explained away- this is human nature. So when gold goes to record highs, instead of recognizing that it is the free market's indictment of the monetary system, people will say "gold is a bubble." When Greece experiences a debt crises engendered by factors indistinguishable from ours, people say "we're not Greece- we can print our own money." Utter nonsense.
By going short U.S. government bonds, I am basically going short the human tendency to cling to a worldview that provides them the most comfort. Always let historical precedent and facts determine your conclusions, not irrational human tendencies.
Crony Capitalism and Collapse of the Rule of Law
The rule of law is perhaps the most underappreciated aspect of functioning markets. Once the system degenerates into a form of crony capitalism (think: Chrysler bond debacle), you know serious economic shocks lie ahead.
When people realize they can "game" the system, believe me, they will. Economics is all about incentives.
The rule of law is perhaps the most underappreciated aspect of functioning markets. Once the system degenerates into a form of crony capitalism (think: Chrysler bond debacle), you know serious economic shocks lie ahead.
When people realize they can "game" the system, believe me, they will. Economics is all about incentives.
Think about the tragicomedy that is Wall Street. Banks on life support get bailed out from the government to "save" the financial system. But to appease the public, politicians throw in a provision that banks can't hand out bonuses unless they repay TARP. No problem! Banks issue stock and dilute existing shareholders to repay TARP. Then they hand out record bonuses. Follow the path of money and realize your tax dollars are going directly to the pockets of morons who brought down our system. The system is being gamed big-time.
What's the net effect? Investors lose confidence in the entire system and withhold their capital. This especially holds true for government bonds. The system can take only so much corruption before imploding at the seams.
Blindly Trusting Financial "Experts"
To rid you of any delusions that experts know what they are talking about, allow me to briefly walk you through the debacle known as subprime.
Most professionals couldn't see the bubble in housing inflating even though it was staring them in the face. And this was a mere 7 years after the collapse of the Nasdaq! Leading up to the crash of housing, the consensus could not envision a national decline in home prices since their "infallible" economic models used data of home prices over a 60 year period. All quants needed to do was adjust their models back about 15 years to the Great Depression and they would have understood that home prices do indeed fall. Garbage in, garbage out. Models are useless without a proper historical backdrop.
Most professionals couldn't see the bubble in housing inflating even though it was staring them in the face. And this was a mere 7 years after the collapse of the Nasdaq! Leading up to the crash of housing, the consensus could not envision a national decline in home prices since their "infallible" economic models used data of home prices over a 60 year period. All quants needed to do was adjust their models back about 15 years to the Great Depression and they would have understood that home prices do indeed fall. Garbage in, garbage out. Models are useless without a proper historical backdrop.
The experts, led by Paul Krugman, are now claiming that the U.S. is not Greece. Some people think this argument is sensible; to me, this is simply evidence of a world gone mad.
The key thing to understand here is correlation. CDO's were priced so richly because it was assumed that different tranches, which respresented a diverse range of mortgages throughout the U.S, were not correlated. This assumption proved to be false because all homes were inflated equally by the same credit bubble and the same fraudulent system.
False assumptions in correlation are prevalent as it pertains to sovereign debt. Somehow we believe the problems in Europe will not find their way to us. Unfortunately, we are experiencing a global sovereign debt crisis. Every single Western government is in debt up to their eyeballs. All bankrupt nations have lent money to each other in a complicated web that can be addressed only through default. Therefore, in the long run, all sovereign debts are correlated.
False assumptions in correlation are prevalent as it pertains to sovereign debt. Somehow we believe the problems in Europe will not find their way to us. Unfortunately, we are experiencing a global sovereign debt crisis. Every single Western government is in debt up to their eyeballs. All bankrupt nations have lent money to each other in a complicated web that can be addressed only through default. Therefore, in the long run, all sovereign debts are correlated.
Failure to Predict Second and Third Order Effects
Perhaps the tendency that underlies policy mistake after policy mistake is the failure to think beyond first order effects. Politicians are especially adept at thinking at a linear level. Let me give you an example.
Imagine you are the governor of California and your state is bankrupt (doesn't take much imagination). Say you want to raise your revenue by $100 million dollars. The easy solution is to tax the arbitrarily defined "rich." Suppose your definition of "rich" is anyone with an income of over $1 million. Assume that the revenue derived from this demographic at current tax rates is $50 million. Simple arithmetic will dictate that you double your tax rate and your problems are solved.
Perhaps people don't believe this could possibly be the fantasy world our politicians live in. But this is essentially what the state of Maryland did. Millionaires promptly went "missing."
Our leaders fail to see potential second and third order effects of debt monetization; the subsidizing of the auto, housing, and financial industry; and the ad hoc disregard of the rule of law. If these trends continue, I am 100% sure capital will flee America. We need to start thinking beyond propping up failed corporations and running up our national debt; this course is unsustainable.
Linear World, Dynamic World
Let's go back to the subprime debacle for a second. Credit default swaps, which were an effective short against housing, only started to crater in mid 2007- even after it was obvious that the models pricing CDO's were seriously flawed. Market makers (Government Sachs) briefly manipulated bond prices to buy time as they faded their clients and ran for the exits. Once people understood the toxicity of CDO's, we saw an all-out stampede as bond prices crashed dynamically,
Does this sound familiar? Is our government not manipulating markets and delaying the inevitable by monetizing debt? Short of saying it outright, our government can't make it any clearer that trouble lies ahead. Seriously, what do you expect? Imagine Bernanke going on national TV and saying the following:
"I would like to inform the American people that we are bankrupt. We have been hoping to maintain confidence in our system by artificially suppressing rates by buying up bonds with money we printed from nothing. We hope that by keeping rates low, we can create another illusory speculative boom and kick the debt can down the road for another administration to take the blame for. I have no clue what I'm doing- after all, I'm the one who thought subprime was "contained."
Yea right. Our leaders are going to spend like drunken sailors until the entire house of cards comes crumbling down. I'm telling you, the evidence is staring you in the face. Gold is your only insurance.
Perhaps the tendency that underlies policy mistake after policy mistake is the failure to think beyond first order effects. Politicians are especially adept at thinking at a linear level. Let me give you an example.
Imagine you are the governor of California and your state is bankrupt (doesn't take much imagination). Say you want to raise your revenue by $100 million dollars. The easy solution is to tax the arbitrarily defined "rich." Suppose your definition of "rich" is anyone with an income of over $1 million. Assume that the revenue derived from this demographic at current tax rates is $50 million. Simple arithmetic will dictate that you double your tax rate and your problems are solved.
Perhaps people don't believe this could possibly be the fantasy world our politicians live in. But this is essentially what the state of Maryland did. Millionaires promptly went "missing."
Our leaders fail to see potential second and third order effects of debt monetization; the subsidizing of the auto, housing, and financial industry; and the ad hoc disregard of the rule of law. If these trends continue, I am 100% sure capital will flee America. We need to start thinking beyond propping up failed corporations and running up our national debt; this course is unsustainable.
Linear World, Dynamic World
Let's go back to the subprime debacle for a second. Credit default swaps, which were an effective short against housing, only started to crater in mid 2007- even after it was obvious that the models pricing CDO's were seriously flawed. Market makers (Government Sachs) briefly manipulated bond prices to buy time as they faded their clients and ran for the exits. Once people understood the toxicity of CDO's, we saw an all-out stampede as bond prices crashed dynamically,
Does this sound familiar? Is our government not manipulating markets and delaying the inevitable by monetizing debt? Short of saying it outright, our government can't make it any clearer that trouble lies ahead. Seriously, what do you expect? Imagine Bernanke going on national TV and saying the following:
"I would like to inform the American people that we are bankrupt. We have been hoping to maintain confidence in our system by artificially suppressing rates by buying up bonds with money we printed from nothing. We hope that by keeping rates low, we can create another illusory speculative boom and kick the debt can down the road for another administration to take the blame for. I have no clue what I'm doing- after all, I'm the one who thought subprime was "contained."
Yea right. Our leaders are going to spend like drunken sailors until the entire house of cards comes crumbling down. I'm telling you, the evidence is staring you in the face. Gold is your only insurance.
Stocks End Worst May Since 1940
The Dow tumbled 122.36 points, or 1.2 percent, to 10,136.63 at 4 p.m. in New York and lost 7.9 percent this month. The Standard & Poor’s 500 Index sank 1.2 percent to 1,089.41, led by financial shares on the Spanish downgrade and energy companies after U.S. President Barack Obama extended a moratorium on new deep-water drilling. Oil erased gains after rallying as much as 1.6 percent to more than $75 a barrel. Ten-year Treasury yields decreased 7 basis points to 3.3 percent. The euro slipped 0.7 percent to $1.2273.
Friday, May 28, 2010
Stocks End May Down 8% -- Biggest Monthly Drop Since February 2009!
NEW YORK (MarketWatch) -- A downgrade of Spain's debt rating rekindled investors' broader fears about European credit sparking a sharp decline in stocks in the last session of May, which saw the market's worst monthly drop since February 2009...
The Dow ended down 7.9% for May, its biggest monthly drop since February 2009, when it was still on its way to the lows of the last bear market. The measure also snapped a three-month winning streak and set its worst percentage performance for May since 1962.
Sickly Spain: Debt Downgrade Debacle
On news that Fitch's has downgraded Spain's debt rating, LIBOR has reversed and begun rising again. Eurodollar futures have accordingly reversed to the downside.Debt worries are back!
Grains Plunge As Sell Stops Hit
3 Min chart
Tick chart
Momentum, Sentiment Shifts Again?
-----------------------
SAN FRANCISCO (MarketWatch) -- Stocks slid further after Fitch Ratings cuts Spain's debt ratings to AA+. The Dow Jones Industrials Average /quotes/comstock/10w!i:dji/delayed (DJIA 10,144, -114.58, -1.12%) fell 145 points to 10,109 on Friday, while the Nasdaq Composite /quotes/comstock/10y!i:comp (COMP 2,253, -25.03, -1.10%) declined 31 points to 2,246 points and the S&P 500 /quotes/comstock/21z!i1:in\x (SPX 1,092, -11.51, -1.04%) lost 16 points to 1,087.
Amazing Bernanke Admission
A couple of days ago in Japan, Ben Bernanke said that the benefits of low interest rate policies that politicians want “are not sustainable and will soon evaporate, leaving behind inflationary pressures that worsen the economy’s long-term prospects…...thus political interference in monetary policy can generate undesirable boom-bust cycles that ultimately lead to both a less stable economy and higher inflation.”
Soggy Spending Saps Market Momentum
NEW YORK (MarketWatch) -- U.S. stocks slipped Friday as discouraging consumer spending and Chicago area manufacturing activity tugged at sentiment on the final day of trading in a bleak month for the market.
Approaching the end of a tumultuous month of trading, stock indexes slid narrowly into the red on Friday as a morning battery of economic data largely failed to meet expectations. The Dow Jones Industrial Average /quotes/comstock/10w!i:dji/delayed (DJIA 10,198, -60.54, -0.59%) dropped 40 points, or 0.4%, to 10219. Cisco Systems /quotes/comstock/15*!csco/quotes/nls/csco (CSCO 23.26, -0.42, -1.75%) was the measure's worst performer, with a drop of 1.4%.
The Dow is on pace to close out May with its biggest monthly drop since February 2009, before the bull-market run started, as well as the biggest May point drop in its history. It would also be the measure's worst percentage performance since 1962. The slide snaps a string of three consecutive monthly gains. Trading during May, which included the flash crash in the first week, has been particularly volatile.
Thursday, May 27, 2010
Exchanges Say Don't Blame Speculators, The Evidence Doesn't Support It
(Reuters) - Government meddling in financial markets risks price distortion and under-investment, and political attempts to tackle "speculators" are misguided, commodity exchanges told Reuters Global Energy Summit.
Executives of the world's trading floors for oil and other raw materials say there is no evidence that speculators cause volatility such as the huge swings in oil in 2008 up to a record of almost $150 per barrel and down to a low of nearly $30.
"Effective regulation is great but any time a politician gets involved, frankly they will screw it up," Thomas Leaver, Chief Executive of the Dubai Mercantile Exchange, said.
"Any time anyone interferes with free and unfettered markets either through regulation, subsidies or through tariffs barriers ... it generates poverty, it generates dislocation," he said.
Leaver said attempts in the United States and elsewhere to limit trading in markets and curb influence of speculators were misguided because outside investors such as hedge funds and others had been blamed wrongly for recent volatility.
"There is no empirical evidence anywhere -- whether it be from us or the CME or ICE -- that (oil's) move up to $148 or the decline to $30 had anything to do with speculation," he said.
"GOVERNMENTS DON'T UNDERSTAND"
Julie Winkler, head of research and product development for CME Group (CME.O), which runs the New York Mercantile Exchange where benchmark U.S. light crude oil trades, agreed.
"There actually haven't been any studies that have proven that speculators were the cause of the price run-up," she said.
David Peniket, president and chief operating officer of ICE Futures Europe, part of IntercontinentalExchange Inc (ICE.N), which trades North Sea Brent crude oil, said there was no evidence that imposing position limits on traders would curb volatility or reduce price levels in oil markets.
"If they (position limits) are being used as a tool to reduce volatility or price levels, then we fear those who are using them will be disappointed," Peniket said.
"There have been a number of studies which demonstrate that speculation has not been a key factor in increasing oil prices."
Leaver said most investors these days did not trade outright, or "naked" positions, betting on a big move one way or the other, but instead tended to trade in spreads, which can be much less risky because markets are so volatile.
"Nobody takes naked longs or shorts any more -- or if they do I haven't met them. It is a much more risk managed business." Leaver said he was concerned that proposed new regulations could interfere with the participation in the DME, which trades futures in Oman crude.
"I think everybody is who is in markets at all whether it is participants, exchanges, everybody in concerned, and governments should be too because what I am afraid is happening is that governments don't understand what is going on," he said.
"They are throwing more regulation at markets rather than making more effective the regulation that have already got," he said. "I just don't think governments have got a clue. Speculators are the great scapegoat. They are easy to identify: the guy with the black hat in the corner."
Leaver said the result could be "distorted markets."
"Distorted markets send the wrong price signals and people make the wrong investments or inadequate investments in areas where there are food shortages or energy demand needs."
Socialism: Buy Now, Pay Later
by Daniel Greenfield:
One of the more stunning bits of insanity to come out of 2008 is that during an economic crisis caused by “Buy Now, Pay Later” fiscal planning, a candidate whose entire economic philosophy was built on “Buy Now, Pay Later” was voted in. The difference is that Obama’s “Buy Now, Pay Later” plans weren’t there for capitalism, but to fund socialism. And now with the national debt tripled, and his approval rating lower than a skunk’s at an aromatherapy session, he’s pushing out ObamaCare’s “benefits” ahead of schedule. Still Buy Now, Pay Later.
And while liberals continue preaching against the sins of Wall Street, they display a flagrant hypocrisy in ignoring the fact that their own policies are based on even worse financial planning. Furthermore major industries now assume as a given that if they’re too big to fail, then they can make whatever missteps they like, and Johnny Taxpayer will be there to bail them out if it all comes crashing down around them. Buy Now. Pay Later. Keep passing the buck and forwarding the bill, without any real thought of who’s going to pay for it all. Now the world economy is tottering because so much of it turned out to be a fraud, which in turn is being held up by the fear that if any part of it collapses, so much more of the fraud will become apparent, bringing it all crashing down.
And so the US government spends like mad and sells the debt to China, which buys it with the proceeds of its own giant financial scamming, and is now terrified that our house of cards will bring their house of cards down. Europe bails out Greece to protect the Euro, whose collapse would expose the house of cards of the EU. The US intervenes to help save the Euro with more taxpayer money which is added to more debt which is sold to China, which hopes the whole wobbly mess will be righted before Dubai’s own royalist house of cards goes down for good. The big achievement of Globalization is that now everyone is too big to fail, so we all have to keep passing the monopoly money around the world table as part of a consensus in which everyone pretends to believe everyone else’s lies, if they believe theirs. The sheer scope of it makes Madoff look like a shoeshine boy pinching nickels.
And the only way to play at every level of this three-ring circus is to keep spending money. If you assign imaginary values to counters in a global pyramid scheme, you have to constantly keep moving more of the counters to keep up the charade. And that means spending money. From the consumer loading up three credit cards to the big developer borrowing hundreds of millions to spend on a grandiose project to a company with no business plan making a public offering of overvalued shares to the government announcing another huge spending package—the counters always have to stay in motion. And someone else always has to get the bill. Until everyone realizes that there’s no money and no one to take the bill.
That hasn’t happened yet, but sooner or later it will. What we think of an economy is actually a tremendously persuasive scam built on maintaining a buzz of activity, but creating no actual value. And people like George Soros who understand that there is nothing beneath the economy but a tissue of mutual deceptions, have profited enormously from their financial terrorism. From causing limited financial catastrophes in the knowledge that everyone else will have to limit the fallout, while pushing to centralize economies further on the “The Bigger They Are, The More Profit There Is In Toppling Them Over” scheme of piratical rewards. Because socialism can be profitable, so long as you set it up and then bet against it. Meanwhile liberal court jester economists like Paul Krugman who put his Enron experience to good use, by encouraging politicians to think that non-stop debt based spending is actually more beneficial than cutting back on spending. And the genuinely terrifying thing, is that like medieval witchhunters, they probably even believe what they’re saying.
What all this adds up to is socialism. Since once a government becomes the financial reservoir for its country’s businesses, the end result is that the companies will use it as a safety net, passing along its own failures, while the government attempts to control the economy—resulting in a government run economy. Which naturally makes them into an even bigger target for financial terrorism and economic hit men. Because there is no such thing as too big to fail. Everything can fail. It just fails bigger. And the bigger it fails, the more it takes down in its wake.
The more an economy runs through the government, the more vulnerable both government and economy are due to their intertwined state. Government authority feeds corruption and waste, opening the door to a cycle of diminishing returns in which more centralization produces less product and profit, which when combined with a Culture of Entitlement can leave a formerly productive country looking like the USSR. But that very same culture also seduces citizens with Buy Now, Pay Later. Entitlement builds hidden debts, which are passed along from generation to generation, until the interest outweighs the principal. Until the debt itself becomes an asset. Until everyone realizes that the emperor has no clothes.
Socialism competes with capitalism for resources. Its philosophy demands that people invest in a government that will take care of them, rather than in pursuing their own economic destiny
Socialism competes with capitalism for resources. Its philosophy demands that people invest in a government that will take care of them, rather than in pursuing their own economic destiny. Put the American Dream on the shelf and say hello to the Nanny State. That’s the general idea here. But Buy Now Pay Later Capitalism and Buy Now Pay Later Socialism are partners in passing the torch from the former to the latter. Authentic free enterprise is built on hard work. Buy Now, Pay Later Capitalism however sold people on the idea that they could buy now, and pay whenever. Entire advertising campaigns were built on luring people into piling up debt. Banks began banking on the financial incompetence of their customers, turning penalty fees into their major revenue source. Debt was resold. Detroit began selling credit instead of cars. And all that debt had to stop somewhere. And that somewhere was always the government.Where the America of generations past understood that there was no free lunch, a new America forgot that fundamental lesson and began putting it all on a card. And from the individual shopper to the halls of the United States Congress, that became the way it was done. War or no war. Recession or prosperity. Rain or shine. It didn’t matter anymore. And thus began the era of the world’s most expensive free lunch. Liberals offered free entitlements with very huge back end price tags that had to be paid in taxes. Free this and free that. All of it more Buy Now, Pay Later.
Now the huge cost of putting Obama where he sits has to be paid for with the biggest Buy Now/ Pay Later package that Americans have ever seen. Socialism in all its sordid glory. Free everything that you and your children’s children will have to pay for through the nose. Bailouts and takeovers. Rivers of regulation, all formulated to benefit the regulators, not the regulated. Enough people have woken up to the lies. Enough families recognize that their children will be in debt for generations to pay off just the debt that has already been accumulated. And despite all the calls of “Don’t Worry” and “The Experts are on the Case”, they’re worried and they’re angry. Because buying socialism now, means we’ll have to keep paying for it forever.
European Debt Headed for a Meltdown
from Edmund Conway at the Daily Telegraph:
Mervyn King, the Bank of England Governor, summed it up best: "Dealing with a banking crisis was difficult enough," he said the other week, "but at least there were public-sector balance sheets on to which the problems could be moved. Once you move into sovereign debt, there is no answer; there's no backstop."
In other words, were this a computer game, the politicians would be down to their last life. Any mistake now and it really is Game Over. Or to pick a slightly more traditional game, it is rather like a session of pass-the-parcel which is fast approaching the end of the line.
The European financial crisis may look and smell rather different to the American banking crisis of a couple of years ago, but strip away the details – the breakdown of the euro, the crumbling of the Spanish banking system to take just two – and what you are left with is the next leg of a global financial crisis. Politicians temporarily "solved" the sub-prime crisis of 2007 and 2008 by nationalising billions of pounds' worth of bank debt. While this helped reinject a little confidence into markets, the real upshot was merely to transfer that debt on to public-sector balance sheets.
This kind of card-shuffle trick has a long-established pedigree: after the dotcom bust, Alan Greenspan slashed US interest rates to (then) unprecedented lows, which helped dull the pain, but only at the cost of generating the housing bubble that fed sub-prime. It is not so different to the Ponzi scheme carried out by Bernard Madoff, except that unlike his hedge fund fraud, this one is being carried out in full public view.
The problem is that this has to stop somewhere, and that gasping noise over the past couple of weeks is the sound of millions of investors realising, all at once, that the music might have stopped. Having leapt back into the market in 2009 and fuelled the biggest stock-market leap since the recovery from the Wall Street Crash in the early 1930s, investors have suddenly deserted. London's FTSE 100 has lost 15 per cent of its value in little more than a month. The mayhem on European bourses is even worse, while on Wall Street the Dow Jones teeters on the brink of the talismanic 10,000 level.
Whatever yardstick you care to choose – share-price moves, the rates at which banks lend to each other, measures of volatility – we are now in a similar position to 2008.
Europe's problem is that the unfortunate game of pass-the-parcel came at just the wrong moment. It resulted in a hefty extra amount of debt being lumped on to its member states' balance sheets when they were least-equipped to deal with it.
Europe was always heading for a crunch. For years, the German and Dutch economies pulled in one direction (high saving, low spending) while the Club Med bloc – Greece, Portugal, Spain, Italy (and their Celtic outpost Ireland) – pulled in the other. At some point, there was always going to be a problem, given that these two economic blocs were yoked together in the same currency, controlled by the same central bank. By triggering the global recession and shovelling an unexpected load of debt on to Greece's balance sheet, the financial crisis has effectively smoked out the European folly.
The Club Med nations – and in many senses Britain – were not so different to sub-prime households: they borrowed cheap in order to raise their standards of living, ignoring the question of whether they could afford to take on so much debt. But, as King points out, sub-prime households – and the banks that lent to them – can usually be bailed out. The International Monetary Fund simply does not have enough cash to bail out a major economy like Spain, Italy or, heaven forfend, Britain. So, again, we find ourselves in unknown territory.
There are plenty of episodes in history when countries have been as indebted as they are now, but they are all associated with periods of war. History shows that when nations reach as high a level of indebtedness as Greece, and have as few prospects of growth, they will almost certainly default. Indeed, the IMF, which has pretty good experience of fiscal crises, privately recommended that Greece restructure its debt (a kind of soft default, renegotiating payment terms). It was refused point-blank by the European authorities.
To understand why, step back for a moment. It is fashionable to compare the current situation to the Lehman Brothers collapse, but that understates its severity. The sub-prime property market in the US, together with its slightly less toxic relatives, represented a $2 trillion mound of debt. The combined public and private debt of the most troubled European countries – Greece, Portugal, Spain and so on – is closer to $9 trillion.
Moreover, whereas the pain from sub-prime was spread out relatively widely, with investors hailing from both sides of the Atlantic, the owners of the suspect European debt tend almost exclusively to be, gulp, Europeans. No one is suggesting all of this debt will go bad, but the European policymakers fear that the merest hint that Greece might default would spark a chain reaction that would cause a more profound crisis than in 2008.
The problem is not merely that holders of Greek government debt would dump their investments, or even that they would ditch their Spanish and Portuguese bonds while they were at it. It is that government debt is the very bedrock of the financial system: should Greek government bonds collapse, the country's banking system would become insolvent overnight. In fact, banks throughout the euro area would be at risk, given that they tend to hold so much of their neighbours' government debt. That, at least, is the theory, but as was the case in the aftermath of Lehman's collapse, no one really knows how great their exposure is.
The other, more cynical, explanation for Brussels' refusal to countenance default is that it fears that this would fatally destabilise the euro project itself – which of course it would. But as the politicians are discovering, organising a European sovereign bail-out is far, far more difficult than rescuing a bank. It took barely more than a few days in September 2008 for the Government to push through the semi-nationalisation of Royal Bank of Scotland and HBOS.
Earlier this month, when the French President Nicolas Sarkozy announced that the continent would be saved by a "shock and awe" $1 trillion bail-out package, markets convinced themselves for a moment that the politicians might be able to manage it. But the challenge of having to co-ordinate an unprecedented rescue across a
16-nation region without a common language or central Treasury is proving too much for Europe's leaders. Add to this the fact that most citizens (particularly in Germany) resent the idea of bailing each other out at all, and are willing to vote out their governments to prove it, and you get the idea of the challenge at hand.
Despite his rather aloof appearance, European president Herman Van Rompuy put it pretty well this week, saying: "Today, people are discovering what a 'common destiny' in monetary matters means. They are discovering that the euro affects their pensions, savings, and jobs, their very daily life. It hurts. In my view, this growing public awareness is a major political development. It forces the governments to act."
That action, so far as Van Rompuy is concerned, means more integration and some eye-watering spending cuts across the continent. Unfortunately, both are being carried out in haphazard fashion. The bail-out package may pave the way for a central EU Treasury, but it is still being muddled through the legislative process, and could well fall foul of voters in France or Germany. Spain and Italy are, rightly, inflicting severe cuts on their budgets, but so is Germany, which ought, according to a host of economists including Mervyn King, to be spending more, not less.
In the meantime, European politicians, torn in one way by their voters, in another by Brussels, emit even more confusing signals which only destabilise markets further. Angela Merkel's ban on investors short-selling German bank shares, and the collapse of a swathe of Spanish savings banks have hardly helped, either. And all the while, the euro continues to fall as investors mull its fate. The single currency can survive – but only if its members agree to more political union, and the prospect of that would be about as palatable to the people of Europe this summer as an ouzo and retsina cocktail.
This kind of card-shuffle trick has a long-established pedigree: after the dotcom bust, Alan Greenspan slashed US interest rates to (then) unprecedented lows, which helped dull the pain, but only at the cost of generating the housing bubble that fed sub-prime. It is not so different to the Ponzi scheme carried out by Bernard Madoff, except that unlike his hedge fund fraud, this one is being carried out in full public view.
The problem is that this has to stop somewhere, and that gasping noise over the past couple of weeks is the sound of millions of investors realising, all at once, that the music might have stopped. Having leapt back into the market in 2009 and fuelled the biggest stock-market leap since the recovery from the Wall Street Crash in the early 1930s, investors have suddenly deserted. London's FTSE 100 has lost 15 per cent of its value in little more than a month. The mayhem on European bourses is even worse, while on Wall Street the Dow Jones teeters on the brink of the talismanic 10,000 level.
Whatever yardstick you care to choose – share-price moves, the rates at which banks lend to each other, measures of volatility – we are now in a similar position to 2008.
Europe's problem is that the unfortunate game of pass-the-parcel came at just the wrong moment. It resulted in a hefty extra amount of debt being lumped on to its member states' balance sheets when they were least-equipped to deal with it.
Europe was always heading for a crunch. For years, the German and Dutch economies pulled in one direction (high saving, low spending) while the Club Med bloc – Greece, Portugal, Spain, Italy (and their Celtic outpost Ireland) – pulled in the other. At some point, there was always going to be a problem, given that these two economic blocs were yoked together in the same currency, controlled by the same central bank. By triggering the global recession and shovelling an unexpected load of debt on to Greece's balance sheet, the financial crisis has effectively smoked out the European folly.
The Club Med nations – and in many senses Britain – were not so different to sub-prime households: they borrowed cheap in order to raise their standards of living, ignoring the question of whether they could afford to take on so much debt. But, as King points out, sub-prime households – and the banks that lent to them – can usually be bailed out. The International Monetary Fund simply does not have enough cash to bail out a major economy like Spain, Italy or, heaven forfend, Britain. So, again, we find ourselves in unknown territory.
There are plenty of episodes in history when countries have been as indebted as they are now, but they are all associated with periods of war. History shows that when nations reach as high a level of indebtedness as Greece, and have as few prospects of growth, they will almost certainly default. Indeed, the IMF, which has pretty good experience of fiscal crises, privately recommended that Greece restructure its debt (a kind of soft default, renegotiating payment terms). It was refused point-blank by the European authorities.
To understand why, step back for a moment. It is fashionable to compare the current situation to the Lehman Brothers collapse, but that understates its severity. The sub-prime property market in the US, together with its slightly less toxic relatives, represented a $2 trillion mound of debt. The combined public and private debt of the most troubled European countries – Greece, Portugal, Spain and so on – is closer to $9 trillion.
Moreover, whereas the pain from sub-prime was spread out relatively widely, with investors hailing from both sides of the Atlantic, the owners of the suspect European debt tend almost exclusively to be, gulp, Europeans. No one is suggesting all of this debt will go bad, but the European policymakers fear that the merest hint that Greece might default would spark a chain reaction that would cause a more profound crisis than in 2008.
The problem is not merely that holders of Greek government debt would dump their investments, or even that they would ditch their Spanish and Portuguese bonds while they were at it. It is that government debt is the very bedrock of the financial system: should Greek government bonds collapse, the country's banking system would become insolvent overnight. In fact, banks throughout the euro area would be at risk, given that they tend to hold so much of their neighbours' government debt. That, at least, is the theory, but as was the case in the aftermath of Lehman's collapse, no one really knows how great their exposure is.
The other, more cynical, explanation for Brussels' refusal to countenance default is that it fears that this would fatally destabilise the euro project itself – which of course it would. But as the politicians are discovering, organising a European sovereign bail-out is far, far more difficult than rescuing a bank. It took barely more than a few days in September 2008 for the Government to push through the semi-nationalisation of Royal Bank of Scotland and HBOS.
Earlier this month, when the French President Nicolas Sarkozy announced that the continent would be saved by a "shock and awe" $1 trillion bail-out package, markets convinced themselves for a moment that the politicians might be able to manage it. But the challenge of having to co-ordinate an unprecedented rescue across a
16-nation region without a common language or central Treasury is proving too much for Europe's leaders. Add to this the fact that most citizens (particularly in Germany) resent the idea of bailing each other out at all, and are willing to vote out their governments to prove it, and you get the idea of the challenge at hand.
Despite his rather aloof appearance, European president Herman Van Rompuy put it pretty well this week, saying: "Today, people are discovering what a 'common destiny' in monetary matters means. They are discovering that the euro affects their pensions, savings, and jobs, their very daily life. It hurts. In my view, this growing public awareness is a major political development. It forces the governments to act."
That action, so far as Van Rompuy is concerned, means more integration and some eye-watering spending cuts across the continent. Unfortunately, both are being carried out in haphazard fashion. The bail-out package may pave the way for a central EU Treasury, but it is still being muddled through the legislative process, and could well fall foul of voters in France or Germany. Spain and Italy are, rightly, inflicting severe cuts on their budgets, but so is Germany, which ought, according to a host of economists including Mervyn King, to be spending more, not less.
In the meantime, European politicians, torn in one way by their voters, in another by Brussels, emit even more confusing signals which only destabilise markets further. Angela Merkel's ban on investors short-selling German bank shares, and the collapse of a swathe of Spanish savings banks have hardly helped, either. And all the while, the euro continues to fall as investors mull its fate. The single currency can survive – but only if its members agree to more political union, and the prospect of that would be about as palatable to the people of Europe this summer as an ouzo and retsina cocktail.
U.S. GDP Revised Downward in Q1
WASHINGTON (MarketWatch) - The U.S. economy grew at a 3.0% pace in the first quarter - lower than the 3.2% previously reported - owing mainly to smaller increases in consumer spending and investment in business software, the government said Thursday. Economists surveyed by MarketWatch expected first-quarter growth to be revised up to 3.5%. The latest revision incorporates data that is not available for the first reading of GDP. Consumer spending, the largest contributor to GDP, grew at 3.5% annualized rate in the first quarter, down from the initial estimate of 3.6%. The increase in business investment, meanwhile, was reduced to 13.1% from the original estimate of 14%.
China Backs EU Debt, Sends Stocks Rocketing
Dow futures jumped 200 points on this news. I'm surprised we haven't seen stocks jump 400 points.
This, however, is troubling in many respects. China has its back against a wall. I have no doubt that Timothy Geithner had his hand in this. He no doubt went to China to persuade China's leadership to make just such a statement. He told them that in the short term, it would be in their interest to make such a statement, and he was right, but only in the short term. If they hadn't, and had indicated a desire to liquidate its bond holdings instead, the world's bond markets would likely have collapsed, with interest rates skyrocketing and investors the world over dumping bonds of all types, including even US Government debt. It would have caused interest rates on corporate bonds, munis, foreign and emerging market bonds, throughout the world to skyrocket. It would have sent the stock market reeling, because the higher interest rates would have sent shock waves world-wide. The value of China's bond investments would have plummeted.Geithner's effort, however, has only bought time. It has not prevented a disaster; it has only delayed one.
Chris Martenson, on his blog, wrote an excellent article documenting that China holds, mostly through foreign banks, about $5.7 trillion of U.S. government debt. That's about 43.8% of all U.S. government debt. If it indicated that it would begin selling European-denominated debt, it would immediately raise the expectation that it would likely begin dumping U.S. debt also. The consequences would be the financial equivalent of a world war!
The bottom line is that China had no choice. It's back was against the wall!
But -- and this is the scary part -- what does this say about the state of the world economy and the stability of the global financial markets? If we were so precariously perched on the edge of the cliff that Geithner felt compelled to travel to China to persuade them to make such a statement, then it says something very perilous about the state of global finance. It says that we're closer to the edge of the cliff than anyone imagined!
China must be shaking in its boots right now. China's leaders must know that if the world suddenly loses confidence in European or other bonds, the world bond market could collapse almost overnight! it could lose trillions in value and send the global financial markets reeling in what could only be called an catastrophe of biblical proportions.
Rather than paying attention to what China says, we should focus on what China does! Over the past year or so, China has been reducing the amount and duration of its US Government debt holdings. It has been buying and stock-piling commodities of all types. It has been buying large quantities of corn and soybeans, for example. The USDA makes frequent announcements of grain sales. In recent weeks, China has been buying surprisingly-large amounts of corn. China has been buying huge quantities of soybeans for several months. In fact, soybeans purchases are of such size that it would outstrip the supply of American beans, even if the USA has a bumper crop this year! The only thing holding back the price of beans from skyrocketing is the fact that the USDA continues to under-report soybean purchases from week to week. China is trying to put its assets into gold and other hard assets while slowly backing away from sovereign debt of other countries.
China has not averted a disaster. It has only delayed it!
----------------
BEIJING -- China's foreign-exchange regulator, in an unusual clarification, denied that it is reviewing its holdings of euro-zone debt, saying Europe will remain one of the key investment markets for China's foreign-exchange reserves of nearly $2.5 trillion, the world's biggest, despite the euro-zone debt crisis.
The direct rebuttal of a Wednesday Financial Times report by the State Administration of Foreign Exchange, an agency which rarely answers questions from the media, highlights China's awareness of how volatile financial markets have become increasingly sensitive to even hints about how Beijing deploys its enormous ...
Wednesday, May 26, 2010
M3 Money Supply Plunges, Giving Ominous Sign of Double Dip, Parallels to Great Depression
The M3 money supply in the United States is contracting at an accelerating rate that now matches the average decline seen from 1929 to 1933, despite near zero interest rates and the biggest fiscal blitz in history.
By Ambrose Evans-Pritchard at the Telegraph:
The M3 figures - which include broad range of bank accounts and are tracked by British and European monetarists for warning signals about the direction of the US economy a year or so in advance - began shrinking last summer. The pace has since quickened.
The stock of money fell from $14.2 trillion to $13.9 trillion in the three months to April, amounting to an annual rate of contraction of 9.6pc. The assets of insitutional money market funds fell at a 37pc rate, the sharpest drop ever.
"It’s frightening," said Professor Tim Congdon from International Monetary Research. "The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US is not recovering properly," he said.
The US authorities have an entirely different explanation for the failure of stimulus measures to gain full traction. They are opting instead for yet further doses of Keynesian spending, despite warnings from the IMF that the gross public debt of the US will reach 97pc of GDP next year and 110pc by 2015.
Larry Summers, President Barack Obama’s top economic adviser, has asked Congress to "grit its teeth" and approve a fresh fiscal boost of $200bn to keep growth on track. "We are nearly 8m jobs short of normal employment. For millions of Americans the economic emergency grinds on," he said.
David Rosenberg from Gluskin Sheff said the White House appears to have reversed course just weeks after Mr Obama vowed to rein in a budget deficit of $1.5 trillion (9.4pc of GDP) this year and set up a commission to target cuts. "You truly cannot make this stuff up. The US governnment is freaked out about the prospect of a double-dip," he said.
The White House request is a tacit admission that the economy is already losing thrust and may stall later this year as stimulus from the original $800bn package starts to fade.
Recent data have been mixed. Durable goods orders jumped 2.9pc in April but house prices have been falling for several months and mortgage applications have dropped to a 13-year low. The ECRI leading index of US economic activity has been sliding continuously since its peak in October, suffering the steepest one-week drop ever recorded in mid-May.
Mr Summers acknowledged in a speech this week that the eurozone crisis had shone a spotlight on the dangers of spiralling public debt. He said deficit spending delays the day of reckoning and leaves the US at the mercy of foreign creditors. Ultimately, "failure begets failure" in fiscal policy as the logic of compound interest does its worst.
However, Mr Summers said it would be "pennywise and pound foolish" to skimp just as the kindling wood of recovery starts to catch fire. He said fiscal policy comes into its own at at time when the economy "faces a liquidity trap" and the Fed is constrained by zero interest rates.
Mr Congdon said the Obama policy risks repeating the strategic errors of Japan, which pushed debt to dangerously high levels with one fiscal boost after another during its Lost Decade, instead of resorting to full-blown "Friedmanite" monetary stimulus.
"Fiscal policy does not work. The US has just tried the biggest fiscal experiment in history and it has failed. What matters is the quantity of money and in extremis that can be increased easily by quantititave easing. If the Fed doesn’t act, a double-dip recession is a virtual certainty," he said.
Mr Congdon said the dominant voices in US policy-making - Nobel laureates Paul Krugman and Joe Stiglitz, as well as Mr Summers and Fed chair Ben Bernanke - are all Keynesians of different stripes who "despise traditional monetary theory and have a religious aversion to any mention of the quantity of money". The great opus by Milton Friedman and Anna Schwartz - The Monetary History of the United States - has been left to gather dust.
Mr Bernanke no longer pays attention to the M3 data. The bank stopped publishing the data five years ago, deeming it too erratic to be of much use.
This may have been a serious error since double-digit growth of M3 during the US housing bubble gave clear warnings that the boom was out of control. The sudden slowdown in M3 in early to mid-2008 - just as the Fed raised rates - gave a second warning that the economy was about to go into a nosedive.
Mr Bernanke built his academic reputation on the study of the credit mechanism. This model offers a radically different theory for how the financial system works. While so-called "creditism" has become the new orthodoxy in US central banking, it has not yet been tested over time and may yet prove to be a misadventure.
Paul Ashworth at Capital Economics said the decline in M3 is worrying and points to a growing risk of deflation. "Core inflation is already the lowest since 1966, so we don’t have much margin for error here. Deflation becomes a threat if it goes on long enough to become entrenched," he said.
However, Mr Ashworth warned against a mechanical interpretation of money supply figures. "You could argue that M3 has been going down because people have been taking their money out of accounts to buy stocks, property and other assets," he said.
Events may soon tell us whether this is benign or malign. It is certainly remarkable.
The US authorities have an entirely different explanation for the failure of stimulus measures to gain full traction. They are opting instead for yet further doses of Keynesian spending, despite warnings from the IMF that the gross public debt of the US will reach 97pc of GDP next year and 110pc by 2015.
Larry Summers, President Barack Obama’s top economic adviser, has asked Congress to "grit its teeth" and approve a fresh fiscal boost of $200bn to keep growth on track. "We are nearly 8m jobs short of normal employment. For millions of Americans the economic emergency grinds on," he said.
David Rosenberg from Gluskin Sheff said the White House appears to have reversed course just weeks after Mr Obama vowed to rein in a budget deficit of $1.5 trillion (9.4pc of GDP) this year and set up a commission to target cuts. "You truly cannot make this stuff up. The US governnment is freaked out about the prospect of a double-dip," he said.
The White House request is a tacit admission that the economy is already losing thrust and may stall later this year as stimulus from the original $800bn package starts to fade.
Recent data have been mixed. Durable goods orders jumped 2.9pc in April but house prices have been falling for several months and mortgage applications have dropped to a 13-year low. The ECRI leading index of US economic activity has been sliding continuously since its peak in October, suffering the steepest one-week drop ever recorded in mid-May.
Mr Summers acknowledged in a speech this week that the eurozone crisis had shone a spotlight on the dangers of spiralling public debt. He said deficit spending delays the day of reckoning and leaves the US at the mercy of foreign creditors. Ultimately, "failure begets failure" in fiscal policy as the logic of compound interest does its worst.
However, Mr Summers said it would be "pennywise and pound foolish" to skimp just as the kindling wood of recovery starts to catch fire. He said fiscal policy comes into its own at at time when the economy "faces a liquidity trap" and the Fed is constrained by zero interest rates.
Mr Congdon said the Obama policy risks repeating the strategic errors of Japan, which pushed debt to dangerously high levels with one fiscal boost after another during its Lost Decade, instead of resorting to full-blown "Friedmanite" monetary stimulus.
"Fiscal policy does not work. The US has just tried the biggest fiscal experiment in history and it has failed. What matters is the quantity of money and in extremis that can be increased easily by quantititave easing. If the Fed doesn’t act, a double-dip recession is a virtual certainty," he said.
Mr Congdon said the dominant voices in US policy-making - Nobel laureates Paul Krugman and Joe Stiglitz, as well as Mr Summers and Fed chair Ben Bernanke - are all Keynesians of different stripes who "despise traditional monetary theory and have a religious aversion to any mention of the quantity of money". The great opus by Milton Friedman and Anna Schwartz - The Monetary History of the United States - has been left to gather dust.
Mr Bernanke no longer pays attention to the M3 data. The bank stopped publishing the data five years ago, deeming it too erratic to be of much use.
This may have been a serious error since double-digit growth of M3 during the US housing bubble gave clear warnings that the boom was out of control. The sudden slowdown in M3 in early to mid-2008 - just as the Fed raised rates - gave a second warning that the economy was about to go into a nosedive.
Mr Bernanke built his academic reputation on the study of the credit mechanism. This model offers a radically different theory for how the financial system works. While so-called "creditism" has become the new orthodoxy in US central banking, it has not yet been tested over time and may yet prove to be a misadventure.
Paul Ashworth at Capital Economics said the decline in M3 is worrying and points to a growing risk of deflation. "Core inflation is already the lowest since 1966, so we don’t have much margin for error here. Deflation becomes a threat if it goes on long enough to become entrenched," he said.
However, Mr Ashworth warned against a mechanical interpretation of money supply figures. "You could argue that M3 has been going down because people have been taking their money out of accounts to buy stocks, property and other assets," he said.
Events may soon tell us whether this is benign or malign. It is certainly remarkable.
Debt's Dark Cloud
The eurozone’s debt crisis hangs like a dark cloud over Europe’s economic prospects. But it is not yet clear that the Continent’s slow recovery from its worst recession since the second world war will be blown off course.
Convincing evidence has yet to emerge of Europe's main economies taking a turn for the worse as a result of the global financial storm created in its own backyard. Germany’s Bundesbank said on Wednesday that so far market turmoil had not affected Europe’s largest economy, which had grown “sharply” in the second quarter. The Paris-based Organisation for Economic Co-operation and Development revised up its forecasts for eurozone growth this year and next, although it highlighted risks to the global outlook.
The biggest economies have been stabilised by emergency measures taken by governments and central banks. In coming months, sharp falls in the euro – its trade-weighted value is down 8 per cent compared with a year ago – should boost eurozone exports.
But the Financial Times’ European economic weather map – published on Wednesday for an eighth time – is at risk of sudden changes if market alarm about public finances does spread into the real economy, compounding the effects of higher taxes and sweeping cuts to public spending in the pipeline.
“All the talk about austerity measures will have an impact on consumer and business confidence – and then you will get the effect of the fiscal tightening itself,” said Robert Bergqvist, chief economist at SEB in Stockholm. “After the stabilisation we have seen in recent months, I think the big test will come after the summer.”
Erik Nielsen, European economist at Goldman Sachs, added: “My best guess would be that the real economy has another three to six months to convince financial markets that fundamentals are indeed improving before continued frozen credit channels would begin to sink the real sector back into recession.”
The effects of the eurozone sovereign debt crisis – which was started by fears over Greece but has spread to concerns about public finances in much of southern Europe – have so far been limited to the consumer sector. On Wednesday France reported a 1.2 per cent drop in consumer spending in April. Germany’s consumer confidence is falling, the country’s GfK research organisation reported.
In contrast, eurozone factory orders rose 5.2 per cent in March, according to data this week, almost certainly boosted by a weaker euro. Purchasing managers’ indices last week suggested that gross domestic product in the 16-country bloc was still expanding at a quarterly rate of about 0.5 per cent. But the pace of growth slowed this month, with manufacturing worst hit.
A test of policymakers’ confidence comes next month when the European Central Bank revises its forecasts. In March, it expected eurozone growth in a range with a mid-point of 0.8 per cent in 2010. But the OECD projections showed expansion of 1.2 per cent this year and 1.8 per cent in 2011.
One trend seems clear. Diverging performances across the Continent are likely to widen further, complicating the ECB’s task in setting interest rates. The falling euro is less help for countries such as Spain than export-dependent Germany, and fiscal austerity will be harshest in southern Europe. Greece is feeling the icy winds of austerity measures imposed by the International Monetary Fund and European Union. Portugal and Spain face bleak, possibly stormy conditions. Ireland has yet to stage a recovery.
Beyond the eurozone, the Baltics – Estonia, Latvia and Lithuania – have stabilised, and prospects have brightened in Russia, Turkey and Ukraine. But the crisis also makes the outlook uncertain beyond the eurozone’s borders. “If the depression is confined to Greece, Portugal and maybe Spain, then emerging Europe should be largely unaffected,” said Charles Robertson, chief emerging Europe economist at ING. “If the depression infects Germany and France, then emerging Europe growth will be hurt.”
Even for western European economies outside the eurozone with stable public finances, there are risks. Sweden has kept its currency but not complete economic independence. “During the most acute phase of the crisis we had a currency devaluation, so that helped,” said Mr Bergqvist. “But now our reliance on exports means we are very dependent on what happens in the rest of Europe.”
Copyright The Financial Times Limited 2010. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.
U.S. Debt Has Reached Level At Which It Hampers Economic Growth
The level of U.S. debt has reached a point at which economic growth traditionally begins to slow, a bipartisan fiscal commission making recommendations to the White House and Congress was told Wednesday.
The gross U.S. debt is approaching a level equivalent to 90 percent of the country's gross domestic product, the level at which growth has historically declined, said Carmen Reinhart, a University of Maryland economist.
When gross debt hits 90 percent of GDP, Reinhart told the commission during a hearing in the Capitol, growth "deteriorates markedly." Median growth rates fall by 1 percent, and average growth rates fall "considerably more," she said.
Reinhart said the commission shouldn't wait to put in place a plan to rein in deficits.
"I have no positive news to give," she said. "Fiscal austerity is something nobody wants, but it is a fact.
Gross debt is at 89 percent and will reach 90 percent by the end of the year, said Sen. Kent Conrad (D-N.D.), a member of the commission.
Another commission member, Rep. Jeb Hensarling (R-Texas), described the situation: "Essentially, the needle is hitting the red zone in respect to economic growth.”
Gross debt, unlike the public debt measure used by the Congressional Budget Office (CBO) and other economic forecasters, includes the money the government owes to all entities it supports, such as mortgage firms Freddie Mac and Fannie Mae, Reinhart said. The CBO expects public debt to grow from 63 percent this year to 90 percent in 2020, largely because of rising healthcare costs.
The bipartisan fiscal commission, which was created by President Barack Obama and contains lawmakers from both parties, is tasked with producing a plan to rein in debt by December 1. Leaders in both the House and Senate have said the commission's proposals would receive votes on the floor later that month.
Reinhart cautioned policymakers against seeing the strengthening of the dollar as a sign that investors can wait for the United States to show how it will deal with the debt.
"I am concerned about complacency," she said. "I am concerned that because the dollar has renewed its role as a reserve currency, we may wait too long."
U.S. Debt Level Reaches $13 Trillion
The U.S. national debt surpassed the $13 trillion mark today. Big trouble!
"Warning, Will Robinson" USA's Credit Rating In Dire Danger
May 25 (Bloomberg) -- The U.S. government’s Aaa bond rating will come under pressure in the future unless additional measures are taken to reduce projected record budget deficits, according to Moody’s Investors Service Inc.
The U.S. retains its top rating for now because of a “high degree of economic and institutional strength,” the New York- based ratings company said in a statement today that was little changed from a credit opinion released in February. The outlook is stable, the statement said.
The government’s finances have been “substantially worsened by the credit crisis, recession, and government spending to address these shocks,” Moody’s analysts lead by Steven A. Hess wrote. “The ratios of general government debt to GDP and to revenue are deteriorating sharply, and after the crisis they are likely to be higher than the ratios of other Aaa-rated countries.”
Debt to revenue has more than doubled over the past three years and is now over 400 percent, which could lead to “potential stress” on finances, the report said.
“This whole financial crisis in Europe has actually benefitted the U.S. government in its access to finance,” Hess said in a telephone interview. “The U.S. Treasury market has become once again, as it was during the recent financial crisis globally, the safe haven, and therefore lots of money flows into the U.S. Treasury market and that is a very positive.”
Treasury Market
The euro has lost 7.1 percent against the dollar this month on speculation Greece’s fiscal crisis will spread to other nations and hamper the region’s economic growth. More than $340 billion of Treasuries changed hands today, 40 percent more than the average daily volume of $241 billion over the past three months, according to ICAP PLC, the world’s largest inter-dealer broker.
The U.S.’s stable politics, fundamentals and economic prospects support a stable outlook, and risks include waning investor confidence on the government’s future access to liquidity and flexibility, as well as costly federal programs like Social Security and Medicare, the report said.
Moody’s analysts, in a Dec. 8 report, said public finances in the U.S. and the U.K. are worsening in the wake of the global financial crisis and the sovereigns may “test the Aaa boundaries.” It said the U.S. and U.K. have “resilient” Aaa ratings, as opposed to the “resistant” top ratings of Canada, Germany and France. The agency said later that week that it has no current plans to lower the U.S. and U.K.’s debt ratings.
Fed's Latest Shenanigans That Risk Catastrophe
from Zero Hedge blog:
Yesterday we reported a rumor that the Fed and the ECB were set to announce "new liquidity measures." Today, the WSJ's Jon Hilsenrath reports that this development would likely materialize in the form of a lowering of the rate at which the Fed offers Euro-Dollar swaps, currently priced at 100 bps over OIS. This has not gone unnoticed by the market: even with 3M Libor flat from yesterday, the front month Eurodollar has surged from yesterday, on this most recent confirmation that the central banks will drown the world in free liquidity before another session of liquidations has to take place.
From the WSJ:
The Federal Reserve has a lever it can pull to help European officials combat a worsening financial crisis: Reducing the interest rate it charges on U.S. dollar loans it makes through the European Central Bank to dollar-starved commercial banks in Europe. The move, though not a cure-all, could relieve some of the strains in European money markets.Ironically, bidder participation in the BOE's dollar repo facility reopening two weeks ago was exactly nil, and rumors dominate that of the thousand or so banks in Europe, few wish to make their liquidity problems even partially known, which is why we anticipate tepid involvement in such ECB liquidity pass throughs. Hilsenrath shares the same perspective: "Some analysts say that adjusting the terms of the Fed's loan program won't achieve much. "The funding is already available" through the Fed program, says Bruce Kasman, chief economist with J.P. Morgan Chase. The price, he says, is "expensive but not onerous."
The loans currently are priced one percentage point above a market rate called Overnight Indexed Swaps (OIS), which tracks the expected path of the Fed's benchmark federal funds rate. The loans are set above OIS to discourage foreign banks from using the government program too aggressively. But the Fed could reduce that penalty to encourage more borrowing and ease some of the financial strain on foreign banks in need of dollars. Whether it chooses to take this step remains to be seen, and will depend in part on how markets behave in the days ahead.
Use of the Fed's central bank "swap" facility—launched during the 2008 financial crisis—reached $583 billion in December 2008. Since the Fed reintroduced it earlier this month, foreign banks have only tapped the Fed program for $9 billion, according to the most recent publicly available data. Fed officials will be watching the ECB's next big auction of dollar loans tomorrow closely for signs of whether demand is increasing.
The Fed has no concerns about being a willing participant with taxpayer capital into a program which could potentially lock up the next time there is a liquidity crunch:
Responding to audience questions following a speech in London, Federal Reserve Bank of St. Louis President James Bullard said the swap lines are "certainly not tapped out," and could provide much more funding if necessary. Mr. Bullard added that the far lower take-up indicates that dollar funding problems aren't as severe as in 2008-09.The only notable feature, as we have reported previously, is that should we get close to the half a trillion in total FX swaps we got to during the last peak, is that excess reserves will surge by a comparable amount. The risk is that with the Fed's balance sheet now entrenched in QE mode, adding emergency liquidity programs to it once again, will do nothing to alleviate inflation expectations, as all this extra liquidity will have to be unwound at some point. For the time being, the market still seems unconcerned about the form this tightening will take place. However, the level of concern is surely rising with every incremental dollar being piled on to the "asset" side of the balance sheet. Should we indeed have to follow through with another iteration of QE, with emergency liquidity measures layered on top, we could easily double the Fed's balance sheet within the year.
"We can go much higher, hundreds of billions of dollars if necessary. We're not anywhere near that right now so I think it's sufficient and there is no limit on it," he said.
This swap program has been the Fed's main response to the financial stresses building in Europe. The market was abuzz with rumors Tuesday that the Fed could take some other step to help European banks—such as restart a commercial paper lending facility it used during the financial crisis or lowering the discount rate that it charges banks in the U.S. for emergency loans.
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