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Eric
07-06-2010, 10:22 AM
By Mike Whitney

Bonds are signaling that the recovery is in trouble. The yield on the 10-year Treasury (2.97 percent) has fallen to levels not seen since the peak of the crisis while the yield on the two-year note has dropped to historic lows. This is a sign of extreme pessimism. Investors are scared and moving into liquid assets. Their long-term expectations have grown dimmer while their confidence has begun to wane. Economist John Maynard Keynes examined the issue of confidence in his masterpiece "The General Theory of Employment, Interest and Money". He says:

"The state of confidence, as they term it, is a matter to which practical men always pay the closest and most anxious attention.

The state of long-term expectation, upon which our decisions are based, does not solely depend, therefore, on the most probable forecast we can make. It also depends on the confidence with which we make this forecast — on how highly we rate the likelihood of our best forecast turning out quite wrong."

Volatility, high unemployment, and a collapsing housing market are eroding investor confidence and adding to the gloominess. Economists who make their projections on the data alone, should revisit Keynes. Businesses and households have started to hoard and the cycle of deleveraging is still in its early stages. The winding down of the Fed's liquidity programs comes at the same time as Obama's fiscal stimulus begins to run out. Bank reserves are not getting into the hands of the people who will spend them and increase economic activity. These things all indicate a generalized tightening in the money supply. Soon, incomes will begin to contract and the CPI will turn from disinflation to deflation. Aggregate demand will weaken as households and consumers hunker down and increase personal savings. The financial crisis may be over, but the Depression has just begun. Here's how Nobel prize winner Paul Krugman sums it up:

"We are now, I fear, in the early stages of a third depression....And this third depression will be primarily a failure of policy. Around the world ... governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending. ... After all, unemployment — especially long-term unemployment — remains at levels that would have been considered catastrophic not long ago, and shows no sign of coming down rapidly. And both the United States and Europe are well on their way toward Japan-style deflationary traps."

More than 8 million jobs have been lost since the beginning of the crisis, and yet, President Barack Obama has made no attempt to initiate a second stimulus. Government spending must increase to make up for the slack in demand and to increase capacity. That means larger budget deficits until households have patched their balance sheets and can again spend at pre-crisis levels. Belt-tightening should wait until the economy is stronger. Withdrawing stimulus now, while the economy is still weak, will crimp spending, collapse state tax revenues and increase unemployment. Here's an excerpt from an article by James K. Galbraith which helps to explain what's needed to get back on track:

"The only way to reduce a deficit caused by unemployment is to reduce unemployment. And this must be done with a substantial component of private financing, which is to say by bank credit, if the public deficit is going to be reduced. This is a fact of accounting. It is not a matter of theory or ideology; it is merely a fact. The only way to grow out of our deficit is to cure the financial crisis.

To cure the financial crisis would require two comprehensive measures. The first is debt restructuring for the entire household sector, to restore private borrowing power. The second is a reconstruction of the banking system, effectively purging the toxic assets from bank balance sheets and also reforming the bank personnel and compensation and other practices that produced the financial crisis in the first place. To repeat: this is the only way to generate deficit-reducing, privately-funded growth and employment.

To be clear: unemployment can be cured without private-sector financing, if public deficits are large enough — as was done during World War II. But if the objective is to reduce public deficits, for whatever reason, then a large contribution from private credit is essential.

The economy cannot grow without private sector credit expansion. But the banks are constrained by toxic assets and a lack of creditworthy applicants. On the other hand, deleveraging households and consumers are less willing to borrow at any rate. Retirement age "boomers" have lost nearly $12 trillion in net wealth since the crisis began and must hunker-down and save for the years ahead. They are no longer in a position to spend freely anticipating their home equity will rise 10% or 15% per year creating a cushion for the future. In fact, bond yields indicate that retail investors have lost faith in both the housing and equities markets. These people have moved their savings into low-yielding, risk adverse assets-- US Treasuries.

Hoarding reduces spending which leads to economic contraction. But behavior can be altered by changing incentives, raising incomes or restoring confidence. Keynes was less sanguine about merely increasing the money supply which he compared to "trying to get fat by buying a larger belt". The point is to increase consumption, which means that money has to get in the hands of the people who will spend it to grow the economy. Bank reserves alone won't do the trick.

Presently--according to data collected by the Federal Reserve-- companies are hoarding capital due to the lack of investment opportunities. High unemployment has led to falling demand which is stifling investment. As households continue to deleverage, many companies will opt to pay down debt rather than seek new investments (as they did in Japan) This will further reduce economic activity and deepen the slump. The government must increase the deficits to offset cuts in state and private sector spending and to avoid another excruciating cycle of debt deflation.

The economy is at a tipping point. CPI is is slipping from disinflation to outright deflation. Unemployment has flattened out at 9.5%, but 650,000 discouraged workers have stopped looking for work altogether which will add to the slowdown. The cash-strapped states are laying off workers in droves. The rate of underemployment has soared to 16.5%. There are 6 applicants for every new job created. Conservatives believe that the ongoing crisis creates a unique opportunity to crush the labor movement and to force down wages. GOP senators and congressmen have quashed a bill that would extend unemployment benefits to over a million workers. Apart from the gratuitous cruelty of the action, their obstructionism only adds to deflationary pressures.

Nomura economist David Resler says that congress's action will have an immediate and damaging effect on the economy and could trim GDP by 0.2 percentage point this quarter and by 0.4 point in the period from July through September. (Bloomberg) Republicans are precipitating a crisis to garner support in the upcoming midterm elections, but they may not fully grasp the knock-on effects of their vote on their constituents.

The FOMC's June statement was a real stunner. The economy is losing-ground in nearly every area. Household spending, business spending, bank lending and housing are all either beginning to slow or falling sharply. The Commerce Dept. revised its first quarter estimate of GDP from 3.0% to 2.7% due to lower than expected consumer spending. The recovery is largely a mirage created by inventory adjustments and fiscal stimulus. 46 of the 50 states are mired in huge deficits that will require substantial cuts to balance. That will be a drag on activity going forward. This is from Bloomberg News:

"States face a cumulative budget gap of $127.4 billion as 46 prepare for the start of their fiscal year on July 1, according to a report this month by the National Governors Association and the National Association of State Budget Officers. They will have to fill that hole largely on their own, as aid from the federal government under programs including President Barack Obama’s $787 billion stimulus package starts to wind down.

State and local governments will have to dismiss 162,000 workers if Congress fails to extend about $24 billion of Medicaid payments, Lawrence Mishel, president of the Economic Policy Institute in Washington, said during the governors’ call. Payrolls have already registered 11 straight months of year- over-year declines, the longest stretch of continuous drops since 1983, based on Labor Department data." (Bloomberg)

State budget cutting will swell the unemployment lines and slow consumer spending. With fiscal stimulus quickly running out and the deficit hawks pushing for greater austerity, the Fed will be forced to intervene in the 4th quarter resuming its quantitative easing bond purchasing program to pump more liquidity into the financial system. The recovery is not self sustaining.

In Europe, the scenario is much the same only worse. ECB head Jean-Claude Trichet has been preaching austerity while conducting a massive stealth bank bailout, providing limitless funds in exchange for dodgy collateral, overnight deposits for wary banks that no longer trust the repo market, and bond purchases of sovereign debt that is vastly overpriced given the fiscal position of the issuers. Germany is calling for additional belt tightening across the eurozone as a hedge against fictitious inflation. German policymakers don't see that their trade surpluses translate into deficits in the Club Med states, or that their solutions will only exacerbate existing imbalances, increase the deficits, and put the EU on course for another contraction.

After Lehman Bros. collapsed in September 2008, the world was pulled back from the brink of depression by an activist Federal Reserve that (arbitrarily) assumed the authority of Congress and conducted a massive rescue operation that provided unlimited liquidity and government support for teetering financial institutions. And, while the Fed's uneven treatment of Wall Street has been widely criticized, (the banks have been allowed to carry on much as they had before) the precipitous slide into the abyss was halted. Now, the Congress seems eager to reverse that achievement for fleeting political gain.

True, in some perverse sense, the market is "self correcting", but in this case, it would take years if not decades of high unemployment, overcapacity, dwindling investment and social unrest. Are we ready for that? The preferable solution is to plug the regulatory holes that allow financial institutions to speculate in massively- leveraged instruments that have implicit government guarantees (CDS, MBS, CDO), and to promote income growth so the supply/demand balance that is essential to economic growth is restored. The way out of this mess is more jobs and higher pay. And that will take public mobilization and whopping big deficits.

dBrong
07-07-2010, 09:17 AM
In the 90's Japan had what was called "The Lost Decade" - IMO we are there now.

Think about this: There are atleast 20,000,000 unemployed people in the US. Multiply that by 2000 working hours / year. We are throwing away 40,000,000,000 (yeah - 40 Billion) man hours a year - with no productivity.

Further, if these people were employed, they would be paying at least $40 billion in taxes!

We are really fu<ked, and our Lord Obama is clueless.

Eric
07-07-2010, 09:23 AM
In the 90's Japan had what was called "The Lost Decade" - IMO we are there now.

Think about this: There are atleast 20,000,000 unemployed people in the US. Multiply that by 2000 working hours / year. We are throwing away 40,000,000,000 (yeah - 40 Billion) man hours a year - with no productivity.

Further, if these people were employed, they would be paying at least $40 billion in taxes!

We are really fu<ked, and our Lord Obama is clueless.

I think it's worse.. far worse.

Among other things, we've eviscerated our skilled manufacturing on the altar of "free trade" (and for the benefit of large corporations and the corporate elite who profit thereby).

Those jobs are gone forever.

How can the US economy rebound given that?

The foundation of US prosperity was an economically secure skilled working and middle class. Now we (increasingly) have a "service sector" economy with a precariously insecure middle class, a disenfranchised working class - and a growing population of latter-day serfs/peons and dependents, lorded over by a monied elite who enjoy Creosus-like affluence.

Again, how does the economy "recover" given this?

My opinion: None of this is accidental. The object is to drag down America (the American working and middle class, that is) to the level of Turd World stoop labor. What the elites wants is a fearful, helpless - and under-educated/addled by infotainment - mob they can exploit and control.

An economically secure working and middle class is anathema to the world elites, since it represents a threat to their dominance and power.

dBrong
07-07-2010, 01:07 PM
...Among other things, we've eviscerated our skilled manufacturing on the altar of "free trade" (and for the benefit of large corporations and the corporate elite who profit thereby).

Those jobs are gone forever.

How can the US economy rebound given that?

....

My opinion: None of this is accidental. The object is to drag down America (the American working and middle class, that is) to the level of Turd World stoop labor. What the elites wants is a fearful, helpless - and under-educated/addled by infotainment - mob they can exploit and control.

An economically secure working and middle class is anathema to the world elites, since it represents a threat to their dominance and power.

Yes, yes, yes. I think the economy is now pitting middle class people against themselves. In a destructive spiral to the bottom!