Gordon Long Describes the Economic Death Spiral

The Economic Death Spiral Has Been Triggered
For nearly 30 years we have had two Global Strategies working in a symbiotic fashion that has created a virtuous economic growth spiral. Unfortunately, the economic underpinnings were flawed and as a consequence, the virtuous cycle has ended.  It is now in the process of reversing and becoming a vicious downward economic spiral.
   
One of the strategies is the Asian Mercantile Strategy.  The other is the US Dollar Reserve Currency Strategy.

These two strategies have worked in harmony because they fed off each other, each reinforcing the other. However, today the realities of debt saturation have brought the virtuous spiral to an end.

One of the two global strategies enabled the Asian Tigers to emerge and grow to the extent that they are now the manufacturing and potentially future economic engine of the world.

The other allowed the US to live far beyond its means with massive fiscal deficits, chronic trade imbalances and more recently, current account imbalances. The US during this period has gone from being the richest country on the face of the globe to the biggest debtor nation in the world.

First we need to explore each strategy, how they worked symbiotically, what has changed and then why the virtuous cycle is now accelerating into a vicious downward spiral.

ASIAN MERCANTILE STRATEGY

The Asian Mercantile Strategy started with the emergence of Japan in the early 1980s, expanded with the Asian Tigers in the 90s and then strategically dominated with China in the first decade of this century.

Initially, Japan's products were poor quality and limited to cheap consumer products. Japan as a nation had neither the raw materials, capital markets, nor domestic consumption market to compete with the giant size of the USA. 

To compensate for its disadvantages, Japan strategically targeted its manufacturing resources for the US market.  By doing this, the resource poor island nation took the first step in becoming an export economy - an economy centered on growth through exports versus an economy like the US, where an excessive 70% of GDP is dependent on domestic consumption.

The strategy began to work as Japan took full advantage of its labor differential that was critical in the low end consumer product segment, which it initially targeted. Gradually, as capital availability expanded, Japan broadened its manufacturing scope, moving into higher levels of consumption products requiring higher levels of quality and achieving brand recognition.

Success soon became a problem as the Yen began to strengthen. To combat this the Japanese implemented the second critical component of what became the Asian Mercantile Strategy template. It began to manipulate its currency by aggressively intervening in the forex market to keep the yen weak.

Further success forced Japan to move to a more aggressive forex strategy to maintain a currency advantage. It was strategically decided that Japan's large and growing foreign reserves were to be re-invested back into the US.  By buying US Agency and US Treasury debt instruments it kept the dollar strong relative to the Yen. The more successful Japan became, the more critical this strategy became.  In the 80s Japan dominated global expansion as it brought US automotive and consumer electronics' manufacturing to its knees.

By the early 90s the Japanese labor advantage was quickly being lost to the Asian Tigers because the Yen versus the Asian Tiger currencies was too strong.  The Asian Tigers were following the Japanese model. The Asian Crisis in 1997 re-enforced to all Asian players the importance of holding large US dollar denominated reserves. This further accelerated and reinforced the strategy of purchasing US Treasury and Agency debt.

With China's acceptance into the World Trade Organization (WTO),  China emerged on the scene in full force. Armed with the lessons of the last twenty years, China took the Asian Mercantile Strategy to another level in its ongoing evolution.

The results were one of the largest and fastest transfers of industrial power ever to occur in history.  In ten years, China assumed the role of the world's undisputed industrial powerhouse in the world.

The virtuous cycle further accelerated as Asia became more dominant because its reserves, reinvested back in the US, began to have a larger and larger impact. The more Asia bought US Treasury and Agency debt, the lower US interest rates were forced, allowing Americans to finance more and more consumption. The more Asia bought US securities, the stronger the US dollar was against Asian currencies, and therefore the cheaper Asian products were relative to US manufactured products. It was a self reinforcing Virtuous Cycle.

The result was  a staggering 46,000 factories transferred from the US to Asia over the same 10 year period.  The transfer  set the stage for chronic unemployment and public funding problems,  but it was temporarily hidden by equally massive increases in debt spending.
The low interest rate driven housing bubble, being of historic proportions, made Americans feel richer than they were. They took on excess debt in various forms such as Home Equity Loans (HELOCs) at unprecedented levels. The acceleration of debt  materially impacted both the GDP and employment  of the nation through Real Estate, Construction and Mortgage Finance job growth further hiding underlying problems.

US DOLLAR RESERVE CURRENCY STRATEGY

Since President Richard Nixon took the US off the Gold Standard in 1971, the US has adopted what I refer to as the US Dollar Reserve Strategy.  After the Second World War, at the Bretton Woods Conference, the US dollar was accepted as the world's reserve currency and as such was pegged to Gold at a fixed rate of $35/oz. due to massive Vietnam  war costs and President Johnson  Great Society, the US could no longer honor its agreement.  In 1971, when France demanded conversion payment in Gold, the US refused. At this point the US become a fiat currency,  not backed by anything other than the full  faith and credit of Washington politicos. 

What were other countries to do in retaliation? What quickly became evident was there was little they could do. The fact was that international trade was conducted in US dollars as a matter of necessity due to the dominance of US export trade;  and as such, nations were forced to have US dollars to transact international trade.

Additionally, the US established agreements with oil producing Middle East countries that oil could only be sold in US dollars. Since energy is a dominant import cost for most nations, this secured the strategic position and requirement that the US dollar would be maintained as the preeminent reserve currency by trading nations.

What this strategy meant to the US was that it could now print money, and effectively export the potential inflationary consequences of its actions. The 1970s were initially marked by dramatic increases in US inflation as the strategy took hold and was implemented. By the time of President Reagan's presidency, the strategy was working thanks to some herculean efforts by Chairman Volker at the Federal Reserve. This well executed strategy is what I refer to as the US Reserve Currency Strategy.

The strategy allowed Regan to implement 'Reaganomics' and his new Supply Side economic policies which launched the longest bull market in US history.  Further enhanced by an extremely loose monetary policy under Greenspan, relaxed reserve requirements under Clinton, and tax cuts under George Bush II, the US moved quickly from being the world's richest country to being the world's largest debtor. 

Historic debt growth was built up without the disease of inflation infecting the US economy. This is explained by inflation that was effectively exported whenever increasing levels of US dollars were printed by the US Treasury.

Any threat to this strategy was rapidly challenged by US military power. As an example, when Saddam Hussein, President of Iraq, decided to sell Iraq oil denominated in Euros, he was invaded by US forces three months later and removed from power. When Libyan leader Muammar Gaddafi wanted gold in exchange for Libyan oil, he almost immediately found himself the target of US planned military intervention.

Presently, oil is still sold only in US dollars, but more and more trade deals are being negotiated between China and its trading partners. This is a serious threat to the US and the US Dollar Reserve Strategy.
THE SYMBIOTIC RELATIONSHIP

One of the reasons the US Reserve Strategy has worked for as long as it has, is because there was an incentive by other countries to sterilize the US dollars they received.  This, in the case of Asia, was because of the Asian Mercantile Strategy they were executing. By sterilizing US dollars, they held down their currency's exchange rate, which helped their exports though creating potential domestic inflation. Until recently, these inflation pressures have been manageable.

In the case of Europe, the Euro was only coming into existence in the late 90s, but then quickly moved from well below par to nearly 1.50 to the US dollar, causing competitive problems for European export trade for many peripheral countries (PIIGS).

The Asian Export Strategy and the US Reserve Dollar Strategy were symbiotic for a number of reasons:

1.    Though the Asian Export Strategy was an Export Trade Imbalance game and  the US Dollar Reserve Strategy a Volume Trade game,  both were centered on global trade. The US won by increased global trading and the growing requirement for the US dollars it required - dollars that could be increased to pay for the military industrial complex without increasing taxation and used as reserves for global banking growth. Asia won by getting an ever increasing share of a growing volume of trade.

2.    The US as a 70% consumption economy needed cheap financing to sustain its insatiable consumption. Asia needed consumption to absorb its growing exports.

3.    The US needed a strong dollar to attract financing for its debt. Asia saw US debt as a store for its growing reserves that additionally reduced financing costs for its export products. In a way Asia was offering a form of vendor financing or 'lay away' financing.

4.    US corporations saw 'off-shoring', 'outsourcing' and 'rightsizing' as major productivity improvements. The Asian Mercantile Strategy offered American corporations an opportunity to significantly increase profitability while Asia needed every increasing and larger market segments to penetrate. US corporations brought know-how, branding and capital to the Asian economies who desperately needed these strengths to employ unskilled populations, increase standards of living and reduce the always present and potential social unrest. 

5.    The US economy which had shifted from an industrial economy to a services economy was quickly becoming a financial economy with 44% of the stock market being financials. The financial economy needed increasing capital inflows to sustain itself.

WHAT HAS CHANGED

So what could possible stop this ideal symbiotic relationship from continuing to feed on itself?

A number of factors, all of which are now coming together to end this Virtuous Cycle.
DEBT SATURATION

I recently authored a paper entitled  Debt Saturation & Money Illusion , that if you have not read, I encourage you to read since it would take up too much space here.  It makes the case that the global economy has reached the point where annual debt costs are now outstripping the global economy's ability to support the exponentially increasing burden.

Additionally, stimulus spending by governments has now reached the point where it is actually counterproductive.

The above chart shows that even using government numbers for inflation (which are disgracefully inadequate and understated) the real rates in the old industrialized economies are negative. By contrast, rates in emerging economies are positive.

This means central banks are effectively paying banks to take money, yet commercial banks cannot find sufficient investments to actually absorb the money.  Like pushing on a string, the global economy simply cannot absorb debt at the levels required to sustain required growth rates which must exceed inflation rates.

The level of nonperforming bank assets is growing at such a rate that global banks have serious concerns with their existing loans and potentially their own solvency.

Growth in Non Performing Bank Loan Levels is shown below.

MALINVESTMENT
I found a recent article entitled: Technology firms struggle to cover interest payments in the Korean Times to be very instructive. Despite Asian economies growing rapidly and now dominating the global electronics industry, the study by the Korean Times found alarmingly that:

a.    One in three firms traded on the Kosdaq stock exchange failed to earn sufficient money to cover their interest payments in 2010.

b.    280 out of 876 Kosdaq-listed corporations, or 32 percent, could not reach the benchmark reading of one in the interest coverage ratio. The interest coverage ratio, otherwise dubbed times interest earned (TIE), refers to the measure of a firm’s ability to honor its debt payments.

This is classic mal-investment in the truest sense of the Austrian School of Economcis.

Corporations now have balance sheets so leveraged with debt that their business models are barely able to cover debt payments even when interest rates are at historic lows. What does this suggest for possible debt default and forced unwinding going forward?

Private Equity corporations with leveraged takeovers and buyouts dominated the US financial landscape for years. These takeovers left corporate balance sheets severely damaged and barely able to pay the debt burdens they were forced to assume.

Additionally, we have learned since the days of Enron, there are significant amounts of debt held off balance sheets today in Special Purpose Entities (SPEs). There is no investor transparency to these obligations. This debt and other forms of 'contingent liability' reporting presently allow corporations to assume ever larger amounts of debt without impacting their corporate credit ratings. Everything works fine until growth slows.

Corporations over the last decade are acting more as highly leveraged hedge funds with the consequential exposure of margin or collateral calls. This is a highly risky and unstable situation in the longer term.

CONSUMPTION IMBALANCES

Another factor causing the unwind is a tapped out US consumer.  This has been forecast for over a decade as an eventuality, but the US consumer continued to surprise everyone with their willingness to consume and take on debt.  However, since the 2008 financial crisis things have changed. The US real disposable income has fallen and US consumer debt loads are now impacting their ability to consume.

Consumption growth rates in the US have slowed.  The Asian economies have consumption rates below forty percent. The consumption growth rates of these Asian economies, though growing,  are increasing from a much smaller absolute size. This imbalance is placing further pressures on the symbiotic relationship.

A VIRTUOUS RISING CYCLE BECOMES A VICIOUS DOWNWARD SPIRAL
Slowly, the cycle is reversing. What was once a virtuous cycle is now a potentially vicious downward spiral.

The death knell for the cycle will be:

1.    A deteriorating  US dollar,

2.    Rising US interest rates,

3.    Sustained and chronic US unemployment,

4.    Asian inflation, especially in food where 60% of Asian disposable income is spent.

5.    Pressures on Asian currency pegs

6.    Collapsing values of US Reserve holdings.

BERNANKE'S BOX

I recently published another paper entitled BERNANKE'S QE^x BOX! where I argued what Chairman Ben Bernanke was likely to do at his critical April 27th FOMC 'Signal' meeting.  I was proven right as he delivered precisely on cue. It was not a difficult call.

The reason I was so sure is because the real problem was clear. It is about what the Basel BIS (Bank of International Settlements) Bankers are more than aware of.

As I point out in Debt Saturation & Money Illusion, the Shadow Banking liabilities have fallen by $5 Trillion since the financial crisis, which is a crushing blow to global liquidity and in fact global financial banking solvency.

An analysis of data by Fathom Consulting for the US Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England, showed their assets swelled from around $4 trillion at the start of 2006 to just short of $9 trillion by the end of February this year.  The increase in the size of G4 central bank balance sheets since mid-07 has ALSO been around $5 trillion to end February 2011, or 8 percent of global GDP.

It is my view that the Basel BIS Bankers have orchestrated their balance sheet growth to offset the contracting Shadow Banking System liabilities. For those that are not aware, Federal Reserve Chairman Ben Bernanke, Bank of England Governor Mervyn King,  ECB President Jean-Claude Trichet and Bank of Japan Governor Masaaki Shirakawa all sit as Board Members and meet regularly.

FED'S DUAL TRIPLE MANDATE

To do this the central bankers have increased their balance sheets to their political limits which can be seen in the following Federal Reserve chart from Zeal.

In the case of the US Federal Reserve, this has meant such significant changes that effectively the Fed's dual mandate has now expanded to three.  Besides the official  mandates of Full Employment and Price Stability, a third has been added: Asset Appreciation.
   
This is clearly evident when we overlay the above balance sheet growth with US equity market appreciation, as represented by the S&P 500 in the chart below.

The top of the red Treasury series (chart above) represents the total Treasuries, MBSs, and agencies the Fed purchased in its quantitative-easing campaigns.  That red line above is then transferred to the second chart below as total QE.  Superimposed on top of it is the US stock markets as represented by the SPX (blue).  The strong correlation between the Fed’s monetization and the post-panic stock-market recovery is remarkable, perhaps even scary.

The Federal Reserve is no longer the "Lender of Last Resort"

The Federal Reserve is now the "Buyer of First Resort"

INHERENT LIMITER: INFLATION

There can be little doubt, despite Federal Reserve rhetoric, that Quantitative Easing , ZIRP (Zero Interest Rate Policy) and negative real interest rates have caused  a surge in global inflation rates.

Recently Oil was at a 31 Month high and up 22 percent Year-on-Year. Corn was up 90 percent,  Wheat and  Soybeans up 45 percent and Rice at yet another high.

This inflation has been acutely felt throughout Asia which has to combat this in parallel with trying to keep their currencies competitive as part of their Asian Mercantile strategy.

Across Asia, interest rates and bank reserve requirements have been increased, and in some instance capital control restrictions implemented.  Pressures are such that many, including China, are now at the point of surrendering sacrosanct currency appreciation.

The problem is food inflation. Food must be imported and a stronger currency would help avoid consumer sensitive food inflation, at the expense of assisting with its own export strategy.

Sixty percent of disposable income in Asia, according to the Asian Development Bank (ADB) in a major report entitled: Global Food & Price Inflation & Developing Asia, is spent on food.  Food is presently expected to average 10 percent inflation in 2011. This has created tremendous pressures on the population and potential social unrest for Asian governments.

64 Million people have already been moved into the category of poverty, which the ADB classifies as  below $1.25/day. With 3.5 Billion consumers, it is expected that 190 Million will be pushed into poverty if food inflation continues. Food prices were up 30% in February's report, so the 10 percent Asian food inflation is no doubt seriously too low.

GLOBAL SLOWDOWN -  Q1 GDP SIGNALS

The efforts to fight inflation are now impacting the 7.8% Asian growth rate, which is now demonstrating the expected signs of slowing.

US Gross domestic product was recently reported as rising only 1.8 percent from January through March, after a 3.1 percent pace in the last three months of 2010. Taking out inventory builds this number as only 0.8 percent.

Britain reported 0.5 percent growth and is now on the edge of a double dip.

The Federal Reserve and most economists are all revising 2011 GDP growth lower, as a steady stream of negative news hits the markets.
If GDP numbers were adjusted for true inflation, rather than the suspect government CPI distortions, real GDP would be negative. Considering government deficit spending is now 20-25 percent of the US economy, can there be any question that we have effectively very negative economic growth?

The Basel BIS Bankers are acutely aware of this. 

QE^X WILL HAPPEN - 'The Risk-Off that Refreshes'

So what is to be done?
I believe a decision has been taken to temporarily remove some of the pressures off increasing money supply before resuming expansion of money and credit later in Q3 or Q4. There is little choice.
Make no mistake about it however, central bank money printing must continue and at an accelerated rate.  I suspect it will emerge not as QE III, but in another form to address the massive and growing problems with non-performing assets, foreclosures and REOs occurring at Fannie, Freddie and the FHA.
Don't get fooled. Watch the balance sheets of the central banks. They will by necessity continue to grow to stop the vicious spiral from accelerating.
CONCLUSIONS

The Basel BIS Bankers fully understand the underpinnings of the shift from a Virtuous Cycle to a Vicious Spiral presently underway.

They are doing everything within their power to offset it. Policies of "extend and pretend" and "kick the can down the road" are all just attempts at buying time.

Unfortunately time is working against them, as existing debt only increases as interest owed is relentlessly and cumulatively added.

The Basel BIS Bankers have no real answers. The eventuality of a fiat currency crisis is ordained and has been since the early warnings in 2007 of the Financial Crisis. The roadmap has been clear to all that actually wanted to look.

Bloomberg: Global Economy Weakens

from Bloomberg:

The world economy is losing strength halfway through the year as high oil prices and fallout from Japan’s natural disaster and Europe’s debt woes take their toll.
Goldman Sachs Group Inc. now expects global economic growth of 4.3 percent in 2011, compared with its 4.8 percent estimate in mid-April, while UBS AG has cut its projection to 3.6 percent from 3.9 percent in January. Downside risks also include a shift to tighter monetary policy in emerging markets.
“The world economy has entered a softer patch with the incoming growth data mostly disappointing,” said Andrew Cates, an economist at UBS in Singapore. “We suspect this soft patch will endure for longer.”
Data this week backed that outlook as reports showed Chinese manufacturing expanding at the slowest pace in 10 months, orders for U.S. durable goods dropping the most since October and confidence among European executive and consumers sliding for the third straight month. Investors are tuning in, pushing the MSCI World Index of stocks in advanced economies down 4.2 percent this month.
Goldman Sachs economists led by Dominic Wilson and Jan Hatzius said in a May 25 report they now expect “less upside in equities” with their colleagues reducing price targets for most of the major regions even though they still anticipate another 10 percent gain in developed markets this year.
The concern comes as leaders from the Group of Eight conclude a summit in Deauville, France, with a statement that declared the world economy is “gaining strength” and that its recovery will pave the way to debt reduction. They identified commodity prices as a “significant headwind” to expansion.
The MSCI World Index rose 0.6 percent at 6:15 a.m. in New York today, paring its weekly lose, after the G-8 statement.

Energy Costs

Oil prices reached a 31-month high of $114.83 on May 2 as the war in Libya cut supply. Goldman Sachs this week raised its forecast for Brent crude at the end of 2012 to $140 a barrel from $120, suggesting the price’s path will be 20 percent higher than anticipated at the start of the year. That’s enough to shave 0.5 percentage point from U.S. growth over two years and a little less in other wealthy nations, they said.
The fallout from Japan’s earthquake, tsunami and nuclear disaster may also be reverberating, said David Hensley, director of global economic coordination at JPMorgan Chase & Co. in New York, who calculates the international expansion will duck beneath its long-term trend this quarter.
Japan’s Consumers
Japan’s retail sales fell 4.8 percent from a year earlier in April, the Trade Ministry said in a report released today, underscoring the impact on consumers from the March disasters and forecasts for gross domestic product to shrink for a third straight quarter in the three months to June.
While spillover to Asia’s emerging economies has been “surprisingly modest,” Hensley said supply-chain disruption is “likely to rise with time” as Japanese production and exports remain depressed before beginning to recover around September.
“The global economy is losing momentum,” Hensley said.
China, after powering the global economy out of the 2009 recession, may also be slowing. The world’s No. 2 economy has raised interest rates four times since mid-October and boosted banks’ reserve-requirement ratio eight times since November, most recently on May 12.
ING Groep NV this month cut its estimate for China’s full- year growth to 9.8 percent from 10.2 percent and reduced its second-quarter forecast to an annual pace of 9.6 percent, from 10.3 percent. Credit Suisse Group AG adjusted its 2011 expansion estimate to 8.8 percent from 9.1 percent. China’s stocks this week fell by the most in eleven months.

Central Banks

“Investors are worried that the tightening is overdone and concerns have widened to a slowdown in earnings and economic growth from just inflation,” said Wang Zheng, chief investment officer at Jingxi Investment Management Co. in Shanghai, which manages about $120 million.
Emerging-market central banks elsewhere are also throttling back. Those in India, the Philippines, Chile, Poland, Peru and Malaysia all raised their benchmark borrowing costs this month to cool price pressures.
Europe’s 18-month debt crisis is another brake on growth as its policy makers prepare a second aid package to save Greece from default and other so-called peripheral economies deploy austerity measures to slash debt. At the same time, the euro’s 6 percent gain against the dollar since the start of the year and the European Central Bank’s shift toward tighter monetary policy may be slowing expansion elsewhere in the region.

Impact on Companies

The global economy’s change in tone is reflected in some company announcements. Chicago-based Boeing Co. (BA), the world’s largest aerospace company, said it received two orders last month compared with 98 in March. Hermes International SCA, the Paris-based maker of Birkin handbags, said on May 11 that its forecast for 2011 is “clouded by geopolitical and economic uncertainties.”
The slower growth may still be short-lived and by cooling the oil price could even provide some support for consumers and inflation relief for central bankers, allowing them to keep monetary policy looser for longer. Other reasons for confidence include job growth in the U.S., expectations for an infrastructure-led bounce in Japan’s economy, supportive equity markets and a likely recovery in inventory accumulation, said Hensley at JPMorgan Chase.
Economists Nariman Behravesh and Sara Johnson of IHS Inc. said in a May 24 report that while they expect worldwide growth to slow to 3.5 percent this year from 4.1 percent in 2010, it will rebound to 4 percent in each of the next two years as the pain of austerity, Japan’s woes and high oil prices passes.
“Assuming these shocks do not get any worse and that the world economy is not hit by additional unforeseen jolts, chances are good that the period of slow growth will be relatively short and that the recovery will pick up steam again,” they said.

20 Questions to Ask About the So-Called Recovery!

by Michael Snyder at Economic Collapse blog:

If you listen to Ben Bernanke, Barack Obama and the mainstream media long enough, and if you didn't know any better, you might be tempted to think that the economic crisis is long gone and that we are in the midst of a burgeoning economic recovery.  Unfortunately, the truth is that the economic crisis is far from over.  In 2010, more homes were repossessed than ever before, more Americans were on food stamps than ever before and a smaller percentage of American men had jobs than ever before.  The reality is that the United States is an economic basket case and all of these natural disasters certainly are not helping things.  The Federal Reserve has been printing gigantic piles of money and the U.S. government has been borrowing and spending cash at a dizzying pace in an all-out effort to stabilize things.  They have succeeded for the moment, but our long-term economic problems are worse then ever.  We are still in the middle of a full-blown economic crisis and things are about to get even worse.
If you know someone that is foolish enough to believe that the economic crisis is over and that our economic problems are behind us, just ask that person the following questions....
#1 During the 23 months of the "Obama recovery", an average of about 23,000 jobs a month have been created.  It takes somewhere in the neighborhood of 150,000 jobs a month just to keep up with population growth.  So shouldn't we hold off a bit before we declare the economic crisis to be over?
#2 During the "recession", somewhere between 6.3 million and 7.5 million jobs were lost.  During the "Obama recovery", approximately 535,000 jobs have been added.  When will the rest of the jobs finally come back?
#3 Of the 535,000 jobs that have been created during the "Obama recovery", only about 35,000 of them are permanent full-time jobs. Today, "low income jobs" account for 41 percent of all jobs in the United States. If our economy is recovering, then why can't it produce large numbers of good jobs that will enable people to provide for their families?
#4 Agricultural commodities have been absolutely soaring this decade.  The combined price of cotton, wheat, gasoline and hogs is now more than 3 times higher than it was back in 2002.  So how in the world can the Federal Reserve claim that inflation has been at minimal levels all this time?
#5 Back in 2008, banks had a total of 27 billion dollars in excess reserves at the Fed.  Today, banks have a total of approximately 1.5 trillion dollars in excess reserves at the Fed.  So what is going to happen when all of this money eventually hits the economy?....

#6 If the U.S. economy is recovering, then why are shipments by U.S. factories still substantially below 2008 levels?
#7 Why are imports of goods from overseas growing much more rapidly than shipments of goods from U.S. factories?
#8 According to Zillow, the average price of a home in the U.S. is about 8 percent lower than it was a year ago and that it continues to fall about 1 percent a month. During the first quarter of 2011, home values declined at the fastest rate since late 2008. So can we really talk about a "recovery" when the real estate crisis continues to get worse?
#9 According to a shocking new survey, 54 percent of Americans believe that a housing recovery is "unlikely" until at least 2014.  So how is the housing industry supposed to improve if so many people are convinced that it will not?
#10 The latest GDP numbers out of Japan are a complete and total disaster.  During the first quarter GDP declined by a stunning 3.7 percent.  Of course I have been saying for months that the Japanese economy is collapsing, but most mainstream economists were absolutely stunned by the latest figures.  So will the rest of the world be able to avoid slipping into a recession as well?
#11 Next week, Republicans in the House of Representatives are going to allow a vote on raising the debt ceiling.  Everyone knows that this is an opportunity for Republican lawmakers to "look tough" to their constituents (the vast majority of which do not want the debt ceiling raised).  Everyone also knows that eventually the Republicans are almost certainly going to cave on the debt ceiling after minimal concessions by the Democrats.  The truth is that neither "establishment Republicans" nor "establishment Democrats" are actually serious about significantly cutting government debt.  So why do we need all of this political theater?
#12 Why are so many of our once great manufacturing cities being transformed into hellholes?  In the city of Detroit today, there are over 33,000 abandoned houses, 70 schools are being permanently closed down, the mayor wants to bulldoze one-fourth of the city and you can literally buy a house for one dollar in the worst areas.
#13 According to one new survey, about half of all Baby Boomers fear that when they retire they are going to end up living in poverty.  So who is going to take care of them all when the money runs out?
#14 According to the U.S. Bureau of Labor Statistics, an average of about 5 million Americans were being hired every single month during 2006.  Today, an average of about 3.5 million Americans are being hired every single month.  So why are our politicians talking about "economic recovery" instead of "the collapse of the economy" when hiring remains about 50 percent below normal?
#15 Since August, 2 million more Americans have left the labor force.  But the entire period from August to today was supposed to have been a time of economic growth and recovery.  So why are so many Americans giving up on looking for a job?
#16 According to Gallup, 41 percent of Americans believed that the economy was "getting better" at this time last year.  Today, that number is at just 27 percent.  Are Americans losing faith in the U.S. economy?
#17 According to the U.S. Census, the number of children living in poverty has gone up by about 2 million in just the past 2 years, and one out of every four American children is currently on food stamps.  During this same time period, Barack Obama and Ben Bernanke have told us over and over that the U.S. economy has been getting better. So what is the truth?
#18 America has become absolutely addicted to government money. 59 percent of all Americans now receive money from the federal government in one form or another. U.S. households are now receiving more income from the U.S. government than they are paying to the government in taxes. Americans hate having their taxes raised and they hate having their government benefits cut.  So is there any hope that this will ever be turned around before disaster strikes?
#19 The combined debt of the major GSEs (Fannie Mae, Freddie Mac and Sallie Mae) has increased from 3.2 trillion in 2008 to 6.4 trillion in 2011.  How in the world is the U.S. government going to be able to afford to guarantee all of that debt on top of everything else?
#20 If the U.S. national debt (more than 14 trillion dollars) was reduced to a stack of 5 dollar bills, it would reach three quarters of the way to the moon.  The U.S. government borrows about 168 million dollars every single hour.  If Bill Gates gave every penny of his fortune to the U.S. government, it would only cover the U.S. budget deficit for 15 days.  So how in the world can our politicians tell us that everything is going to be okay?

Economy Slows, But Stocks Rise

Correlated: GDP and Job Losses

Stocks Rise on Bad GDP News

GDP Revised Lower, Jobless Claims Rise, Stock Futures Go Red

GDP was revised lower to 1.8% on expectations of 2.2%, and new unemployment claims rose to 424,000, with a rising moving average. Both bad! But Pollyanna was partying all night long!

Stocks Rally on Durable Goods Bad News

Wall Street's Pollyanna Party is back on today!

“For the stock market nothing seems to matter until, suddenly, it does.” --Charlie Minter, Comstock Partners

Signs of Fed Desperation

from EconomicPolicyJournal.com:

Thanks to Ben Bernanke's new monetary "tools", the Federal Reserve continues to operate in panic mode. Specifically, because the Fed now pays interest on reserves held by banks at the Federal Reserve, excess reserves are piling up at the Fed at a remarkable rate.

There are now $1.5 trillion in excess reserves just sitting there that could explode and hit the economy at anytime and cause huge price inflation. There has never, ever, before Bernanke started paying interest on  reserves so much of an overhang in excess reserves. In the month before the Fed started paying interest on excess reserves, September 2008, excess reserves stood at only $27 billion.

Here's the difference between then and now:

THEN:      27,000,000,000

NOW:   1,500,000,000,000

Here's a graph of the situation:

Click on chart for larger view.

This is where most of the QE1 and QE2 money has been going. It hasn't even hit the economy, yet. The Fed has no idea what is going to happen with this $1.5 trillion once it does hit the system or how quickly it will flow into the system---and cause price inflation. Or how high they might have to raise interest rates to stop the flow.

An alternative the Fed is considering in draining the reserves by getting money market funds to conduct reverse-repos with the Fed. This gets a little technical, so just know that if the Fed does reverse-repos with money market funds, it will drain reserves from the system.

But the money market funds have nowhere near the cash on hand to do the sizable reverse-repos with the Fed that the Fed may need to do. The money markets have most of their funds in short-term paper that they would be required to sell (or certainly not roll-over) if the Fed came to them wanting to do sizable reverse-repos. Huge sales of short-term paper would panic the markets. It is a very dangerous scenario.

The Fed knows this. When they actually figured this out I am not sure. Trust me, they would have never started paying interest on reserves, if they understood the problem back then. So here we are with $1.5 trillion in excess reserves, with Bernanke not knowing when these might hit the system, and so the Fed desperately continues to add money market funds to the list of those they may in the future do reverse repos with. They are expanding the list hoping that with a larger list any reverse-repos conducted won't damage the economy. It's total desperation.

Durable Disappointment

Kudos to Tyler Durden at Zero Hedge:

At this point there is no need to even highlight the stagflationary crunch the US economy has entered, although the just released Durable Goods number seals the deal: -3.6% on expectations of -2.5%, an 8% revised swing M/M! Ex transportation -1.5% with consensus of +0.5% (down from 1.3%). Q2 GDP now trending sub 2%. Absent the BOJ flooding the market with trillions of fresh Yen, QE3 is now inevitable.
From the report:

New orders for manufactured durable goods in April decreased $7.1 billion or 3.6 percent to $189.9 billion, the U.S. Census Bureau announced today. This decrease, down two of the last three months, followed a 4.4 percent March increase. Excluding transportation, new orders decreased 1.5 percent. Excluding defense, new orders decreased 3.6 percent. Transportation equipment, also down two of the last three months, had the largest  decrease, $4.9 billion or 9.5 percent to $46.7 billion.

This even with the now default increase in inventories (which will be liquidated eventually: thank you FIFO/LIFO).

Inventories of manufactured durable goods in April, up sixteen consecutive months, increased $3.2 billion or 0.9 percent to $350.5 billion. This was at the highest level since the series was first published on a NAICS basis in 1992 and followed a 1.7 percent March increase. Transportation equipment, also up sixteen consecutive months, had the largest increase, $1.0 billion or 1.0 percent to $106.1 billion. This was also at the highest level since the series was first published on a NAICS basis in 1992 and followed a 2.4 percent March increase.

From SMRA:

April new durable goods orders were reported down 3.6%, following a revision higher to up 4.4% in March (previously +4.1%). This was near our forecast for down 3.5%. Expectations in a Bloomberg survey centered at a 2.5% decrease. The range was from down 5.7% to up 2.0%. While the decrease is fairly substantial, it needs to be taken in context with supply chain disruptions that had an impact on new orders for a variety of manufactured goods, but particularly for the manufacture of motor vehicles. Also, new orders typically seesaw between up and down months, and this appears to be the case for April.

Transportation orders fell 9.5% in April. Orders for motor vehicles and parts were down 4.5%, and civilian aircraft orders dropped 30.0%. Boeing had a scant two new orders in the month. However, as we noted in our Chart of the Day on May 6, it is not unusual for the number of orders for aircraft to be low in the months in advance of an airshow, and then jump in the week of the show and for a few weeks afterward. The last major airshow was at Farnborough in July 2010, so there may be some pent-up demand to which to look forward.

And so forth. There is no way to spin the data. In other news, the Japanese earthquake may after all end up not being beneficial to global GDP.

Global Slowdown Coming This Summer

James Saft is a Reuters columnist. The opinions expressed are his own.
HUNTSVILLE, Ala. — With QE2 set to end in five weeks and with Greece rolling downhill towards default, the world is not best placed to withstand a weakening economy.
That, however, is exactly what looks to be happening, as Asian demand is hit by a cooling China and a struggling Japan.
Let’s take a look at the evidence:
Japan’s economy shrank by 0.9 percent in the three months to March, battered by the earthquake, tsunami and ongoing nuclear fiasco.
The preliminary HSBC/Markit purchasing managers’ index for China fell to 51.1 in May from a final reading of 51.8 in April, holding in expansionary territory above 50 but amidst growing evidence that China is coming off the boil. Chinese demand for raw materials and semi-finished products has been one of the global economy’s principal supports, but now a monetary policy tightening campaign may be gaining traction.
The Chicago Fed national index, derived itself from 85 economic indicators, came in at negative 0.45 in April compared to 0.32 in March. There are numerous signals of an industrial slowdown in the U.S., while the housing market continues to weaken, threatening financial stability and consumer spending.
Finally, in Europe the euro zone composite flash PMI, an indicator combining service sector and manufacturing purchasing, fell to 55.4 from 57.8. More worryingly, the headline manufacturing index had its biggest fall since Lehman Brothers failed, falling by 3.1 points to 54.8.
“All in all it seems to us that the odds are high that a domestic and global economic slowdown is already in place.  In the U.S. the slowdown is happening with only weeks to go before the end of QE2, a program that has been a major prop for even the tepid recovery we’ve undergone so far,” said Charlie Minter of fund managers Comstock Partners in a note to clients.
“For the stock market nothing seems to matter until, suddenly, it does.”
It has begun to matter recently to the stock market, which has fallen in recent sessions after a sustained rally. The bond market has already figured this out; since mid-April U.S. 10-year yields are down more than 12 percent to 3.12 percent. Given that the U.S. debt market faces a debt showdown and the end of QE2, both factors which should theoretically send yields higher, this slide in yields shows real doubts about future growth.
CRUEL SUMMER
It is worth noting that the euro zone’s woes were not this time concentrated in the weak peripheral states; this time Germany got whacked too. That may well reflect the wrench thrown into production from Japanese plant closings, which in itself will self-correct. It is also likely reflecting a slowdown in demand for German products from China. If you believe that Chinese demand was artificially boosted by very easy credit, and that Chinese demand in turn was driving global growth, then this is an indicator of a very busy and volatile summer in financial markets.
Global markets have ignored, more or less, the euro zone’s issues for more than a year, but did so in a very supportive atmosphere. The Federal Reserve was buying up Treasuries, sending cash into risk markets in waves, while China continued to grow at a blistering pace. It may be that China is important not just because its slowdown affects demand, but because it lets investors focus on the actual prospects in the euro zone.
Will Germany and France be as willing to foot the bill for Greece if their own manufacturing bases begin to shrink? It is possible but a lot less likely.
Meanwhile the crisis both builds and spreads, with a dispute over debt reprofiling (a sort of doe-eyed default) between the European Central Bank and European officials and a fantasy plan by Greece to raise 15 billion euros through asset sales.
Greece may turn out to be a minor worry; Belgium and Italy have been threatened with credit downgrades by Fitch.
So what happens from here? A palatable outcome would be a gentle decline in economic momentum followed by a strong second half. This makes absorbing the impact from Europe easier, and makes it easier for Europe to come to terms with itself.
A less likely, perhaps, but still possible scenario is that the manufacturing slowdown gains speeds just as Europe faces a contagion from the periphery, either to parts of the core, to the banking system of the core, or both.
At this point the Federal Reserve will have an ugly choice; does it extend and expand quantitative easing to support the newly weakening economy, or does it sit tight, brace for the recession and hope something else will turn up?
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

Sure Enough! Here's the End-of-Day Sell-Off!

The After-Lunch Rally

This happens quite frequently! I expect a sell-off, however, in the closing 30 minutes or so, as day traders liquidate their positions to take short-term profits!

Choppy Downward Drift

European Industrial Orders Slow, Show Signs of Degradation

Zero Hedge:

Following the recent negative Chinese PMI print, the latest confirmation of the global economic slowdown/stagflation comes from Europe where Eurostat reported that EMI Industry Orders declined 1.8% in March, in line with expectations. This was the first M/M decline since September, although the Y/Y number was still a substantial +14.1%. Not surprisingly, previous months were revised lower: February revision: +0.5% m/m (+0.9%) January revision: +1.1% m/m (+1.2%). The momentum of previous months assured a 3.4% average gain in 1Q. As Market News reports: "The drop in March was accentuated by falling demand for heavy transport equipment, which tends to be very volatile with a limited immediate impact on production. Excluding this category, orders fell 1.1% on the month and were 15.2% higher on the year. Intermediate goods orders increased 0.6% on the month and were 19.2% higher on the year, suggesting that the industry recovery will continue for some time. The drop in heavy transport demand helped drag down capital goods orders 4.6% on the month, giving a 14.5% rise on the year. Consumer durable goods orders plunged 6.8% in March and were 2.6% lower on the year. Still-sluggish consumer demand and competition from low-cost producers abroad have undermined capacity in this branch. Non-durables orders fell 3.5% on the month and were 0.5% lower on the year." And for those still wondering why there is a concerted effort at pushing the EUR lower, here it is: "Leading indicators suggest that demand will wane in the months ahead. Manufacturers polled by the European Commission in April expected new orders to lose steam in 2Q. The outlook index fell 5.1 points from the record high in January to return to the level in July. Still, their assessment of order book levels continued to improve, thanks mainly to higher export back orders. They estimated that orders on hand would assure 3.7 months of production, up from 2.6 months in January." In other words: must keep that export dynamo turning or else.

Livestock Futures (Near) Limit Down

Feeder cattle was limit down, and live cattle was nearly limit down. Lean hog was near limit down. I don't think I've ever seen this occur before!

Feeder cattle

Live cattle

Lean Hog

Daily chart for live cattle

Stocks Lose Support

Just reached new lows for the day.

Chicago Fed Index Drops to Lowest Levels Since August 2010

"Led by declines in production-related indicators, the Chicago Fed National Activity Index fell to –0.45 in April from +0.32 in March. April marked the lowest reading of the index since August 2010. Three of the four broad categories of indicators that make up the index deteriorated from March, but two of those three categories made positive contributions to the index in April."
"A zero value for the index indicates that the national economy is expanding at its historical trend rate of growth; negativevalues indicate below-average growth; and positive values indicate above-average growth." And: "When the CFNAI-MA3 value moves below –0.70 following a period of economic expansion, there is an increasing likelihood that a recession has begun."

But Pollyanna Roars

This is a rather large loss (Dow down about 160) to start the day, but anything can happen! Right now, Wall Street is trying to fix a bottom in the equity markets.

European Debt Disaster Tumbles Equity Markets

Examples of How U.S. Is Buried In Debt

(Reuters) - President Ronald Reagan once famously said that a stack of $1,000 bills equivalent to the U.S. government's debt would be about 67 miles high.
That was 1981. Since then, the national debt has climbed to $14.3 trillion. In $1,000 bills, it would now be more than 900 miles tall.
In $1 bills, the pile would reach to the moon and back twice.
The United States hit its legal borrowing limit on Monday, and the Treasury Department has said the U.S. Congress must raise the debt ceiling by August 2 to avoid a default.
The White House is trying to hammer out a deal with lawmakers to cut federal spending in exchange for a debt-limit increase.
Most people have trouble conceptualizing $14.3 trillion.
Stan Collender, a budget expert at Qorvis Communications, said the biggest sum most Americans have ever handled -- in real or play money -- is the $15,140 in the original, standard Monopoly board game.
The United States borrows about 185 times that amount each minute.
Here are some other metrics for understanding the size of the national debt and United States borrowing:
* U.S. Treasury Secretary Timothy Geithner has said the United States borrows about $125 billion per month.
With that amount, the United States could buy each of its more than 300 million residents an Apple Inc iPad.
* In a 31-day month, that means the United States borrows about $4 billion per day.
A stack of dimes equivalent to that amount would wrap all the way around the Earth with change to spare.
* In one hour, the United States borrows about $168 million, more than it paid to buy Alaska in 1867, converted to today's dollars.
In two hours, the United States borrows more than it paid France for present-day Arkansas, Missouri, Iowa and the rest of the land obtained by the 1803 Louisiana Purchase.
* The U.S. government borrows more than $40,000 per second. That's more than the cost of a year's tuition, room and board at many universities.
"That usually gets their attention," Doug Holtz-Eakin, who was chief White House economist under President George W. Bush, said in an email. "I have two kids, so every 10 seconds, the feds borrow more than I paid lifetime."
* The Congressional Budget Office projects the total budget deficit in fiscal 2011 at about $1.4 trillion.
"The net worth of Bill Gates, roughly around $56 billion, could only cover the deficit for 15 days," said Jason Peuquet, a policy analyst with the Committee for a Responsible Federal Budget. "The net worth of Warren Buffet, roughly around $50 billion, could only cover the deficit for 13 days."

Stock Futures Deep in the Red

Dow is down about 120 points at this writing. The Fed must be worried that their primary indicator of prosperity is faltering still five weeks from the end of their current debt monetization fiasco.

Utah First State to Make Gold, Silver Legal Tender

SALT LAKE CITY (AP) -- Utah legislators want to see the dollar regain its former glory, back to the days when one could literally bank on it being "as good as gold."

To make that point, they've turned it around, and made gold as good as cash. Utah became the first state in the country this month to legalize gold and silver coins as currency. The law also will exempt the sale of the coins from state capital gains taxes.

Craig Franco hopes to cash in on it with his Utah Gold and Silver Depository, and he thinks others will soon follow.

The idea is simple: Store your gold and silver coins in a vault, and Franco issues a debit-like card to make purchases backed by your holdings.

He plans to open for business June 1, likely the first of its kind in the country.

"Because we're dealing with something so forward thinking, I expect a wait-and-see attitude," Franco said. "Once the depository is executed and transactions can occur, then I think people will move into the marketplace."

The idea was spawned by Republican state Rep. Brad Galvez, who sponsored the bill largely to serve as a protest against Federal Reserve monetary policy. Galvez says Americans are losing faith in the dollar. If you're mad about government debt, ditch the cash. Spend your gold and silver, he says.

His idea isn't to return to the gold standard, when the dollar was backed by gold instead of government goodwill. Instead, he just wanted to create options for consumers.

"We're too far down the road to go back to the gold standard," Galvez said. "This will move us toward an alternative currency."

Earlier this month, Minnesota took a step closer to joining Utah in making gold and silver legal tender. A Republican lawmaker there introduced a bill that sets up a special committee to explore the option. North Carolina, Idaho and at least nine other states also have similar bills drafted.

At the moment, Franco's idea would generally be the only practical use of the law in Utah, given the legislation doesn't require merchants to accept the coins, either at face value - $50 for a 1-ounce gold coin - or market value, currently almost $1,500 per ounce. And no one expects people will be walking around town with pockets full of gold and silver.

Matt Zeman, market strategist for Kingsview Financial in Chicago, expects more people will start investing in gold as America's growing debt and bankruptcies in other countries continue to decrease the value of government-backed money.

"You've seen gold replacing these currencies as safety instruments," Zeman said. "If I don't feel good about the dollar or other currencies, I'm putting my money in precious metals."

Some supporters, including the law's sponsor, seek to push Congress toward removing the tax burdens that discourage use of the coins, such as a federal capital gains tax.

"Making gold and silver coins legal tender sends a strong signal to Congress and the Federal Reserve that their monetary policy is failing," said Ralph Danker, project director for economics at the Washington, D.C.-based American Principles in Action, which helped shape Utah's law. "The dollar should be backed by gold and silver, so we have hard money."

The U.S. and many other countries largely abandoned gold-backed money during World War I because they needed to print more cash to pay for the war. Later, during the Great Depression, President Franklin D. Roosevelt took steps that essentially prohibited gold and silver as legal currency to prevent hoarding.

In 1971, President Nixon formally abandoned the gold standard.

Fifteen years later, the U.S. Mint began producing the gold and silver American Eagle coins, primarily aimed at investment portfolios and allowing people to trade them at market value but with capital gains taxes on profits.

Utah is now allowing the coins to be used as legal tender while levying no taxes.

Opponents of the law warn such a policy shift nationwide could increase the prospect of inflation and could destabilize international markets by removing the government's flexibility to quickly adjust currency prices.

"We'd be going backward in financial development," said Carlos Sanchez, director of Commodities Management for The CPM Group in New York. "What backs currency is confidence in a government's ability to pay debt, its government system and its economy."

Larry Hilton, a Utah attorney who helped draft the law, disagrees and says the gold standard would restore faith in American money at a time when spiraling debt is weakening confidence.

"We view this as a dollar-friendly measure," Hilton said. "It will strengthen the dollar by refocusing policy matters in Washington on what led to the phrase, `the dollar is as good as gold.'"

Recovery Begins to Slow

By Pedro Nicolaci da Costa

WASHINGTON | Sun May 22, 2011 3:05pm EDT

(Reuters) - It was fun while it lasted.
After several strong quarters, the global economic recovery appears to be sputtering. In particular, the industrial sector, a key driver of the bounce-back from a historic worldwide recession, looks to be fraying.
"People need to seriously consider the scenario where global industrial growth, once again, starts to throttle back -- because it's not that far away," said Lakshman Achuthan, managing director of the Economic Cycle Research Institute.
A report on U.S. durables goods orders due Wednesday should give fresh insight into manufacturing demand after an unexpected plunge in the Philadelphia Federal Reserve Bank's index of May factory activity caught investors by surprise.
Economists are looking for a 2.2 percent decline in durables orders for May, according to a Reuters poll. A closely watched measure of non-defense orders excluding aircraft, seen as a proxy for business investment, is projected to inch up just 0.2 percent.
"This week will bring what is likely to be another round of discouraging news, with May's durable goods orders data pointing to further evidence that the manufacturing recovery is losing momentum," said John Higgins, economist at Capital Economics.
The deterioration in U.S. manufacturing is being exacerbated by a slowdown in Japan, which is essentially in recession in the wake of a devastating earthquake and tsunami.