It seems this time of year everyone starts throwing out predictions for the new year. I know many wiser people would do better at predicting, and many wiser people refrain from making predictions at all in our unstable and complex world. But based on some long-term trends that have a connection with biblical prophecies, let me add my 10 questions highlighting trends to watch in 2010.

1. Will Iran’s provocations over its nuclear program lead to an Israeli attack to prevent Iran from building nuclear bombs? Tensions continue to heat up. As the BBC reported Nov. 29:

After more than 60 years, will nuclear weapons be used again?

“Iran’s government has approved plans to build 10 new uranium enrichment plants, according to state media…

“It comes days after the UN nuclear watchdog rebuked Iran for covering up a uranium enrichment plant…

“BBC Tehran correspondent Jon Leyne says Sunday’s announcement is a massive act of defiance likely to bring forward direct confrontation over Iran’s nuclear programme.”

Read more of the background of this crisis in “What Would an Israel-Iran Nuclear War Mean?”

2. How much will implementing the Lisbon Treaty streamline and unify Europe? The treaty went into effect Dec. 1, and the newly created positions of full-time president (Belgian Prime Minister Herman Van Rompuy) and foreign minister (Britain’s Catherine Ashton) have been quickly filled.

Both are seen by many as compromise candidates without the name recognition to “stop the traffic” in Washington and Beijing. But will their terms bring further strengthening of the European Union’s goal of ever-closer union? Or will there be continued frustration that Europe isn’t able to speak with one voice and assume the superpower status to match its economic clout?

Bible prophecy shows that it is important to watch events in Europe.

3. Where will the next threat to the world economy come from? More bubbles and insecurities lie just beneath the surface all around the world, as the Dubai World debt crisis showed last week.

Governments and financial institutions understand the need to rush in to shore things up to prevent a meltdown. For example, Bloomberg reports, “The United Arab Emirates’ central bank said it ‘stands behind’ the country’s local and foreign banks, which face losses from Dubai World’s possible default…” But too many of the rushed “cures” only set the stage for future crises. We may not have to wait for 2010 for the next shock to the global system.

4. Will Americans spend or save? MarketWatch reports that the madness of Black Friday discounts only brought in a half percent increase in sales. This is a reminder that the American consumer, once considered the engine of the world economy, is still overstretched and cannot serve as the catalyst of another boom. In fact, the only sustainable approach would be for Americans to save more and spend less. But this tough medicine has its dangers. We’re in so deep, the prudent thing in the long run can be foolish in the short run.

5. How long can America afford to fight two wars? And what will the exit strategy be in Afghanistan? How will other nations take advantage of America being stretched too thin?

6. How long can Americans continue to buy far more from other countries than we sell to them?

7. Will the U.S. government be able to agree on how to cut the record-shattering deficits?

8. How long will countries like China be willing to bankroll the American government’s deficit as well as loaning us the money to buy their goods? As faith in the dollar decreases, what will other countries demand in return for feeding America’s addiction to more and more borrowed money?

9. How long can the U.S. dollar remain the world’s reserve currency?

10. Will the United States continue its slide into immorality, ignoring and even flaunting disobedience to God’s laws? Will America continue to export ungodly and degrading entertainment around the world, with the resultant spread of evil and decline of respect for America?

We cover many of these trends regularly in our publications The Good News and World News and Prophecy. You can also get more background information in The United States and Britain in Bible Prophecy. It explains where we believe the United States, Britain, Canada, Australia and New Zealand are mentioned in Bible prophecy, and why we make the connection between immoral and irresponsible behavior and the decline of our nations’ power. The good news is, the Bible also prophesies an end to these trends with the return of Jesus Christ to save us from ourselves and set up the Kingdom of God. I encourage you to download or request a free copy of these priceless publications and prepare for that wonderful time.

~~By InsightAnalytical-GRL

OK, here we go again, in all likelihood, with another big blast of hot air from Barack Obama.

Reuters, like the AP, doesn’t appreciate quoting from their articles.  So, for details follow the link from 11/10/2009:

World Bank: yuan to become alternative reserve currency

Let’s summarize.  Former Bush Adminstration biggie Robert Zoellick who has moved on to become President of the World Bank thinks the dollar as a reserve currency is “relatively secure” but the Chinese yuan is going to become an alternative to the greenback. Zoellick muses that it might take 10-15 years and that we shouldn’t be “complacent” about the dollar.

As if anybody these days is complacent???  And, don’t you think that these comments just confirm the actions of Ben Bernanke and the Fed that are allowing the dollar fall?

Ah, but according to the Telegraph (U.K):

Barack Obama pledges to tackle Beijing on yuan

President Obama, who, since taking office in January, has resisted branding the Chinese government as currency manipulators, promised to discuss the thorny issue of the yuan, and whether it is undervalued, as part of a visit to Shanghai and Beijing.

“Currency, along with a host of other issues, will come up, and I’m confident that both the United States and China can arrive at a broad set of policies that encourages trade that benefits both countries, that allows ongoing economic growth,” said Mr Obama.

snip

But Mr Obama will have to tread carefully as the Chinese government owns almost $800bn (£477bn) of US Treasuries, its largest foreign creditor.

Earlier in the day, the Chinese premier, Wen Jiabao, urged the US to “effectively discharge its responsibilities” and “maintain an appropriate size” to its budget deficit.

Yup.

A couple of days ago on CNBC, PIMCO’s Bill Gross made this point (see minute 4:30 on the video titled America Still Number 1?:)

Gross notes that over the last year alone the depreciating dollar means that every single Treasury purchased by China, Japan etc with a 1 to 2 % yield has essentially generated a negative 13 to 14% return. Yes, NEGATIVE 13 to 14% return.

Yeah, I guess Obama will HAVE to tread carefully.  China owns us and is not happy, especially about that negative return…

If you read our previous post Globalization/U.S. Decline Right on Schedule Courtesy Obama Backdown…Summer 2010 Projected Completion of Integration of NAFTA with EU to Counter BRIC/ASEAN Bloc, you’ll see an example of Obama’s big talk and big backdown type of leadership.

And, on this currency issue, Obama supporters are urging The Chosen One to live up to his campaign promise:

Yuan Critics Want Obama to Keep Campaign Promise

At the time, Obama said that he would “”insist that China stop manipulating its currency because it’s not fair to American manufacturers, it’s not fair to you and we are going to change it when I am president of the United States of America.”

I can’t wait to see this unfold over the next few days as the Obama crowd hits Beijing…I’ll be looking for the “insisting” part of the trip…

Eighty-five million barrels a day.

That’s the world’s current production of crude oil…and that may very well be close to the world’s PEAK production of crude oil. Although the recession caused a temporary decrease in consumption, demand is already bouncing back toward pre-crisis levels. Too bad production isn’t.

“Can’t we get more than 85 million barrels?” some folks are bound to wonder. Let’s look into that…

A couple weeks ago, I attended the 2009 international conference of the Association for the Study of Peak Oil and Gas (ASPO), out in Denver. Here’s the long and short of it. We’re in trouble. With a capital “T,” and that rhymes with “P,” and that stands for Peak Oil. By every measure, the world’s output of crude oil peaked between 2005 and 2007.

Yes, the worldwide total output of what we generically call “oil” has risen – slightly – in recent years. But that’s because there are increasing volumes of natural gas liquids (NGLs) in the mix, plus unconventional oil like what the global marketplace obtains from Canada’s oil sands. But the production of oil – actual oil – has peaked already. The future of conventional petroleum output is downhill, even with the future output from the deep-water offshore discoveries.

“There’s no such thing as West Texas Intermediate [WTI] oil anymore,” Peak Oil apologist, Matt Simmons, moaned to the ASPO conference attendees. Instead, the pipeline crossroads like Cushing, Okla., have become little more than “crude oil pharmacies.”

In other words, as the quality of the crude from the traditional US oil patch continues to degrade, oilmen must mix and match their product with “sweeter” forms of crude if they hope to sell it as the premium-priced WTI. Thus, operators at Cushing take whatever oil they can obtain from one place, plus whatever oil they can obtain from another place. They mix and match, and blend it all with synthetic crude from Canada. Maybe they add some imported oil juice and then send it down the line as WTI.

Along these same lines, Venezuelan economist Carlos Rossi stated to ASPO his analysis of oil trends in the US. “You are worried about your foreign oil imports now,” he said. “You in the US import about 65% of your oil today. You don’t like it. But if you follow the clear trends, by 2025, you’ll be importing about 92% of your oil. You’ll like that even less.” No doubt.

The market meltdown and world recession of the past year has bought some time. But the planet is still staring at an energy problem that’s coming down the tracks like a runaway freight train.

Sure, there’s a lot more oil “out there”…as in WAY out there – 150 miles offshore, beneath 8,000 feet of water and 20,000 feet of rock and salt. Yes, that offshore resource is out there, but it’s super hard to extract.

And so what? Aren’t the world’s oil companies busy developing these massive offshore deposits? Yes, but this development will take decades. It’ll take time and capital and expensive cutting-edge technologies, some of which are barely commercially viable.

Future energy supplies have never been more uncertain, according to Simmons. It’s difficult to say with specificity how bad things are, he says, because the data are so poor on a worldwide basis.

“Look at what happened with the bad information we had, or didn’t have, with the financial institutions over the past couple of years,” Simmons said at the recent ASPO Conference. “With our energy data, it’s worse. We’re in for some shocks that will change our lives in ways that’ll rival Pearl Harbor.”

Things could go wrong with energy supplies in any of a dozen places, according to Mr. Simmons. In Venezuela, the output of the state oil company PdVSA is declining at alarming rates due to political interference and underinvestment. In Nigeria, the low-grade civil war could quickly morph into a large-scale civil war. In Iraq, according to Mr. Simmons, “They’re in the dark about how to rebuild their oil industry.”

Closer to home, Simmons expects net oil exports from Mexico to vanish within 24 months or less. This event will play havoc with US refiners on the Gulf Coast. Mexico has simply delayed for too long its effort to explore, drill and rebuild its fast-depleting oil resources. Mexico is going to have to scramble to salvage something from its looming energy disaster.

But even without a supply shock, Simmons believes that the mere inevitability of declining production will cause oil to hit $200 a barrel by the end of next year. Longer term, Mr. Simmons expects to see oil at $500-700 per barrel. “People need to understand how expensive it is to obtain oil,” said Simmons.

Much of the world’s energy infrastructure is old and rusting and will require several trillions of dollars to replace – if it can be replaced. Furthermore, new technology is coming on line slower than most people anticipate. The deeper, more challenging environments are sucking down technology and money, and yielding less than expected in many cases. According to one study, only eight out of 100 major energy projects came in on time, were within budget and yielded the expected volumes of oil and natural gas.

The stark fact is that oil is going to get a lot more expensive and the bull market in oil will be firmly in place for a long time. Smart investors would take advantage of any corrections or dips to get themselves buckled-in for the ride.

Regards,

Byron King,
for The Daily Reckoning

Peak Oil – The Risks was originally published in the Daily Reckoning on 27/10/2009.

Multi-Year Stock Market Top Could Be In

by Michael Shedlock

Professor David Waggoner posted the following chart yesterday on Minyanville that I think is worth noting.

click on chart for sharper image

Professor Waggoner commented “The next intermediate level pivot down is around 882. It is a 50% retrace of the entire move up from the low and is a possible pivot for an extension of the entire A-B-C pattern off the low. It is also a natural support level as shown on the chart.

These intermediate level targets are based on the interpretation that the move up from the March low is a corrective retrace of a 5 wave set down from October 2007.

I concur with Professor Waggoner’s analysis.

The important point in above chart is that the move up from the March low is likely a correction, not the start of a new bull market. That information alone is worth far more than any details as to how the market may decline from here. Many patterns are still in play.

Depending on the index, you can count these moves off the bottom as a simple A-B-C correction as shown, or as an A-B-C-D-E wedge. We’ll know which one was correct in hindsight, but both suggest stocks will eventually make new lows – either sooner (in 2010) or later. A multi-year top could be in. Fundamentally, it should be in.

In the short-term, if we have in fact seen the end of the rally, the SPX will likely decline to the 200 day moving average, currently at 916. By the time we get there, it could be in the neighborhood of the 38% retrace line near 933. If things go quickly, it could be down there by the end of the year.

This is not a recommendation to short; this is a notice that risk is tremendously high and a top could be (and in my opinion should be) in. The market may have other ideas.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Mises Daily by Daniel Krawisz

In the great book Man, Economy, and State, Rothbard’s vast compendium of economic wisdom, we read much that has not yet been properly popularized. Rothbard’s production theory, for example, is quite different from the standard account. I have tried to distill this theory into the following synopsis, although it is by no means the only part of the book that warrants exposition.

Economics is about using our available means to achieve the best possible ends. Achieving an end is called consumption and applying a means towards an end is called production.

There are four broad categories of means, or factors of production, which are involved in achieving our ends. The first is labor, which refers to our own exertions, whether mental or physical. The second is land, which refers to any natural resource as it exists in nature. The third is time. At least a small amount of each of these is required in any production process.

Together, these three factors are called the original factors of production because they exist in nature prior to any human production. The fourth kind of factor is that which is produced, not because it directly brings satisfaction, but because it can be used in a different production process. The fourth factor is capital goods.

Since the time spent producing a good could have been consumed immediately as leisure, all production requires that one forgo present consumption for future consumption. In addition, one must have savings of some kind, enough to sustain one’s self until the production is complete.

For example, a hunter-gatherer, feeling the pangs of hunger, must renounce laziness immediately if he is to hunt any food. If, however, he has already indulged himself too long, he might not have enough energy saved up in his body to complete a single hunt.

One not only has the choice of whether or not to produce at all, but whether to produce via a longer or a shorter process. A hunter-gatherer might choose to gather fruits around him with his bare hands, or to fashion weapons and hunt animals, or to farm a plot of land.

Since, all things being equal, people will tend to prefer present over future consumption, it is necessary that a longer production process result in a superior set of consumer goods than a shorter one — enough so to induce people to wait to reap its benefits. The hunter-gatherer will choose hunting over gathering only if he finds the meat he will gain in the future, after presently constructing and using a spear, sufficiently more enticing than the leisure he could enjoy in the present.

An unavoidable feature of capital is that it wears out and therefore must be replaced. An economy that relies on capital must expend work simply to maintain its capital. In an economy that relies on capital, therefore, people must be continually willing to forgo present consumption to maintain their standard of living.

On the other hand, it is not necessary to save again; this is only necessary for the economy to grow, not to stay the same. The original savings are still around, embodied in the capital goods on which the economy relies. An economy with an abundance of capital goods has a long history of saving and thrift behind it, and as a result has a production process that is long, many-staged, and very productive.

One aspect of any production process that I have not yet mentioned is risk. Since the decision of what to produce takes place in the present whereas consumption is not available until the future, it is always possible that a person could choose incorrectly, and later realize that what he decided to produce was not the best use of his time and resources.

As we see, production requires the convergence of several conceptually different elements. There must first be savings. Then there must be factors of production (land, labor, and capital), which are combined over a period of time into a good that (we hope) will satisfy our desires. Each of these contributions is necessary regardless of whether the economy is capitalist or socialist, and if one contribution is not rewarded sufficiently, it will not be given.

Although a real person can contribute in more than one way, we can embody each of these contributions in a separate hypothetical person as a means to better conceptualize the value of each:

The laborer labors in exchange for wages and the landlord allows the use of his land in exchange for rent. In Austrian economics, the capitalist is the one who owns capital and rents it out; he does not own the business and he does not earn profits, only interest off the use of his capital good. The moneylender deals in the initial act of saving, which makes production possible. He must work now and wait for his reward later on. The landlord and capitalist have similar functions, so I refer to them together as proprietors.

Finally, the entrepreneur assumes the risk should the venture fail. He retains whatever, if anything, is leftover after the laborer, capitalist, and landlord are paid and his product is sold; and he pays the debt if there is not enough. The entrepreneur earns profits and losses based on his success in estimating the desires of his customers.

On the free market, goods can be valued in terms of prices, which say what sum of money might be exchanged for them. Prices tend toward the level at which demand equals supply and all the available stock is sold. If the price is higher than this, a seller has the incentive to bid lower to ensure that they sell their stock, and if it is lower, buyers have the incentive to bid higher so as to make sure they can get the goods they desire.

Consumer goods directly satisfy our desires, so the fact that they are demanded needs no explanation. Their demand and the available supply determine their prices.

Capital goods are not able to satisfy our desires directly when used, so the demand for them on the market is determined by the prices of the consumer goods that they produce. The demand for capital goods used earlier in production are determined by the prices of capital goods used later on, and so on.

The original factors of production (land, labor, and time) can be directly consumed because people can live on land and consume leisure time (instead of laboring). Therefore, the demand for original factors is caused both by their immediate use and their indirect uses in production.

There will also be a price for savings on the market, to induce people to become moneylenders and give up a given sum of money for a given length of time. This price will be determined by peoples’ preference for present consumption over future consumption, and it is called the interest rate. The interest rate is determined by peoples’ time preference, that is, the degree to which they prefer present consumption over later.

The rents of land and capital goods are determined by the interest rate as well as by their prices. If the rent is too low to enable the proprietor to maintain his property and earn enough on top of that, he will have the incentive to sell his property and go into moneylending or into some other kind of property. If the rent is too high, others have the incentive to become proprietors as well, thereby raising the price of land.

The entrepreneur will always attempt to earn the highest profits he can, and he is thereby induced to produce whatever is the most urgently demanded. Since the entrepreneur’s function is to accept risk, he does not receive any set price, but he gains profits or suffers losses depending on how successful he is at forecasting demand.

He provides laborers and proprietors with certainty in exchange for the hope of having correctly anticipated some new consumer demand. There will be profits available in an economy to the extent that such opportunities are available, but as the entrepreneurs alter an economy to better satisfy a given set of preferences, profits will become more and more difficult to earn.

With an idea of the overall workings of the free market, let us now discuss how the economy grows and shrinks. The ultimate size of the economy is limited by peoples’ time preference. Once the economy has reached its maximum size, the point where all the best uses of the available capital have been found by the entrepreneurs, then the economy can grow no more.

However, if peoples’ time preference decreases, and people find themselves more willing to invest rather than consume, more of them will become moneylenders. This competition causes the interest rate to decline and in turn enables the entrepreneurs to engage in newly profitable production processes.

Some productive processes, those that require more time or are more reliant on capital, then become feasible due to the lower cost of loans. There will tend to be positive overall profits in the economy because there are lots of new opportunities to take advantage of.

On the other hand, if time preference should increase, then fewer people will become moneylenders, the interest rate will increase, and the economy will become less productive overall.

What about the effect of a progressing economy on the laborers and the proprietors? If a factor of production becomes more productive, entrepreneurs will be willing to bid higher for it. In fact, each one must bid higher so as to prevent another entrepreneur from outproducing him.

In an economy that relies heavily on capital, factors of production will tend to be more productive. Factors whose supply cannot be readily increased, such as land and labor, will command a higher price in a more advanced economy. On the other hand, capital goods, though they might well be more productive, may become cheaper due to being produced in greater quantity.

The laborer, in particular, benefits from the progressing economy. Labor is an especially nonspecific factor, so that even those who have chosen to specialize in professions no longer needed in an advanced economy are still capable of doing much and of learning new skills.

As the economy improves, therefore, so will the productivity of labor, and hence so will its price. This does not necessarily mean that the price of labor will rise in terms of gold, dollars, or whatever money is in use; but rather that the price of labor will be exchanged for a larger amount of real wealth in an advanced economy than in a primitive one.

It is a common error in economics to believe the opposite, that more-productive labor will have a lower price, due to the fact that the same quantity of consumer goods can be produced with less labor. However, there is not some specific set of goods that is appropriate under all circumstances; the production of consumer goods is a decision limited by what is economically feasible.

Therefore, if labor becomes more productive, people will not simply go on producing the same goods they did before; they will produce more goods, and of a greater variety. Since an entrepreneur in a more-advanced economy stands to lose more production when he loses one employee, he will necessarily be more willing to pay higher wages to keep him.

Among anticapitalists, the contribution of the laborer is often seen as being somehow more legitimate than the others. Since the laborer physically builds the good that is produced, his contribution is often thoughtlessly seen as more real, more legitimate, than the others; but we have seen that production cannot take place without the contributions of the rest. Any attempt to give to the laborer what was meant for any of the other contributors makes production in an economy more difficult, and ultimately restricts or reduces the wages of labor.

The laborers, necessarily, are always paid immediately in any venture, whereas the landlord and moneylender must wait. The laborers, in addition, take on no risk in the venture. For each pay period, the laborers are paid the same amount whether the venture shows a profit or loss. Attempts to give the laborer what would otherwise have gone to the entrepreneur or moneylender reduces the incentive of people to become entrepreneurs or moneylenders.

There is no reason, therefore, that the laborers ought to share in the profits and losses of the ventures they work for. Laborers are perfectly able to buy stock in their own companies, yet generally they do not; this demonstrates that they are more interested in receiving the wages of labor than in contributing risk.

But what of the capitalist and landlord? Why should they get money for simply owning something? Yet the very fact that the capitalist and landlord own their goods and wish to obtain the highest rents for them ensures that these goods go to their most productive and most urgent uses.

It is necessary that the owner gain through his service as “gatekeeper” to the use of these goods; if he did not, he would prefer to use them for his own consumption rather than for productive uses more urgent to the economy as a whole.

Very well, but couldn’t this job be done by any rube, any idiot capable of identifying the highest bidder? Why should the benefits go to this person simply because of some historical circumstance that puts it in his possession, especially since he may have inherited his land or capital rather than earned it himself?

But as we have seen, the entire economy is built upon historical circumstances: without the historical act of saving, which is now embodied in capital goods, or the original act of appropriation which brought heretofore unused land into productive use, there would be no economy at all. So there is no particular reason why a person should not benefit because of history; we all do this every day simply by participating in the economy.

It is this very history that is negated by any attempt to prevent the rightful factor-owner from gaining his rent. Capital goods can be consumed without being replaced, and land can be abandoned and left unproductive. When the proprietor is prevented from earning his rent, he has an incentive to do precisely this. Why should he build or maintain what does not provide benefits, when he could instead focus on immediate consumption?

Someone might try to appropriate property and extract the maximum rent from it; he would therefore perform the job of the original proprietor. However, why would other proprietors maintain their property if they believe that property can be taken away?

Why would the appropriator maintain his property if he can just take more instead? If no rent can be extracted from a capital good, there is no reason to save up and buy it, and therefore there is no profit to entice an entrepreneur to produce it. Though we might be envious of the wealthy proprietors, no one can better allocate a factor of production than its rightful owner.

To own capital or land (whether bought or bequeathed) and to live off its rents should not be seen as unfair or

illegitimate; when we honor the property of a person who has inherited all his wealth, we are not honoring his right to lead a privileged existence as if he were a king, but rather honoring the original saver who bequeathed this property. In so doing, we demonstrate to other savers that their thrift will not be in vain.

Living off of capital can be seen as no different from living off a talent. Whether proprietors ever did anything to “deserve” their capital is irrelevant.

Their property helps to make us all more productive. We should appreciate that they have taken on the responsibility of owning and maintaining it. We should not look enviously upon the proprietors as somehow illegitimate or unfair; for when we infringe upon their property, ultimately we harm ourselves.

_______________________________________________________________

How the Free Market Works was originally published in The Ludwig Von Mises Institute blog on 27/10/2009

By Chuck Butler

Well, the non-dollar currencies didn’t enjoy such good news yesterday, as they got whacked a good one! After signing off yesterday, the non-dollar currencies continued to rally versus the dollar, and then the rug got pulled out from under them in a NY minute! What happened? The risk assets were dropping like the Cardinals’ batting averages at the end of the season. Well… Remember yesterday when I said that the data for the week looked like it might show some healing in the economy, which would be bad for the dollar?

Well, it wasn’t data that caused this move… It was a few things that I’ll list for you that ganged up on the currencies and gave the markets the thought that the US economy just might not be free and clear, which brought about a return of the “risk aversion” trades… Here’s the list that ganged up on the non-dollar currencies.

Things making the US economy look like it’s on shaky ground again include:

1. Rumors that first-time homebuyers’ credit will not be extended past November 30th
2. Rumors that the ING rights issue is not being well received
3. Talk of bank downgrades
4. Mention of a new bill addressing ‘too big to fail’ giving the government broad power to dismantle financial companies that get into trouble

I was asked by our public relations people to put together some thoughts for CNBC… So, the above stuff was what I put together… CNBC then asked for an interview… Well, this is where I get off the bus… Long time readers know that I’ve been ambushed twice at CNBC, and decided to not go back for a third time. So, even though this interview has little chance of an ambushing, since they asked for the info… The Big Boss Frank Trotter will be doing the honors at 8:40 CT/9:40 ET, today… So, don’t forget to tune in!

Another thing that may be giving the dollar some love is the yield on the 10-year Treasury… This yield, as reported in yesterday’s Pfennig, had bumped up to 3.50%, which had been the proverbial line in the sand in the past. 3.50% had been the level that had seen strong Treasury buying (probably by the Fed!) to bring the yield back down… But yesterday, we saw this yield inch higher to 3.54%… We should keep an eye out for this, to see if there is any slippage in the yield, because that would only mean one thing… The Fed is buying again! And that’s the reason the dollar got some love yesterday from this yield… Because so far… The Fed hasn’t gotten their hands dirty here… But should they, once again, it won’t support the dollar.

So… There you have it! Just when we thought the data this week would send the dollar to the woodshed, these things popped up to underpin the dollar! Hopefully, it’s just a case of sell the rumor and buy the fact for the non-dollar currencies, as most of this stuff was just rumors in the markets.

But it did get people/investors/traders thinking about just how oversold, in the short-term, the dollar was… It normally takes something like this to get those thoughts to come to the front of the class, as the negativity had such a stronghold.

We’ve seen these “risk aversion” moves in the past seven months, and each time they’ve only lasted a short while. But that doesn’t mean we’ll see the risk aversion campers leave shortly this time. They might… And they might not… Don’t you just love it? I know one thing for sure! The sell-off yesterday was swift and strong. For instance, the euro (EUR) was 1.5050 before the sell off, and is 1.4890 this morning! What does that look like to you? Buzz! If you said, “Chuck, it looks like a cheaper level to buy” then you may have won a free subscription to the Pfennig newsletter! If you did not have that answer, then there’s a free parting gift for you at the door! HA!

Yes, it certainly does look like a cheaper level to buy… Of course it doesn’t mean that tomorrow’s price won’t be cheaper, but given the history of the risk aversion reversals in the past, it doesn’t mean that it will be cheaper either!

And… According to Commerzbank… “It would probably be premature to call this the end of the dollar’s weakness. It remains under pressure due to the low interest rates and the resulting attractiveness as a financing currency for carry trades.”

I saw a story last night about the Brazilian real (BRL), and how the real has gained +35% versus the dollar this year, as a Big Mac in Brazil costs more than it does in New York and London… Uh-Oh! That Big Mac Index again! But that doesn’t scare the research team over at Goldman Sachs, for they still believe the real has room to gain versus the dollar… And you know me and the Big Mac Index… While it’s a “nice” measure, it’s not the holy grail of currency outlooks… I can point back to 2000 and 2001, when the Big Mac Index said the dollar was overvalued, but it took nearly two years before we saw dollar weakness… So, I don’t put much faith in the Big Mac Index, for short term forecasting. Not that I forecast – at least not in this letter I don’t – for I would be hung out to dry by readers if I got something wrong… I mean look at when I said I thought the Aussie dollar
(AUD) COULD go to parity, and it only got to 98.5-cents!

OK… Dr. Marc Faber was in the news last night, as he was giving an interview on Bloomberg TV…

“The dollar will become worthless when people eventually realize the fiscal situation in the US is a disaster. It will go to a value of zero eventually, but not right now. Looking at Mr. Obama’s administration, it should already be there.” He went on to say…

“In my opinion, about 50% of tax revenues will be used just to cover interest payments on the government debt. That’s unsustainable. Then you’ll really be forced to print money. The best investments right now are foreign currencies, commodities, and equities.” And then when asked about Fed Chairman, Big Ben Bernanke, Dr. Faber said, “He’s a money printer. He’s nothing else.”

Whew! That’s taking the whole shootin’ match of the government and the Fed, to the woodshed, eh?

For those of you keeping score at home, make sure you’ve jotted down the right figure of dollars that the US government and the Fed have spent, lent or guaranteed… $11.6 trillion!

OK… It looks like the last country that’s needed to sign the Lisbon Treaty, the Czech Republic, is going to sign it… Now, let me be perfectly clear about this… I don’t agree with the Lisbon Treaty, but the European Union has gone so far down this road now, that there’s no turning back, so you might as well go along and sign the thing, I guess… The one thing it does do, is underpin the euro… For if this Treaty did not get signed, the pressure on the euro would be great, because you would have had all the naysayers coming out of the walls again talking about a collapse of the European Union and a return to the legacy currencies. You know: Deutsche marks, French francs, Spanish pesetas, and so on.

Speaking of Europe… I know it’s not really November… But it’s close enough! The Norges Bank of Norway will meet tomorrow, and are expected now to raise rates, which would make them the first European central bank to raise rates… Notice I said “now”? Well, the rest of the crowd are jumping on my bandwagon that began a couple of months ago when I said that it was a race between Australia and Norway to be the first to raise rates… There weren’t many pundits out there calling for rate hikes… But as time has gone on, and they read the Pfennig, they’ve come along nicely! HAHAHAHAHAHA!

In the last couple of weeks, the Pfennig and I have been mentioned a couple of times by the best writer on the planet, Richard Russell… And now, I have learned that Harry Schultz has mentioned us in his most recent letter… The Pfennig is really beginning to get noticed, eh? That just puts more pressure on me to come up with fresh, informative information!

Hmmm… And then there was this… PIMCO’s Bill Gross, who is known as the “bond king” admitted that he “has some concern on owning Treasuries”… If Bill Gross has some concern, folks, shouldn’t we? I recently did about a 20-minute video for our friends over at the Sovereign Society on the Treasury Bubble… Sure wish Bill Gross would have said something like this when I was putting that video together! Imagine what I could do with a statement like that when I’m doing a video on the Treasury Bubble!

OK, to recap… The dollar came back with vengeance yesterday, after some rumors on the street led people to believe that things in the US won’t be free and clear after all, which led to risk aversion… We’ve seen this risk aversion before, and each time it hasn’t lasted too long… Dr. Marc Faber checks in with some comments on the dollar, and Bill Gross has some concern about owning Treasuries!

Rumors Kill the Currency Rally was originally published in the Daily Reckoning on 27/10/2009.

Zero Discount Value of Gold in the Total Banking System

by Michael S. Rozeff

Recently by Michael S. Rozeff: The Zero Discount Value of Gold and Dethroning the Dollar

The U.S. banking system has many banks with large amounts of bad loans on their books. How do these bad loans affect the value of the dollar and gold? Specifically, how do they affect the Zero Discount Value (ZDV) of gold?

Zero Discount Value (ZDV) in review

An earlier article introduced the concept of gold’s Zero Discount Value (ZDV). Applied to the central bank whose only asset is gold and whose liabilities are currency and bank reserves, the ZDV is a value for gold such that every outstanding dollar liability in the central bank’s monetary base (currency plus bank reserves) is backed by an equivalent dollar’s worth of gold. It is what the dollar price of gold would be if the central bank’s liabilities were 100 percent backed or covered by gold.

To estimate the ZDV in this simple situation, in which no other assets than gold qualify as valuable assets, divide the monetary base by the number of ounces (oz) of gold that the bank holds. If, for example, 200 oz. of gold are held against 400,000 dollars of monetary base, then the ZDV is $400,000/200 oz. = $2,000 an oz. Only if gold is valued at $2,000 an oz. does every dollar that has been issued by the central bank correspond to one dollar’s worth of gold.

The market price of gold need not be the ZDV we estimate from central bank data. Gold has sold at a discount to ZDV for many years in the U.S., which is the main reason the term “zero discount” is used. However, there are market and arbitrage forces that move gold’s price toward the ZDV, if they are not thwarted. This statement is a special case of a proposition that applies to any enterprise whatsoever: Market forces tend to make the value of the outstanding liabilities equal the value of the outstanding assets, inasmuch as the cash flows or other returns of the assets are what give value to the liabilities and investors can usually find ways to buy either the assets directly or else buy the securities that represent them.

The statement that market value of liabilities equals market value of assets is so widely accepted as true that it is taken for granted. One can invest directly in the real assets of an enterprise (that is, in some replica or close substitute of them) or indirectly by means of the debts and stock that finance them. If the values of these two options are not in line, one invests in the less costly alternative. Possibly one arbitrages by selling or issuing the more costly alternative simultaneously. If the debts and stock have market values that are low compared to the market value of the associated real assets, then the tendency is for the real assets to be avoided or sold and the financial claims on them to be bought. Conversely, if the debts and stock have market values that are high compared to the market value of the real assets, the tendency is to buy the real assets directly and sell the financial claims. These actions align the market values on both sides of the balance sheet.

Gold is the real asset of the FED, and currency and reserves comprise its main liability. If the currency value is its face value and the face value is $400,000, then a 200 oz. holding of gold has a ZDV of $2,000 per oz. If the gold sells for less than this, there is a tendency to buy the gold instead of the currency, and vice versa. We observe that gold has in fact sold at a hefty discount to its ZDV for many years. The tendency to buy gold and sell the dollar has been seriously thwarted in the world’s monetary dealings, but not entirely so. Gold has shown a long-term tendency to rise as its ZDV has risen, even if the discount remains large. That tendency has been very far from being a smooth and continuous one. The market price depends on human recognition and action. It depends on many factors, including the actions of authorities, interventions, and sundry political matters. The result is a market price whose many ups and downs depend at times, sometimes long times, on factors other than convergence to ZDV. But still it is my judgment that ZDV exerts a very long-term pull or an attraction for gold’s price.

Bank Money and Bank Money Inflation

In addition to the central bank, the banking system has as its main component the many ordinary banks that make loans to the public and create bank deposits accordingly. Ordinary banks do not hold gold as an asset. Their loans are their main assets. What is the ZDV when we take these banks into account?

When a bank creates a mortgage loan or a business loan, it simultaneously creates a demand deposit or checking account in the name of the borrower, who then spends out of the account to buy a house or perhaps business inventory. Since checking accounts are used as money, the bank creates money when it creates loans. The accounting for this is a debit to a Loan account and a credit to a Deposit account. When loans are repaid, the borrower writes a check to the bank. The bank then credits the Loan account and debits the Deposit account.

We use demand deposits as money. We use currency as money. Time deposits are not used in everyday exchange, but yet time deposits are easily converted into demand deposits. If a bank certificate of deposit matures, we can instruct the bank to credit a demand deposit account. When it comes to getting gold’s ZDV, these distinctions among the various kinds of deposits are not relevant. What we want to know is what value of gold it takes to back up all deposits in full. I simply call all deposits bank money to distinguish them from the central bank’s money, which is the monetary base consisting of current plus bank reserves.

The backing of deposits is defined as the value of the bank’s assets that can be used to extinguish the deposit liabilities. Good loans are defined as loans that pay off the promised amounts. Good loans back deposits in the sense that when these loans are paid off, they provide their promised amounts of payments by borrowers to the bank. These payments then shrink deposits by the extent of the loans being paid off.

Bad loans are loans that fail to provide the full amount of the promised payments. Any losses in value of bad loans below the promised payments mean that borrowers have not collected enough dollars from their customers or jobs to write checks to the banks and reduce deposits. The dollars remain in the system as deposits. How so? If a borrower has bought a house on a mortgage loan that he cannot repay, he has written a check to the house’s owner. That seller then has those funds on deposit in his account. They will only be offset when the borrower pays off the bank loan. If he is unable to do this, then bank deposits or bank money do not shrink. But since the bad loan has reduced or no market worth, we see that bad loans reduce the loan backing of the still outstanding dollar deposits that were created against them.

Banks are supposed to write the bad loans off. This requires them to credit the Loan account to reduce it and debit an Equity account, which reduces it. When many loans go bad and reduce Equity drastically, the bank owners and/or managers have to get more equity capital somehow if the bank is to survive. If they do not or cannot, the bank fails and its creditors, the depositors, lose some or, in the worst case, all of their deposits.

Deposit insurance is a bank asset and a method to counteract the effect of bad loans. The extent to which it backs deposits is an important element that I discuss below. Until that discussion commences, it is convenient to carry this analysis forward assuming that there is no deposit insurance. Since I conclude later that deposit insurance does not substantially alter the situation, this assumption is warranted.

Suppose a bank has a simple balance sheet with $200 of good loans and $200 of deposits. The ratio of the market value of the deposits to the loan assets is 1. This indicates a viable or sound bank, that is, a bank with enough backing for deposits to reduce them when the loans are paid off. Now suppose that $40 of the $200 in loans are a total loss. The ratio of deposits to loans is $200/$160 = 1.25. This signifies that even if the loans are fully liquidated, the bank does not have enough bank money to pay off on its deposits.

A bank might have certain off-balance sheet assets to remedy such situations. It might also have off-balance sheet obligations that make the situation even worse. It might have a commitment by its owners to supply capital in such circumstances, or it might have lines of credit with other banks. It might have deposit insurance.

I define bank money inflation as an issue of bank money (deposits) not secured by additional assets of equivalent worth. In the preceding instance, there was no inflation when the deposit/asset ratio was 1. There was inflation when the bad loans produced a deposit/asset ratio of 1.25. Sufficient backing to the deposits means the same thing as no bank money inflation. Insufficient backing means inflation. As long as loan values keep pace with deposits, there is no bank money inflation, simply because good loans mean that loans are being repaid and that they are extinguishing the bank deposits and money as they are repaid. If the loan values are overstated, which has certainly happened in the past decade, then there is insufficient backing and there is bank money inflation.

Notice that bank money inflation does not refer to inflation of prices in the economy, whether of wholesale goods, consumer goods, stocks, bonds, labor, commodities, interest rates, or real estate. Analyzing how this vast array of prices relates to bank money inflation and to central bank money inflation is another ball of wax. I steer clear of mixing up that analysis with the one at hand.

Individual banks within the banking system can always inflate by making bad loans. If the bank’s loans are good loans, it is not inflating money. If the loans are bad loans, then it is inflating money. Critical to bank money inflation occurring is the nature of the loans the banks make. Are they good loans or are they bad loans? That is what determines the extent of bank money inflation.

Inflation (of bank money) is not an economy-wide phenomenon unless banks in general are creating loans whose values fail to keep pace with deposit liabilities. This can occur in a central banking and government-influenced system, even when banks compete with one another in making loans. A government might, for example, subsidize or use its powers to encourage the economy-wide expansion of an industry to which banks make loans that ultimately become bad loans due to overbuilding. The FED’s creation of monetary base can influence interest rates and create bank reserves that induce banks to make what turn out to be bad loans. I’ve discussed these issues at length in an earlier article. It seems to me that these kinds of actions are exactly what caused the present credit debacle, and I’ve argued that case in many articles. The government and the FED stimulated bank lending that gave rise to bad loans and the concomitant bank money inflation. Many observers saw this happening while it happened and others predicted it would happen. Warnings filled the air, but the authorities caused the inflation anyway.

Zero Discount Value with Bank Money

There are two layers involved in the banking system. There is the central bank that produces base money and there are the ordinary banks that produce bank money. Gold backs the monetary base, and loans back the bank money or deposits. If the bank money is fully backed by good loans, does this alter the ZDV? The answer we shall find is that it does not. If the bank money loses value because the banks experience bad loans, does that affect the ZDV? We shall find that it does. In this case, if the deposits are not covered by bank loans, they have to be covered by gold.

For purposes of thinking about the price of gold, which is my objective in all of this, I suggest we obtain a ZDV for the total system. I will sketch out how to do this by consolidating the banks and the central bank. I show that the ZDV for the total system cannot be any lower than the ZDV for the central bank alone. A chain is no stronger than its weakest link. Even if the banks make sound loans and produce no bank money inflation, the currency is still subject to the inflation produced by the central bank. This means that sound bank loans cannot lower the ZDV. Second, if the banks make unsound loans and produce bank money inflation, then the total ZDV must be higher than the ZDV of the central bank alone.

Suppose that the banks have Assets of 10, consisting of Reserves of 1 and Loans of 9. If these are in trillions, they are nearly the same as in the U.S. banking system. The Reserves are held as deposits at the central bank. The Liabilities are Deposits of 10. Equity is 0.

The central bank has Assets of gold, or G, which is a certain number of ounces of gold. Its liabilities are Currency of 1 and Reserves of 1. The Reserves are the deposits of the banks. This fifty-fifty split between currency and reserves is roughly the current situation at the FED. The ZDV of the central bank is (R + C )/G = (1 + 1)/G = 2/G. With gold later to be taken as 261.5 million ounces and the bank’s numbers expressed in trillions, the central bank’s ZDV is $2 trillion/261.5 million oz. = $7,648 per oz. This is actually quite close to the FED’s ZDV at present, which I estimate to be $7,456.

We consolidate the two balance sheets in order to obtain a useful picture of the total banking system. The Reserves disappear from the consolidated balance sheet, because they are an asset of the banks and a liability of the central bank. The combination has no net asset or liability arising from bank reserves.

In actuality, the reserves help the central bank control or influence the maximum amount of bank lending and deposit creation. That is their main role. Competition among individual banks by the production of bank notes and money is thereby replaced by a centralizing influence and a single form of bank money throughout the whole system. Consolidating the balance sheets does nothing to change this reality. It simply allows us to gauge values in an otherwise complex system.

The combined entity has two assets: Loans (L) of 9 and Gold of G ounces. Its Liabilities are Deposits (D) of 10 and Currency (C) of 1.

In order to measure a total ZDV in this situation, we need to incorporate Deposits and Loans of the banks. We need to use the idea that good loans back deposits and bad loans do not.

Consider the case first where all loans are good loans. Bank Reserves identically equal Deposits minus Loans, when all loans are good loans. In that case, ZDV = (D – L + C)/G. The numerator of the ZDV when all loans are good has Deposits minus Loans plus Currency. The denominator is G ounces of gold. The term D – L is the net deposit liabilities of the ordinary banks.

Gold still has to cover the issue of Currency. Since all the loans in L are good, they all subtract from Deposits, and that leaves D – L = R to be covered by gold too. The system ZDV equals the central bank ZDV.

In this particular example, total system ZDV = (10 – 9 + 1)/G = 2/G. The system ZDV is identical to the FED’s ZDV. The reason for this is that Deposits minus Loans equal Reserves, and that is because there are no bad loans.

The total system Zero Discount Value has to equal the central bank’s Zero Discount Value when the banking system’s net liabilities of D – L equal its Reserves. This occurs only when the system’s loans are good loans, that is to say, their market values equal their accounting values or values carried on the books of the banks.

The intuition of the unchanged ZDV in the good loans case is this. The central bank base money inflation gives a certain ZDV of gold. If the derivative bank money that banks then produce is backed up by sound loans, the inflation situation is not made worse. That is, there is no further bank money inflation, for loan repayments are capable of shrinking the bank money supply. We get bank money inflation, as shown earlier, if and only if the banks make loans that go bad. In that case we should find that the ZDV rises above the ZDV using only the central bank balance sheet, because more net deposits and thus money are being backed by the same amount of gold.

Bad Loans and the ZDV

Now we are in a position to evaluate the ZDV of gold when the banking system produces bad loans. The intuition in this case is that since bad loans cannot cover the deposit liabilities as fully as when they are good loans, the system’s net deposit liabilities rise relative to the same amount of gold held. Consequently, the money falls in value relative to gold or gold’s price rises in terms of this money.

To model this case, I modify the Loans (L) to be L – hL, where h is a positive number that provides a “haircut” to Loans. The number hL measures the loss in value of the bank loans. These loans may be carried on the books at face value, but their real market values are less. This is what justifies replacing L by L – hL, where h < 1. Then we find

ZDV = (D – (L – hL) + C)/G = (D – L + hL + C)/G = (R + hL + C)/G.

Hence, we obtain an important result: When bank loans are bad, the system’s ZDV has to be above the central bank’s ZDV alone. If loans are bad in amount hL, then G has to cover that amount of deposits in addition to covering R and C. R of these deposits have always to be covered by gold because every dollar of these deposits that total R in amount has been made through a FED loan whose excess earnings revert to the Treasury, so that they lack asset backing other than gold.

With a 10 percent loan loss, h = 0.1. I use the numbers (in trillions) that are close to those of the U.S. system, with D = 10t, L = 9t, and C = 1t. G = 261.5 million oz. Then ZDV = (10 – 9 + hL + 1)/261.5 = (2 + hL)/261.5 = (2 + 0.1(9))/261.5 = $11,090 per oz.

Looking at a range of h values that are less than 1, we get a range of total system ZDV values of gold:

In a previous article, I was critical of an estimate of $30,000 per oz. of gold. This analysis shows that to get such an estimate, one must assume that bank loans have lost 65 percent of their value. If real estate values have fallen by roughly 30 percent and affected total loan values by the same degree, then the estimates of ZDV are still very large. But since there are many good business and other loans, a loss estimate of 10–20 percent may be more realistic. Whatever estimate of loan losses one chooses, the ZDV ratio provides a way of translating it into a gold price estimate.

The large amount of bad bank loans in the U.S. banking system indicates a very serious bank money inflation and points to a much lower value of the dollar and a much higher price of gold. Before this bad loan debacle, the ZDV of gold of the central bank already was substantially above gold’s market value. The FED’s rush to supply Reserves raised it further, sending it above $7,000. When we bring bad loans into the picture, the ZDV is even higher.

I recognize that some loans can be structured and be so good that h > 1. The bank may have arranged its duration in such a way that when interest rates change, the bank becomes even more solid. However, for the system as a whole, this case is not typically relevant and surely not relevant at this time.

The FED once was restricted to issuing currency with a 40 percent backing of gold. If that has any relevance to what our society considered to be a reasonable amount of fractional-reserve lending at the central bank level, then the above ZDV values can be multiplied by 0.4 to obtain more conservative numbers. They are still very high, ranging from $4,436 to $9,943 in the event of a 50 percent haircut.

A feature of this model is that the ZDV is very sensitive to the destruction of loan values. A 10 percent drop in loan value (h = 0.1) caused the ZDV to rise from $7,648 to $11,090. That’s a whopping 45 percent increase. The reason for this is that the banking system is highly leveraged to gold. The coefficient of h is L/G, and the loans are very high compared to the number of gold ounces. Hence, a small decrease in loan values indicates a much larger loss in the value of the dollars whose backing is gold.

When loan values are impaired but the loans remain on the balance sheet, Deposits minus Loans no longer equal Reserves. If D = 10 and L = 0.9(9) = 8.1, then their difference is 1.9; but R = 1. This difference is what causes the system ZDV to go up. Banks have a hole on the asset side of their balance sheets. There is legal and regulatory forbearance, which is a postponement of action to remedy a problem of obligation. The situation is as if the FED were supplying phantom or shadow reserves. The effect of the bad loans on ZDV is somewhat the same as if the FED had actually created Reserves in even larger amount than they have. Deposit money stays in the economy while the real loan values decline.

The problem I raised at the outset was how the Zero Discount Value of gold might be related to the bad loan problems evident in banks. My way of solving this problem is to define a Zero Discount Value for the total banking system that consolidates the central bank and the member banks. We discover that when bad loans occur, the system ZDV has to be higher than the central bank’s ZDV alone.

The fractional-reserve central banking system has great problems. It pays to pin down what these problems are. Bank money inflation does not follow automatically from the fractional-reserve creation of money by free market banks not under the control or influence of a central bank. Free market banks are monitored by those who use their notes as money. The market punishes banks that inflate and rewards those that do not. Bank money inflation results from the fractional-reserve creation of money when bad loans result from the central bank’s fractional-reserve creation of bank reserves followed by deposit and loan creation. A key question is whether banks are necessarily induced to make bad loans when they find that they have excess reserves created by the central bank. In a previous article exploring this question, I argue strongly that the central bank’s provision of reserves does induce the system to make more loans that eventually go bad. In the same article, I point out that frequently government (as distinct from the central bank) gets into the act by encouraging banks to lend into certain industries and activities that eventually do not pay off, such as housing and railroad building.

Capital Infusions

Banks with bad loans have been raising funds by selling new equity and debt to the public and the government. They have raised something like $900 billion dollars in the last two years or so. Nearly all of this has been in the form of debt, not equity. About $200 billion have been used to sustain dividend payments, which reduce equity.

These capital infusions are not a free market phenomenon. A substantial portion of them came under a brand new FDIC program (Temporary Liquidity Guarantee Program) that fully guaranteed newly-issued senior undescured debt of FDIC insured banks, financial holding companies, bank holding companies, and savings and loan holding companies. A substantial amount (over $300 billion) still exists under this program which has recently been renewed for six more months.

The FDIC’s program was for up to $1.4 trillion. The FDIC could never have paid off on such a huge amount. It cannot pay off on the ordinary deposits it has insured, much less new debt of these companies. These guarantees are a fiction.

The financial system was given a reprieve due to a rush of government guarantees, some of which facilitated capital infusions that back deposits. They bought some time.

These desperation moves also revealed that the government-backed, government-run, government-regulated, government-insured, and government- manipulated banking system cannot stand on its own two feet. It is extremely untrustworthy. It remains alive today only because the American people retain confidence in “the government” and government guarantees. The system will collapse the moment that this confidence collapses, which will be when people at large realize that the guarantees mean little. In the meantime, the banking system is being transformed more and more into a government enterprise. The guarantees are a sign of that as are government’s direct infusions of capital. The absorption of the mortgage business is another sign of that. The regulation of executive pay is yet another.

At some point, the U.S. system will cross over into the existing Chinese communist banking system which is a state-run affair. All such systems collapse, although sometimes the news of the collapse is withheld from public attention.

Deposit Insurance

Deposit insurance is a bank asset that backs deposits. It therefore mitigates a rise in the ZPV. This means that the total system ZPV is an upper bound. The lower bound is the central bank’s ZPV.

Deposit insurance encourages the central bank to produce base money and the banks to produce bank money via loans, because they have a backup credit insurance policy that is typically underpriced to banks. Because it is underpriced insurance, deposit insurance encourages bad loans and inflation because the banks act as if taxpayers will bail them out and make all deposits good despite loans going bad.

In the U.S., the Federal Deposit Insurance Corporation (FDIC) assesses banks with insurance fees. The fiction is maintained that the banks co-insure each other. As long as failures are few and loans are good, this fiction can be maintained. This system can survive if bank loan risks are independent of one another and not too large. The banks together build up an insurance fund asset that stands behind deposits, in which case inflation is mitigated when loans go bad in amounts that threaten deposits.

But this system does not work if many kinds of loans go bad at the same time as in a widespread recession, for then the insurance fund is insufficient. That is currently the case.

The FDIC protects about one-half of bank deposits. If one believes that only the other half is subject to lower loan backing, then one can easily modify the ZDV model by reducing the haircut factor accordingly. But where in fact is such backing to come from? Who is going to pay for it? Who is going to pay for the insurance of deposits? Who is going to remedy the hole on bank balance sheets due to trillions of dollars of bad loans?

The FDIC fund is almost broke. The FDIC will assess banks with higher fees. That has to be a trivial amount compared to the amount of bad loans. The FDIC will borrow billions from the Treasury. How long will it be before it collects enough fees from banks to repay such loans? It appears that taxpayers will be making good the bank deposits for a long time to come. However, the taxpayers are in large part the same people who are the depositors! They cannot back up their own deposit accounts. The idea that the Treasury and thus taxpayers save their own deposits is also a fiction.

As long as the FDIC has only to deal with isolated bank failures spread over time, it can go on. In times like the present when failures are widespread and pervasive due to bad loans that are worth much less than deposits, the entire insurance scheme is revealed as a fiction or a fraud. People who believe that their deposits are insured are not seeing that in their role as taxpayers, they are being made to insure their own deposits.

The FDIC often merges bad banks into good banks. The insured depositors do not lose. The bad loans are either absorbed and worked out or written off. In either case, loan values remain below deposit values. Such mergers do not magically create value. The inflation does not disappear. The money is still in the system and supported by lower loan values.

It seems that no matter how one looks at this, the deposits remain alive in the economy while the bad loans mean that the backing has fallen. If there were truly an exogenous deposit insurer, who paid the banks compensation for their bad loans, the bank money inflation would be mitigated. There is no such sugar daddy. The banks have not put enough money into the FDIC piggy bank over the good years to pay for the lean years. The taxpayers can’t bail themselves out.

I conclude that, although the Zero Discount Values for gold seem high, they are accurately reflecting the facts of the case.

October 27, 2009

Copyright © 2009 by LewRockwell.com

The Best of Michael S. Rozeff

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Twelve Reasons For A Job Loss Recovery

by Michael Shedlock

I have been talking about the Job Loss Recovery for quite some time. Here are a few recent examples.

July 14: Bernanke Sees Chance of Jobless Recovery

Given that the Fed’s first mission is to delay, confuse, hope, and otherwise attempt to buy time while engaging in wishful thinking along the way, that Bernanke is willing to admit this may be a jobless recovery is a sign that things will likely be at least that bad. In other words, prepare for a job loss recovery.

August 3: Thoughts On The “Recoveryless Recovery”

Most know that I am in favor of an “L shaped recession“, but that definition includes a “WW” or even a “WWW” where the economy slips in and out of recession for a decade, as happened in Japan.

August 6: Dismal Unemployment Situation In Chart Form

Job Loss Recovery

The last three recessions are unlike the eight preceding recessions. For numerous reasons described below we are heading for another job loss recovery.

Job Loss Recovery Detail

click on chart for sharper image

If the pattern holds, unemployment will rise until 2011 or beyond.

So while everyone is tooting horns and cheering the end of the end of the recession before it has even ended, those graphs and comments from Bernanke himself will put the pending job loss Recovery into better perspective.

What is bringing this idea to the forefront now is all the enthusiasm over what is destined to be the weakest recovery ever.

Others seem to be catching on.

Rebounding Economy Shedding Jobs

Please consider Experts see rebounding economy shedding jobs.

Forget a jobless recovery. The economy may be entering a recovery with job losses.

Third-quarter estimates this week are expected to show that the economy grew for the first time since the quarter ending in June 2008. Despite the estimated 3 percent expansion and a stock market that has been on a tear since March, hundreds of thousands of people are still being laid off each month.

Eight million jobs have been lost nationwide since the recession began two years ago, and by some measures workers face the worst job market since the Depression. The average laid-off worker has been without a job for 61/2 months, a post-World War II record. Many of those workers will never recover financially.

California’s hole, deepened by a state budget mess and volatile tax system, is far worse: Unemployment is at

12.2 percent, third highest in the nation; and adding discouraged and part-time workers puts it over 20 percent.

“It’s not even a jobless recovery; it’s a recovery with more job losses,” said UCLA economist Lee Ohanian. “The idea of having essentially no net job creation after a remarkably severe recession is a real pathology for the U.S. economy.”

‘Painfully weak’ job growth

Top White House economist Christina Romer of UC Berkeley told Congress on Thursday that employment growth could remain “painfully weak” through next year, and that the largest effect from the $787 billion stimulus enacted in February, mainly aid to states, is past. By mid-2010, she said, the stimulus will no longer contribute to growth.

Alarms are ringing at the White House and in Congress. But with a mind-boggling $1.4 trillion deficit this year, Democrats have used up their bullets. The word stimulus has such a bad connotation that the term has been banished from new efforts to goose the economy and help workers

Employment mystery

Economists are puzzled as to why job growth has slowed, citing everything from higher health care costs, to higher productivity, to Chinese currency manipulation.

“The answer is, we don’t know,” said Tim Bartik, a liberal economist with the Upjohn Institute for Employment Research in Michigan who is proposing a tax credit for employers who hire new workers.

There Is No Mystery

Of course we know why job growth has slowed. Here are 12 good reasons.

1. We consumed more than we produced for a decade. Consumers are deep in debt and need to take care of their balance sheets.

2. We built enough houses for 15 years in a 5 year window.

3. People thought home prices would rise forever and borrowed against their homes. They are now underwater and cannot sell or move.

4. There is rampant overcapacity everywhere. We do not need any more Walmarts, Pizza huts, nail salons, Targets, Home Depots, Lowes, gas stations, grocery stores, or anything else.

5. Global wage arbitrage and outsourcing.

6. Boomers heading into retirement are scared half to death. They will not be spending or traveling as much as they thought. Indeed they will be attempting to downsize their lifestyle.

7. Attitudes everywhere have changed. People have finally caught on to the idea that home prices do not always go up. Businesses have caught on to the idea that home prices and commercial real estate does not always go up. Thus banks have tightened lending standards and consumers are reluctant to borrow.

8. “Frugality is the New Reality”. Here is a Search for the word “frugality” in this blog.

9. Misguided federal tax policy. The administration plans to raise taxes on the wealthy. On top of that the health care plan is going to be very costly for small businesses. Thus the administration has inadvertently given small businesses two more reasons not to hire. Instead the administration should be slashing corporate tax rates.

10. Government Pension Plans. States are raising property taxes to help fund pension plans that have blown up. This is a drain on the economy. These plans need to be killed. Please see California Treasurer Spanks Legislature Over Pension Reform And Reckless Spending for an interesting rant about the pension mess in California. Most states are in the same boat, although California is the worst of the lot.

11. Stimulus Spending. Japan has already proven that Keynesian and Monetarist solutions cannot and do not work, yet we try anyway. Please see Will Stimulus Take Hold? for details.

12. Deficit spending in general. Spending what you don’t have and cannot afford never solves anything. We can no longer afford to be the word’s policeman but still attempt to do so at enormous cost. Indeed, there are many things we cannot afford and do anyway. As a result, interest on the national debt is soaring, the dollar is weakening, and this is drain on the real economy regardless of what the stock market thinks about it.

Tax Credits And Other Bad Ideas

Giving tax credits for hiring cannot possibly accomplish anything worthwhile. Businesses are not likely to take on needless expense just for a tax credit. They will just hire who they were going to hire anyway.

Of course the might be exceptions. For example: Give me a big tax credit and I will hire my wife. Our pre-tax household income would not change one iota but our after-tax income would change by the amount of the tax credit. While this would be worthwhile to me, it does not seem to be an effective way to stimulate the overall economy.

Returning to the article for another ill-advised solution….

University of Maryland economist Peter Morici said the administration’s efforts to restore growth by directing spending to such things as alternative energy are too expensive for the number of jobs created and ignore larger problems in the economy.

“You can’t grow with a huge trade deficit,” Morici said. “If you don’t revalue the Chinese yuan against the dollar you can’t get out of this mess, and if you don’t do something about oil imports you can’t get out of this mess. Industrial policies won’t fix it.”

Morici is correct about the Obama Administrations misguided energy plan. However he is wrong about the trade deficit.

According to Rothbard “More nonsense has been written about balances of payments than about virtually any other aspect of economics.”

Inquiring minds are reading Does the widening US trade deficit pose a threat to the economy? by Frank Shostak.

Most economists are of the view that the ever-growing US trade deficit and the subsequent expanding foreign debt pose a threat to the well-being of Americans. What is then required, so it is held, is to set in motion policies that will help curtail the widening trade imbalances between the United States and the rest of the world. Focusing on the trade deficit as the supposedly major problem of the US economy only diverts the attention from the real culprit, which is the US central bank.

What matters for the process of wealth formation is the flow of real savings. The balance of payments statement doesn’t provide such information. Consequently, it is not possible to determine the implications of a given state of the current account on the well-being of Americans without information regarding the state of the flow of real savings. Therefore various pessimistic assessments regarding the US economy, which are based on the state of the balance of payments, are likely to be without much foundation.

For a complete rebuttal to the trade deficit myth, please read Shostak’s article in entirety.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

By Bill Bonner

We’re heading for the hills…really!

Last week, stocks went up. Stocks went down. Not much was proved one way or another. The week ended in a draw, as near as we can tell.

But we think we are making progress in understanding what is going on. The private sector is de-leveraging. Now, it’s the public sector doing the heavy lifting. It is leveraging everything it can.

Leverage in the private sector led to the banking crisis/bear market of 2007-2009. Debt always leads to trouble. Next up: a crisis in the public sector.

But wait…hold on…not so fast…we haven’t reached the end of the private sector crisis yet! Bank lending is still falling. House prices are still falling. Unemployment is still falling. Soon, stock prices will be falling again too…

First, let’s see what’s in the headlines. Last week there was a lot of press about the pay czar and his efforts to limit compensation in the companies that the feds bailed out. The public and the news media love this sort of thing. It’s a battle between the greedy rich and the public interest, or so they believe. The public hates bankers. But they don’t want to see just pay capping; they want to see knee-capping. We’d like to see it too. Or maybe public flogging. Or at least a lapidation or two.

But our true sympathies are with the greedy CEOs. After all, they stole the money fair and square. They should be allowed to keep it. The feds wanted to leverage up the financial sector by giving money to the banks. What’d they expect? The bankers took it.

Yes, the financiers are paid outrageous amounts of money – far beyond anything they are worth. In fact, if you studied it carefully, you’d probably discover that their net contribution to the betterment of mankind is now negative.

The bankers are betting that the money they were given by the feds will be worth less next year than it is this year. So they exchange it for everything and anything, confident that when it comes time to pay it back it will be even easier to come by than it is now.

So far the bet has gone their way. Copper has doubled. Gold is up 20%. Stocks markets all over the world are up 60%. Foreign currencies, too, have beaten the dollar.

Will the wager against the dollar continue to pay off? Well, that’s the big question. If so, you should stay in stocks, gold and commodities. If not, you should move to cash.

But it hardly matters to the gamblers. They’re playing with someone else’s money! If the bets go well, they pay themselves huge bonuses. If they go badly…well…hey…gimme a bailout!

In the long run, bets against the dollar are almost sure to turn out okay. All paper currencies go to zero, eventually. But in the short run, who knows? The whole world is betting against the greenback. With such a massive short position against the buck, it would be just like Mr. Market – aka Mr. Mischief- maker — to send the dollar up.

But you can’t blame the bankers. They’re performing a very valuable service. They are helping to separate fools from their money. Too bad we taxpayers are the fools…

Among all the whiners and kvetchers about bankers’ huge bonuses hardly a single one draws the obvious conclusion:

That them that deserve to go bust should be allowed to do so.

“I remain of the view,” writes Martin Wolf, a bit pompously, in The Financial Times, “that the only thing worse than rescuing the system would have been not rescuing it.”

He’s welcome to his opinions. And if he used his own money to bail out the bankers we would have no objection. In that case, it would just be a futile and foolish act. Instead, he insists upon using our money…which raises the charge from stupidity to larceny.

Another message that came through last week was that the real economy is not improving. Good news came in from several quarters. But the news that really counts – housing prices and jobs – was bad.

“It’s all bad. That’s all we know,” said John Stepek, editor of MoneyWeek. “People ask if we’re going to have inflation or deflation. The bulls think we’re going to have inflation. The bears bet on deflation. But I’m not sure it matters. We’re probably going to have both.

“The point is, whichever we have, it’s going to be the bad sort. Neither inflation nor deflation is necessarily bad. Prices have to adjust. That’s how the market conveys its signals. When prices rise, it tells producers to get busy and increase output. When prices fall, it tells them to lay off. In the natural order of things prices usually fall. Or, they should fall. This is ‘good’ deflation. It just means that producers are becoming more efficient, as they should. There’s good inflation too – when prices rise due to increased real demand. When people earn more money, they can buy more things; prices rise.

“But what we’re going to see is bad. Bad inflation. And bad deflation. It is the result of monetary problems and mismanagement. And it is going to send all the wrong signals and inevitably make things worse. First, the deflation is bad because it is result of a massive de-leveraging accompanied by a write-down of debt and assets. It’s a depression. Or a major recession. Or a ‘great contraction.’ Call it what you will. It’s a deflation in which prices fall…and it’s not going to be any fun.

“Then, there’s most likely going to be bad inflation too – caused by the central banks printing too much money. This is bad inflation because it is just an increase in the quantity of paper money, not an increase in real demand.

“We don’t know exactly what is coming. But whatever it is, it will be bad.”

Another big item in last week’s financial press was the “Cash for Houses” scheme. The feds give new house buyers an $8,000 tax credit. But since not all new buyers buy because of the credit, the actual cost to the government per additional new house purchased is much higher than 8 grand. For each additional house purchased because the credit taxpayers are paying as much as a quarter of the entire cost of the house.

And now there is a proposal to extend and broaden the credit. Soon it may be “Cash for Everything.”

This sounds crazy, but there are a lot of economists who think more stimulus is necessary. Nobel prize winner Paul Krugman, for example. And Richard Koo, mentioned here last week. They’ve seen what happened in Japan. And they see that the real economy is not recovering as they hoped it would. Now, they warn that America might have a “Lost Decade” if it doesn’t continue to stimulate the economy.

How long must it continue bailing out and stimulating? Until consumers have finished de-leveraging, they say. How long will that take? Maybe another 5 years, by our calculation…maybe much longer.

But wait…the whole problem is too much debt, right?

Yep.

But the only way the government can stimulate is by going further into debt, right?

Yep.

And isn’t the budget deficit already at $1.6 trillion…or 11% of GDP…the most it has been since WWII?

Yep.

Well, then where’s the benefit? Won’t the public sector have to de-leverage too?

Bingo!

How does the public sector deleverage?

Two possible ways – honestly…and dishonestly. It can pay down its debts to a level at which they can be carried even if interest rates go up sharply. They did it after the War Between the States…after WWII…and even during the Clinton years. Believe it or not, when the Congressional Budget Office looked ahead in 2001, it saw a budget SURPLUS for 2008 of more than $600 billion. Surpluses had been coming in for years during the Clinton administration. They thought it would keep going like that. Instead, 2008 saw a DEFICIT of nearly $500 billion.

The higher the debt and deficits go the harder it is to pay them down honestly. Eventually, the feds reach the point of no return…like a guy who’s so deep in debt he can’t possibly work his way out. Then, you get another crisis…either in the form of default…or (hyper) inflation…or both.

Bill Bonner

The Daily Reckoning

A Housing Bust Chronology was originally published in the Daily Reckoning on 26/10/2009.

By Ron Paul

Last week a new bill was introduced in the Senate to audit the Federal Reserve.  Some backers of my bill HR1207 and the existing Senate companion bill S.604 were a little miffed at this, but depending on how you think about it, this new legislation poses no great threat to our efforts.

With the economy in shambles, people are looking for answers – not just because of lost savings on Wall Street, but because of lost houses on Main Street. Because of the many problems we face, the Federal Reserve and its powers over the economy have come under scrutiny.  This translates into a lot of political pressure on Congress.  With all the House Republicans signed on as co-sponsors and over half of the Democrats, HR 1207 has enormous bipartisan support.  It would be disingenuous for Washington not to embrace the principles behind this bill after all the promises for transparency.  How can one credibly argue for more transparency in government in one breath and defend the secrecy of the Federal Reserve in the next?

However, there is still very powerful resistance to the disclosures that HR 1207 would require and efforts to weaken it will continue to pop up before this issue is settled.

The good news is that Washington is responding and the Federal Reserve has become the issue.  Concerned Americans need to keep the pressure on by continuing to define what we want, and what we do not want.

One major concern is that HR 1207 constitutes some kind of power grab for Congress.  Congress would not do a better job dictating interest rates or managing money supply growth than the Federal Reserve does for exactly the same reasons: Congress is not the free market.  Any select group of people, no matter how wise and educated, simply cannot replace the wisdom of the market.  HR 1207 does not seek to replace the wisdom of the Fed with the wisdom of Congress.  That would be a giant step backwards.  HR 1207 simply asks for full disclosure, and I am agreeable to allowing for a reasonable lag time to calm the fears that Congress intends to dictate monetary policy.

What we do want, what we insist upon, is that no longer will decisions that carry so much economic weight be made in  absolute secrecy.  We want to know what arrangements the Fed makes with other governments and central banks.  We want to know who is benefitting from the actions of the Fed and what deals are being made.  The Fed is already reacting to pressure by scaling back its liquidity facilities and returning to more traditional monetary policy through direct asset purchases.  With nearly $800 billion in mortgage-backed securities on its books already, $800 billion in Treasury securities, and no real limit to what the Fed can acquire, there is a tremendous opportunity for malfeasance.  We need to know who the Fed deals with, what they buy, how much they spend, and who benefits.  As good as any step towards Federal Reserve transparency is, anything less than full disclosure at this point is unacceptable.

Anything Less Than Full Disclosure is Unacceptable was originally published in Ron Paul’s Texas Straight Talk on 26/10/2009.

By Chuck Butler

The Big Dog, euro (EUR) has stretched its gains versus the dollar overnight. The single unit did see a brief period of selling that amounted to about 1/4 cent, after it was reported that German consumer confidence unexpectedly declined for the first time since September 2008, last month… The European traders shrugged it off and went back to pushing the dollar down. It will be interesting to see what the NY traders do when they see this data… I personally doubt it will amount to a hill of beans for the NY traders, but we’ll have to wait-n-see, eh?

On Friday, the Swiss franc (CHF) hit parity to the dollar… I was not here to see it, obviously, but Chris tells me the franc’s strong move on Friday morning was the result of a Morgan Stanley report. The report said that the recovering European economy and accelerating inflation would keep the central bank from selling the Swiss franc in order to push it lower versus the euro and the dollar.

The franc is back below parity this morning, as that level brought about some profit taking, but I don’t expect for this move back below parity to last too long.

Chris also told me that Bank of Canada (BOC) Governor Carney was sending out warnings that the markets had taken the loonie (CAD) too high… Carney doesn’t believe the inflation fears are unwarranted, and that he might have to keep an option open to weaken the currency (by selling it) should this continue… OK, what we have here is a failure to communicate! Carney isn’t going to intervene except with his jawbone, folks!

At least I don’t think Carney will intervene… It’s not that I know something that everybody else doesn’t know about his situation, it’s just a hunch on my part. But as Chris mentioned in his note to me, with commodity prices continuing to rise, thus taking the loonie along for the ride, we’ll get to see just what Mr. Carney has up his sleeve!

Still, though, the fear that the BOC could step in and cause losses to currency traders does carry some weight, at least until the markets push the envelope inch by inch to see if the central bank bites. If it doesn’t bite, then they will push a little more… Eventually, they’ll see that the central bank is not going to intervene, and then the cow is out of the barn!

The other commodity currencies of Australia (AUD), New Zealand (NZD), Brazil (BRL) and Norway (NOK) continue to inch higher versus the dollar as we go along here day to day. With this being the last week of October, we’ll soon be turning the calendar pages to November, which just might bring us another rate hike in Australia, and the first hikes from Norway and New Zealand. Brazil has stated that rates need to go up 200 basis points (2%) but has not given any timeline for that to take place.

I spent a lot of time last week talking about the interest rate/yield differentials and how that’s going to be the next thing to beat down the dollar… And November has the potential to be a month of fireworks regarding rate hikes, and rate/yield differentials.

Last Thursday, I told you about China’s reported +8.9% economic growth… And since then, I’ve read quite a few stories from people who do not believe China’s claim… All have their reasons for saying that… I recall a conversation I had with a customer a month ago who had lived and had a business in China… He told me that whatever the Chinese say, believe half of it… So, with that in mind… If the Chinese say they grew +8.9%, then 1/2 of that would be +4.45%… And that’s still far greater than any country on this earth!

Well… Here in the US, the number of bank failures this year topped 100, last week… I believe the number is now 106 for 2009… 106 bank failures… Six would seem to be too many for my taste, but then add another 100! OUCH! All these failures and bailouts and TARP and TALF and back rooms deals to keep firms alive… And here at EverBank, we just continue to grow… OK, I’m slapping us on the back… But I just couldn’t pass up that opportunity!

OK, getting back to the failed banks… Why didn’t the government bail out these banks? Well, I think we all know that answer, but it kind of ticks you off doesn’t it? I’m not for bailouts, but shoot Rudy, once you start something like that, where do you draw the line? Oh! You silly bird! You know exactly where the government drew the line! With Lehman Brothers! Of which I still contend had some conspiracy undertones to it, with Lehman being Goldman’s chief competition, and all.

I was gone for a minute… Did you miss me? HA! No I slid my chair over to take a closer look at the economic calendar for this week that I pulled up on my trusty Bloomie! It looks as though the data we do get this week will show that the US economy is healing ever so slightly…

Anyway… The data this week includes the S&P/CaseShiller Home Price Index, and other “stuff”… And by week’s end, like I said, the data should show healing… But, if the trading theme plays out, that would be bad for the dollar!

Confused? Well, you’re probably a newer reader, and so… For you, I’ll explain… The trading theme for the currencies for over six months now has been to punish the dollar whenever the data shows economic improvement. That’s counter-intuitive to what you would think… But the thinking here is that: If the US economy is healing, the rest of the global economies will rebound much faster, and investors will shift funds from low yielding US assets to higher yielding foreign assets.

So… Now you know!

The Japanese stock market (Nikkei) posted a gain overnight, moving the index to a four-week high… The only reason I tell you this, is that it probably will lead to US stock strength, which has also been a nail in the dollar’s coffin the past seven months.

So, I guess what I’m getting at here is that we could very well see further weakness in the dollar this week… But, you can’t count on these trading themes, for just about the time you do, they reverse themselves! Or at least that’s how it always seems for me when I buy into an asset class!

Ty showed me a website last week called “thenothingstore.com” they had a note that I found to be simply genius! They make fun of the “unmighty dollar” and give you dollar bills to print (Funny money!) And then tell you to: “Click on a denomination above, print the bills, cut them out, and stuff in an envelope. Send to your congressman or senator marked as a CAMPAIGN CONTRIBUTION. They’ll get the message!”

Now that would be funny!

Then there was this… It is rumored that the Russian government is going to sell some of their gold holdings to help reduce their budget deficit… It’s thought that the Russians would have to sell about 50 tons of gold to fill their budget gap… The price of gold is not reflecting this story yet, so maybe it’s just a rumor… But, I would have to think the Russians would not think twice about doing something like this… Once again, we’ll have to call on the Chinese to soak up the gold that will hit the streets, or else we could see slippage in the gold price.

That reminds me of a conversation with our Mortgage guru, Stacy Blair, while in North Georgia two weeks ago… Stacy asked me why the US didn’t just sell their gold holdings to fill their budget gap… I told him that while that sounded good, what do we do next year? And the year after that? I mean the government has said that we need to prepare for $9 trillion in budget deficits for the next nine years… And then there are the conspiracy people that question just how much gold the US has? I mean Ft. Knox hasn’t been audited in a month of leap years!

To recap… The euro had pushed higher into the 1.50 handle until German consumer confidence caused a bit of slippage. The Swiss franc hit parity to the dollar last Friday, but has seen some profit taking since, and the Canadian dollar / loonie is softer on a warning from the central bank about the strength of the currency. US data this week could show some healing in the economy, which would not be good for the dollar.

Swiss Franc Hits Parity was originally published in the Daily Reckoning on 26/10/2009.

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How The Citi-Grinch Stole Christmas (and Why It’s a Good Thing)

by Michael Shedlock

Emails are pouring in over Citigroup’s “Hail Mary Pass”: How To Know Citigroup Is In Serious Trouble.

Here is one from “HG” who writes

Hey Mish,

We have a 7 figure net worth, no mortgage debt (we do own our own home), pay credit debt in full each month, and have credit scores of 726 and 702 respectively. We are 56 and 53 years old.

Just got the Citi 29.99 credit card rate increase notice. It’s not limited to those who carry a balance like the folks who carry 25k in debt.

Needless to say, I’m cutting it up on principle, but not closing it so that my credit limits don’t go down.

Enjoy your posts and look forward to reading them going forward.

HG

Matters of Principle

Want to take it out on Citigroup? If so, then do what “HG” did.

If you have a Citibank credit card just stop using the Citicard to deny Citigroup every cent you can.

It is high time for people to stop buying junk they do not need with money they do not have. Citi’s actions help.

Citibank Sends Out 2 Million Letters

Here is an Email from “MJ” who writes

Hi Mish,

I got a Citibank letter last week raising my interest rate to 29.99% from 7.99%. I have a 780 credit score and pay my account off every month. My limit was $18,200. I never made a late payment to Citibank (or anyone else).

When I called them to either maintain my current terms or opt-out, the rep told me she had been getting nothing but complaint calls all day. She said Citibank had sent out 2 million such letters. I was given one choice: accept the new terms or have my account canceled upon its expiration of 12/31/09. I told them to cancel the account.

The “hail Mary” you describe is even larger than you imagined.

MJ

I am hearing many stories about ridiculous rates but this one takes the cake.

First Premier Banks Offers Card With 79.9 Percent Rate

Please consider No, You’re Reading That Right

Gordon Hageman couldn’t believe the credit card offer he got in the mail.

“My first thought, it was a mistake,” Hageman said.

The wine distributor called the number on the offer, gave them the offer code and verified his information. Sure enough, it was right: the pre-approved credit card came with a 79.9 percent APR.

Yes, 79.9 percent.

The offer is for a Premier card from First Premier Bank, which is based in South Dakota. On its Web site, First Premier says it is the country’s 10th largest issuer of Visa and MasterCard credit cards. The site also says it “focuses on individuals who have less than perfect credit but are actually still creditworthy.”

According to information on the South Dakota Legislative Web site, there is “no maximum or usury restriction.” In other words, the individual bank can set its own interest rate limits.

Several calls made to First Premier for a comment were not returned.

Banks Scream To Be Regulated

If ever there were screams of “Please Regulate Me” these actions by First Premier and Citigroup must be at the top of the list.

Stories like these are piling in from everywhere all over the internet. Yet, it is the Citigroup stories that seem to be jacked up more frequently without reason.

I just checked my United Plus Chase Credit Card and it is 13.15%. I don’t carry a balance, except by accident (a bill comes in while on extended vacation). I think 13.15% is high.

29.99% across the board actions is absurd. It is also begging Congress for rate caps.

Some have Emailed me telling me this is nothing but greed. Others said this is nothing but preemptive action by banks to raise rates before new credit card protection laws go into effect.

I am sure there is a lot preemptive action happening. However, Citi’s mass sending of 2 million letters, Citi’s canceling of Gas-Linked cards and Citi’s jacking of rates for virtually no reason on some accounts suggests other problems.

Email From A Collections Specialist

Inquiring minds will wish to consider the following email from “MM” who works in the financial industry. “MM” has a collections background. This Email is also in regards to Citigroup’s “Hail Mary Pass”: How To Know Citigroup Is In Serious Trouble.

“MM” writes:

Hello Mish

I wanted to clarify Karl Denninger’s comments regarding Citigroup’s 10% defaults on their credit cards.

I work in the financial industry, and have a heavy collections background. ‘Defaults’ is a loosely used term. For example, when my company says it has x% defaults, it is in reference to the number of loans. Karl seems to be assuming 10% is measured against fees, or what other people call revenue. This is not an accurate way of measuring true losses.

Here is a practical example to illustrate my point. At my company, if we give out 3 $100 loans and charge $10 per loan, we generate $30 in fees or revenue; However, we still have to get the $300 back we lent.

If one of those loans defaults, that is a 33% default rate, but the practical impact to revenue is a loss of $270.

So, while the default rate is 33%; the loss is $270. Karl is assuming the 10% of defaults is measured against revenue. It could just as easily be calculated against the principal. You have to check their annual report and go through their math, because default is not universally calculated the same way.

Thus, that 10% default could be exponentially much larger than Karl is characterizing. In fact, I would be willing to bet it is, because I have a friend who worked in the credit card industry for 15 years, and he was telling me his company uses the term default the same way we do.

MM

Credit Card Panic

The actions by Citigroup smack of panic. That panic is likely to backfire.

Those who have other cards can simply stop using their Citicard as “HG” did. Even those without other cards may simply tell Citigroup to go to hell by stop using the card.

Those in real trouble probably do not care and have no intent to pay anyway.

Add that all up and what you have is a scenario in which Citibank (and anyone else following the same misguided rate-jacking policy) is going to drive good business away while keeping the bad business.

How The Grinch Stole Christmas

Think these rate-jacking actions are going to spur sales at Christmas? I don’t. Rising unemployment does not help one bit either.

Many people will look at those jacked-up rates and not buy. Some will not even have a choice because of slashed limits and canceled cards.

This Christmas is setup to be worse than last because of reduced credit lines, canceled cards, and rates that amount to usury. Last year was one of the worst in retail Christmas seasons in history.

Citigroup has no idea what it is doing. It would already be history had it not been for taxpayer bailouts. Yet….

It’s A Good Thing

• To the extent that these jacked-up rates cause people to stop buying, it’s a good thing.
• To the extent that canceled cards cause people to stop buying, it’s a good thing.
• To the extent that these actions cause people tell greedy banks where to go, it’s a good thing.
• To the extent that these actions cause people just give up, stop paying ridiculous rates, and declare bankruptcy, it’s a good thing.

Thank You Citi-Grinch.

The same thanks go to every other bank that jacked up rates. The odds are this will be the final incentive for many to get out of the debt slavery trap they are in. The more people that cut up their cards and tell banks to go to hell, the better off we will all be, and that’s a good thing.

Addendum:

An Email from Citi’s Vice President of Public Affairs; Dodd introduces bill to freeze credit-card rates

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Will Stimulus Take Hold?

by Michael Shedlock

Timothy R. Homan, writing for Bloomberg says GDP Probably Grew as Stimulus Took Hold

The economy in the U.S. probably grew in the third quarter at the fastest pace in two years as government stimulus helped bring an end to the worst recession since the 1930s, economists said before reports this week.

The world’s largest economy grew at a 3.2 percent pace from July through September after shrinking the previous four quarters, according to the median estimate of 65 economists surveyed by Bloomberg News. Other reports may show sales of new homes and orders for long-lasting goods increased.

Americans flocked to auto showrooms and real-estate offices last quarter to take advantage of government programs such as “cash-for-clunkers” and tax credits for first-time homebuyers. Growing demand caused stockpiles to keep falling, which will prompt companies to rev up assembly lines and help sustain the recovery into 2010 even as unemployment climbs.

“The recovery is off to a decent but unspectacular start,” said Joe Brusuelas, a director at Moody’s Economy.com in West Chester, Pennsylvania. “While another large drawdown in inventories will be a drag on third-quarter growth, it sets the stage for a longer and stronger upturn in manufacturing.”

Consumer spending last quarter probably jumped at a 3.1 percent annual rate from the previous three months, the biggest gain since the first quarter of 2007, the GDP report is also projected to show.

September readings on household purchases, due from the Commerce Department on Oct. 30, may show the quarter ended on a soft note after the Obama administration’s car incentive expired the month before. Spending probably fell 0.5 percent last month as car sales slowed after jumping 1.3 percent in August, the biggest gain since 2001.

The so-called cash-for-clunkers program offered buyers discounts of as much as $4,500 to trade in older cars and trucks for new, more fuel-efficient vehicles. The plan boosted sales by about 700,000 vehicles, according to a Transportation Department estimate.

Homebuyer Credit

The administration’s $787 billion stimulus package, signed into law in February, included an $8,000 tax credit for first- time homebuyers that expires at the end of November.

Take Hold Of What?

If the government gives everyone $4,500 I am sure we will see a fine increase in spending. I am equally sure nothing will take hold and the dollar will go into a free-fall, which of course is the opposite of take hold.

Cash for clunkers ended, pushing demand forward. Now what?

Uncle Sam Adds 5% to Prices of Homes

Goldman Sachs says Uncle Sam Adds 5% to Prices of Homes.

Uncle Sam’s interventions in the housing market have pushed home prices 5% higher on a national average than they would have been otherwise, Goldman Sachs estimates in a report released late Friday.

The government over the past year has slowed the pace of foreclosures through moratoria and the drive to modify mortgage terms to keep more borrowers in their homes. It also has pumped up demand for housing by giving tax credits to many first-time home buyers and by driving down mortgage interest rates. As a result, home prices in some areas have risen in recent months, particularly for homes that appeal to investors and first-time buyers. Bidding wars for the more attractive bank-owned homes have become common.

But these artificial props won’t last forever and may have created a false bottom in the market. “The risk of renewed home-price declines remains significant,” Goldman economist Alec Phillips writes in the report, “and our working assumption is a further 5% to 10% decline by mid-2010.”

False Bottom Indeed

I am and have been in the “false bottom” camp (even calling for a false bottom in advance). The fact remains, homes are still not affordable and inventories are high, yet artificially low. How can that be? Easy. There is a huge amount of shadow inventory as noted in Zombie Subdivisions and “Pig In The Python” Shadow Inventory.

That shadow inventory is poised to come out of the woodwork in the next decline as the pool of early fools dries up. Granted, there are way more bargains than three years ago when there were no bargains at all, but most are jumping the gun and this insane $8,000 tax credit is not helping anything in the long run.

Unfortunately, the tax credit is temporarily inflating home prices that are still out of line with wage and job growth. Once the stimulus ends, prices will resume deflating. Moreover, even if the stimulus does not end, prices will resume deflating (it will just take longer).

Shrinking Pool Of Greater Fools

Once everyone who wants a house and can afford a house has one, price appreciation will stall or go into reverse. The difference between now and 2006 is people are not buying 3 houses and a vacation home. Nor are lenders willing to finance three houses and a vacation home. Nor are lenders willing to do liar loans, pay option ARMs or other toxic financing. Thus, the pool of greater fools is far smaller than in 2006.

UK Stimulus Dies On Vine

Across the Atlantic, things are not looking so hot in the UK. Please consider BOE More Likely to Expand Bond Purchases After GDP Slump.

Britain’s failure to escape the worst recession since World War II may force the Bank of England to increase its bond-purchase plan next month, economists said.

Seven months after Governor Mervyn King’s central bank started a 175 billion-pound ($286 billion) program to rescue the economy, the Office for National Statistics said yesterday gross domestic product unexpectedly shrank 0.4 percent in the third quarter. None of the 33 economists surveyed by Bloomberg predicted a contraction.

The GDP figures “reopen a serious possibility that the Monetary Policy Committee increases its QE target,” said Philip Shaw, chief economist at Investec Securities in London, in a note titled “Champagne Corks Go Back Into Bottles.”

“It seems to me inconceivable that the recession is deepening and the housing market is recovering,” said Steven Bell, chief economist at London-based hedge fund GLC Ltd. and a former U.K. Treasury official. “The last refuge of the failed forecaster is to challenge the statistics, but that’s what I’m left with.”

Illusion of Stimulus

Here is a snip worth rereading from U.S. Faces Second Lost Decade “Because” of Misguided Stimulus written by my friend “HB”

I know Romer best for her misinterpretation of what happened in 1937-38. She believes that the fallback into full-scale depression from ‘depression light’ (as evidenced by unemployment in 1938 almost returning to the highest levels of the depression trough 32/33) is proof that it was a mistake to tighten policy (fiscal and monetary) too early.

In other words, according to her, if the Fed had continued pumping as furiously as possible, then everything would have been alright.

In reality, the entire inflationary mini-boomlet-within-the-depression was simply an illusion. ‘GDP growth’ that is bought with monetary pumping and feckless fiscal spending only misdirects and ultimately consumes even more scarce capital.

Fiscal stimulus may temporarily give the impression of a recovery, but it is not a genuine recovery. It makes things worse. The moment the pumping is abandoned, the true state of affairs is simply unmasked. That is what happened in 37/38 – a slight tightening of monetary policy revealed the fact that the mini-boomlet was as unsound as its predecessor boom in the years prior to the ‘29 crash.

It would not have been possible to hide this reality forever. There is nothing, absolutely nothing, that government intervention can achieve in terms of ‘fixing’ the economy. The choice was in either abandoning the unsound policy and the unsound investments it produced, or careen toward a complete destruction of the currency system.

Once again, I stand amazed at how people can look at this, and look at Japan, and look at the housing bubble/bust sequence, and still believe that monetary pumping and deficit spending are viable tools of economic policy when a bust occurs. It really boggles the mind, reminding me of Einstein’s definition of insanity, ‘doing the same thing over and over again and expecting a different result’.

Champagne Corks To Go Back Into Bottles

The hard reality of an “L” shaped recovery or a string of “WWs” looms large, leading indicators be damned. Please see A Look at ECRI’s Recession Predicting Track Record for details.

Any celebrating in the US (or Canada, or China, or Australia, or anywhere else) is simply premature.

In the coming months, expect to see more comments like “The last refuge of the failed forecaster is to challenge the statistics, but that’s what I’m left with.”

By the way, that is how the term “stagflation” came about. Under misguided Keynesian logic it was impossible to have a recession and inflation at the same time. We all know how that worked out.

In the US and globally we are in uncharted territory. Odds are we will see many things we have never seen before as stimulus after stimulus fails to produce desired results. Actual results, as in the examples above may very well be unbelievable to all the Keynesian and Monetarist clowns.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Recent months have witnessed a steady erosion in the greenback’s value, down 16% since March against the currencies of the top U.S. trading partners. On Wednesday, the euro broke through the symbolically important $1.50 barrier for the first time in 14 months.

Depending on whom you believe, a dollar hovering near its 52-week low represents either the market’s devastating verdict on the Obama administration’s profligacy or a salutary rediscovery of risk by newly emboldened investors.

Maybe it’s a bit of both. But the downbeat drumbeat bangs on. Chinese officials openly worry about taking a bath on their enormous U.S. Treasury holdings. Foreign bankers talk of promoting an alternative global currency, such as the euro, yuan or a new synthetic medium of exchange cooked up by the International Monetary Fund.

In the U.S., some voices on the right, such as Rep. Michele Bachmann, R-Minn., detect an anti-American conspiracy to scuttle the dollar. But the roster of those opining on the dollar’s woes includes establishmentarians such as Robert Zoellick, president of the World Bank and a former top official in Republican administrations. “Looking forward, there will increasingly be other options to the dollar,” he warned last month.

As the U.S. tries to repair its crisis-battered economy, is the end of dollar supremacy about to make a tough job even tougher?

Not any time soon. There are “lots of reasons to be concerned about the dollar. … (But) a weaker dollar is a fantastic boost for the United States, and it’s a problem for the rest of the world,” says Kenneth Rogoff, former IMF chief economist.

A natural monopoly

Since supplanting the British pound more than 60 years ago, the dollar has reigned supreme in global markets. As of the end of June, the most recent data available, 62.8% of foreign exchange reserves worldwide were held in the form of U.S. dollars. An additional 27.5% were stockpiled in euros, according to the IMF.

The dollar’s position has eroded in the past five years. In mid-2004, it made up 67.9% of world reserves. “A lot of people get excited about this. But in the 1970s and 1980s, there was even bigger volatility in the dollar share of reserves,” says Stephen Jen, managing director of BlueGold Capital Management, a London-based hedge fund.

In March, Chinese Central Bank chief Zhou Xiaochuan proposed shifting global finance to a reliance on a new international reserve currency rather than the dollar or any other national unit. The aim would be to avoid the periodic crises that have characterized recent decades. But Zhou acknowledged that any such change would take “a long time.”

The instability of a world economy so dependent on any single national currency is prompting even some leading American figures to argue for a gradual move away from the dollar. Fred Bergsten, former assistant Treasury secretary in the Carter administration, says a major cause of the current crisis was the destabilizing linkage between the U.S. trade deficit, enormous capital flows from abroad that financed it and the global dominance of the U.S. dollar. He argues in a new Foreign Affairs article that, to avoid a repeat episode, the U.S. should promote a move to a “multi-currency system” involving the euro and the yuan.

For now, the dollar’s fundamental standing remains what it’s been for decades: a convenient medium of exchange for buyers and sellers around the world. Just as Chinese merchants speak the global language of English when trading with Saudi oil barons, they use the global currency to buy the oil. “The reserve currency is a natural monopoly. It’s so convenient to list prices in a single currency,” says Harvard University’s Rogoff, co-author of This Time Is Different, a study of financial crises.

The U.S. benefits from the dollar’s unique role, enjoying what French President Valery Giscard d’Estaing memorably labeled the “exorbitant privilege” of being able to borrow abroad in its own currency. That insulates Americans from the danger of seeing their debts skyrocket in response to a sharp decline in the dollar’s value.

The dollar doesn’t owe its global role to international affection for Americans. Investors relying on the cold logic of the marketplace are drawn to the greenback by specific advantages that make the rise of a dollar rival inherently difficult. “There’s no equally attractive alternative,” says economist Barry Eichengreen of the University of California-Berkeley.

In the short run, the only currency that could challenge the dollar is the euro. It, too, has a continental-size economy behind it, and a decade after its introduction, the European currency has established itself as a fully convertible, stable store of value.

But for all its attractions, the euro lacks some essential attributes. Although the European Union has a central bank, comparable to the Federal Reserve, there is no European treasury. Instead, there are 27 European treasuries. Investors can’t easily track or influence fiscal policy on the continent.

The dollar is also buoyed by the existence of a massive government bond market. There’s roughly $4 trillion worth of U.S. Treasuries floating around, and almost $100 billion changes hands each day, according to investment management firm Pimco. Trading that’s carried on almost 24 hours a day, rolling east to west from Tokyo to London to New York, makes it easy to move into and out of dollar positions in a hurry.

Europe, by contrast, has no analogue to the U.S. Treasury market. Instead there is a fragmented scene with individual sovereign debt from Germany, Italy, France and other EU members. No individual market enjoys anything like Treasuries’ liquidity and size.

There’s another potential dollar rival on the horizon, though its day likely lies a decade or more in the future. Just as the United States overtook the British empire, China’s economy one day is likely to pass the U.S.’s. When it does, the yuan would be in position to fill the dollar’s global role.

But before it does, China will have to thoroughly overhaul its existing financial system. Today, the yuan isn’t freely convertible into other currencies, and there are strict limits on the cross-border movement of the Chinese currency. Chinese officials publicly have committed themselves to freeing the yuan to float alongside the dollar, euro, yen and other major currencies. That change, however, won’t happen overnight.

Even if foreign investors have concerns about having so much of their national wealth tied up in dollars, there is a limit to what they can do about it in the short run. The Chinese, for example, have little choice but to keep recycling into Treasury purchases their dollar surpluses from trading with the United States. Beijing wants to prevent the yuan from appreciating against the dollar, to protect employment in its export sector. Even as it worries about the long-term prospects for its dollar-denominated investments, it has to keep buying dollars to do so.

“There’s a gap between what’s feasible and what central banks would like to do,” said Steven Englander, chief foreign exchange strategist for Barclays Capital in New York.

Further to fall

The dollar’s long-run prognosis is negative. In the wake of the crisis, a retrenchment in cross-border financial flows will mean less demand for dollar-denominated assets. And with Uncle Sam’s printing press running overtime to cover the government’s trillion-dollar budget deficits, the currency is expected to be further cheapened, says Eichengreen.

The decline in the dollar’s value in the past seven months largely reflects an unwinding of the “flight to quality” that occurred during the most panicked crisis phase. Amid unprecedented levels of uncertainty late last year, investors flocked to assets denominated in the largest, most liquid currency. That drove the dollar’s value against the euro, for example, up about 13% over the three months ended in March.

Since then, the euro has regained the lost ground and then some. A euro, which settled at $1.50 Wednesday, was at $1.43 in December.

In the political realm, the dollar’s weakness is interpreted as a referendum on American decline. But its steady slippage this year is in line with economic fundamentals — that is, near-zero U.S. interest rates.

That said, neither the euro nor Japanese yen have had anything to celebrate. The biggest beneficiaries of the move out of dollars since March have been currencies of countries that heavily export raw materials, such as the Australian dollar (up 33% against the greenback) and the Canadian loonie (up 21%).

U.S. officials historically repeat mantra-like that they favor a “strong dollar.” That really should be interpreted as a fancy way of saying “no comment.”

So far, the dollar has only retreated back to the level it was at before the Lehman Bros. bankruptcy filing in September 2008 turned an economic downturn into a global financial panic. A weak dollar would be a problem if it contributed to inflation by increasing the cost of imports, or if it got so low so fast that the Fed felt compelled to raise interest rates to attract foreign investors. Neither is the case today.

The shrinking dollar also carries important economic benefits for the U.S. economy as it tries to climb out of recession. By making U.S. goods less expensive overseas, a weaker dollar provides a welcome boost for exports. The Obama administration has said it wants to rebuild the U.S. economy to rely more on making goods here to sell to people in other countries instead of depending on buying more and more stuff made elsewhere.

“The U.S., in the new normal, is going to have to export more because U.S. households will be saving,” said Eichengreen.

For that to happen, the dollar likely has further to fall.

Source: David J. Lynch, USA TODAY

U.S. Faces Second Lost Decade “Because” of Misguided Stimulus

by Michael Shedlock

Japan has gone through two lost decades, in and out of deflation, with nothing to show for it but increasing debt to GDP and a stock market still 70% below its peak.

Now, Richard Koo of Nomura Research Institute Ltd. says U.S. Risks Japan-Like ‘Lost Decade’ on Stimulus Exit

.

U.S. officials contemplating an exit from record fiscal stimulus are in danger of repeating mistakes that plunged Japan into its lost decade of stagnant growth, according to Richard Koo of Nomura Research Institute Ltd.

“This isn’t a cold, its more like pneumonia,” said Koo, author of “Balance Sheet Recession,” a 2003 book about the malaise that hit Japan after its stock and real-estate markets crashed in 1990. “We still need more government spending,” he said, adding it could take “three to five years to get out of this mess, even under the best of circumstances.”

Koo’s comments echo the view of economists including Nobel laureate Paul Krugman, who warn that the U.S.’s likely return to growth in the second half of 2009 doesn’t mean a sustained recovery is assured. The Obama administration aims to rein in a record $1.4 trillion budget deficit as growth returns, seeking to safeguard the value of a declining dollar.

“If you learn your lesson from the Japanese experience, you don’t remove your fiscal stimulus until private sector de- leveraging is over,” Koo, 55, chief economist at the research arm of Japan’s biggest brokerage, said in an interview at his Tokyo office last week. “When we see the private sector coming to borrow again, I’ll be the loudest person on earth arguing for fiscal reform. That’s the exit.”

Koo calculates that the bursting of Japan’s asset bubble in 1990 erased 1,500 trillion yen ($16 trillion) in wealth, equivalent to three times the size of the economy. Companies focused on repaying debt rather than undertaking new projects, causing demand to plummet and triggering a cycle in which cash flows fell, asset prices dropped and balance sheets deteriorated.

This time it’s the U.S. consumer that’s inundated with debt. Household debt soared more than 10 percent each year from 2002 to 2005, when the economy expanded an average of 2.75 percent.

“We have zero interest rates and still nothing’s happening,” Koo said. Businesses and households don’t want to borrow money even at zero rates; they’re too busy rebuilding savings and paying off debt, he said.

“We had these false starts,” Koo said. “The economy would begin to improve and then we’d say ‘oh my god, the budget deficit is too large.’ Then we’d cut fiscal stimulus and collapse again. We went through this zigzag for 15 years.”

Real Lesson of Japan’s Lost Decades

Neither Koo nor Krugman have learned a thing about the Real Lesson of Japan’s Lost Decades.

The real lesson is no matter how much money you throw around, economies cannot recover until noncollectable debts are written off. That is why you have “zero interest rates and still nothing’s happening.”

The moment fiscal stimulus stops economies are virtually guaranteed to relapse until the core problem is resolved. The problem is Asset Bubbles, Malinvestments, and debts that cannot possibly be collected.

Bailing out the banks did nothing to fix these problems. Consumers are still saddled in debt, in underwater mortgages, with no job. Moreover, there is no driver for jobs given rampant overcapacity in nearly every sector.

Banks do not want to lend in this kind of environment so they don’t. Businesses do not want to expand in this kind of environment so they don’t. Meanwhile the Obama administration is making matters worse by increasing taxes on small businesses and proposing everyone pay for health insurance, with businesses forced to offer a plan or pony up part of the cost.

This too is giving small businesses an incentive not to hire. Housing prices are too high yet the Administration and Congress are hell bent on propping up prices. The solution is to let prices fall until they are affordable.

The irony is after all the bitching we have heard and all the “Affordable Housing Plans” out of Congress, we have a golden opportunity for affordable housing and no one wants it.

This proves beyond a shadow of a doubt that “affordable housing” was nothing but a scam for the Fannie Mae, Freddie Mac Congressional slush fund all along.

Creative Destruction

Please consider some excerpts from Creative Destruction

Two Lost Decades

The Japanese Stock Market is about 25% of what it was close to 20 years ago! Yes, I know, the US is not Japan, that deflation can’t happen here, etc, etc. Of course deflation did happen here, so the question now is how long it lasts.

The five month, 50% rebound in the S&P 500 was certainly spectacular. However, the more important question is where to from here?

Take a look at Japan’s “Two Lost Decades” for clues.

Creative destruction in conjunction with global wage arbitrage, changing demographics, downsizing boomers fearing retirement, changing social attitudes towards debt in every economic age group, and massive debt leverage is an extremely powerful set of forces.

Bear in mind, that set of forces will not play out over days, weeks, or months. A Schumpeterian Depression will take years, perhaps even decades to play out.

The chart shows that over the last two decades, Japan had four rallies of 50% or greater, yet two decades later the Nikkei is 75% off its peak.

Is it impossible for that to happen here?

Christina Romer on Impact of Stimulus on GDP

Christina Romer, on the Obama Administration Council of Economic Advisers talks about Lessons from the Great Depression for Economic Recovery in 2009.

She is another one with totally hopeless views about the lessons of Japan. The above link points to a 11 page PDF filled with complete nonsense about the lessons of Japan.

How “Something For Nothing” Ideas Become Policy

Romer is a true believer in the free lunch theory of economics, that one can spend one’s way out of a problem of too much debt.

Logically it cannot be done. Inquiring minds might be interested in How “Something For Nothing” Ideas Become Policy

Illusions of Stimulus

My friend “HB” has the following thoughts I wish to share.

I know Romer best for her misinterpretation of what happened in 1937-38. She believes that the fallback into full-scale depression from ‘depression light’ (as evidenced by unemployment in 1938 almost returning to the highest levels of the depression trough 32/33) is proof that it was a mistake to tighten policy (fiscal and monetary) too early.

In other words, according to her, if the Fed had continued pumping as furiously as possible, then everything would have been alright.

In reality, the entire inflationary mini-boomlet-within-the-depression was simply an illusion. ‘GDP growth’ that is bought with monetary pumping and feckless fiscal spending only misdirects and ultimately consumes even more scarce capital.

Fiscal stimulus may temporarily give the impression of a recovery, but it is not a genuine recovery. It makes things worse. The moment the pumping is abandoned, the true state of affairs is simply unmasked. That is what happened in 37/38 – a slight tightening of monetary policy revealed the fact that the mini-boomlet was as unsound as its predecessor boom in the years prior to the ‘29 crash.

It would not have been possible to hide this reality forever. There is nothing, absolutely nothing, that government intervention can achieve in terms of ‘fixing’ the economy. The choice was in either abandoning the unsound policy and the unsound investments it produced, or careen toward a complete destruction of the currency system.

Once again, I stand amazed at how people can look at this, and look at Japan, and look at the housing bubble/bust sequence, and still believe that monetary pumping and deficit spending are viable tools of economic policy when a bust occurs. It really boggles the mind, reminding me of Einstein’s definition of insanity, ‘doing the same thing over and over again and expecting a different result’.

Japan’s Public Debt Nightmare

Japan’ public debt is 170 percent of GDP, the highest in the G20. Increased debt is all that has been accomplished by Keynesian silliness and Monetarist nonsense.

Over 10 years ago, the advice from Greenspan and the Fed to Japan was to write off the debts so that a recovery could begin. Japan did not do so and now has a dramatically escalating government debt to GDP problem, virtually guaranteed to blow sky high.

Death of Muddle Through

If you have not yet done so please consider Death of Muddle Through

Japanese Disease

John Mauldin: Some readers wrote this week telling me I am far too worried about a rising government deficit. Right now we are at roughly 42% of debt to GDP. In 1989, at the start of the lost decades, Japan had a debt-to-GDP ratio of 51%. Now it is at 178%, and the world has not come to an end for them. In fact, they are running massive government deficits today and plan to do so for a long time. Why, I am asked, can’t we be like Japan?

In 1989, private Japanese debt (businesses and consumers) was at a debt-to-GDP ratio of 212%. Now it is at 110%. And the total of both government and private debt is roughly the same (within 5%) of where it was 20 years ago. Along with running large trade surpluses, private debt has been exchanged for government debt. Savings have fallen from the mid-teens to about 2% today, as the country is rapidly aging and now using its savings to live on. And how much has all that government spending helped the country?

John Mauldin Quoting Hoisington: For all intents and purposes, Japan has had no growth for almost two decades. Their nominal GDP is where it was 17 years ago, and the number of employed people is at 20-years-ago levels. An aging population has masked their unemployment problems, as older citizens retire. Their savings went to government debt. Taxes were raised numerous times. Since government deficit spending has no long-term multiplier effect, growth has been nonexistent. (By the way, that research about multiplier effects has also been done by Christina Romer, the chairman of the current President’s Council of Economic Advisors, and further explored by European economists. There is general agreement on these facts.)

Japan Rethinks A Dam

The irony is Christina Romer does not even recommend what she knows to be true, assuming that Hoisington has summarized her position on multipliers accurately.

Now, Krugman, Romer, and others are all espousing the same tactics that got Japan in deep, deep trouble, except the “lesson” supposedly is Japan did not spend enough even as Japan rethinks its own policy.

Please consider Japan Rethinks a Dam, and a Town Protests.

The clatter of construction machinery still fills this forested mountain gorge, where legions of men in hard hats busily pour concrete, clear hillsides and erect a huge, unfinished bridge whose concrete supports tower over the valley floor like crucifixes in an immense graveyard.

It seems an apt analogy. Japan’s new government has suspended the $5.2 billion Yamba Dam being built here and turned this valley four hours north of Tokyo into a symbolic final resting place for the nation’s postwar order, which relied on colossal public works spending.

The Democratic Party government of Prime Minister Yukio Hatoyama has chosen this dam as the first of 48 national government-financed dams that it wants to scrap, worth tens of billions of dollars.

Japan had around 60 large dams under construction in 2005, making it the world’s fourth largest dam-building nation, according to The International Journal on Hydropower and Dams, despite having a land area smaller than California’s.

Decades of pouring concrete have been widely blamed in Japan for cluttering rural areas with needless dams and roads to nowhere. They have also saddled the country with the developed world’s largest national debt — nearly twice its $5 trillion economy. Mr. Hatoyama’s party has vowed to replace Japan’s postwar “construction state” and the jobs it created with something closer to a European-style social welfare system.

That my friends is exactly what public work stimulus projects do on average. Now Obama wants to gut public schools, rewire them, and make them energy efficient. At what cost? At what benefit?

Expect other infrastructure projects as well. Some may be useful, many won’t. The money has to come from somewhere and that somewhere is higher taxes, a cheapening of the US dollar, or both.

Such infrastructure projects did not work in Japan and they will not work here.

Yen Poised To Blow Up

Fiscal stimulus failed in Japan, it will fail here as well. When it fails, expect to see more calls for more “stimulus”.

Japan has already reached the boiling point. The Yen is poised to blow up as Japanese savers in an aging population need to live off their savings instead of saving more at 0% interest rates.

Cause and Effect

Final analysis shows the U.S. Faces Second Lost Decade “Because” of Misguided Stimulus, not as a result of pulling stimulus too early as Koo, Krugman, and Romer suggest.

If that sounds wrong then just take a look at how we got here: Hoping to end the recession of 2001-2002, the Fed slashed interest rates, held them too low, too long, we had the mother of all housing/credit booms and the global economy crashed.

The US has nothing to show for all that stimulus other than a wrecked economy, massive debt that needs to be written off, and extremely wealthy parasite bankers bailed out by consumers after contributing to these problems.

Koo, Krugman, and Romer think more spending and more debt will solve the problem although Japan has proven without a doubt that such attempts are economic madness.

What got the world out of the great depression certainly was not insane monetary stimulus but rather WWII. War destroyed the productive capacity of much of the world, and with US productive capacity completely untouched and with returning soldiers ready to start families, the US led the world out of depression.

Let’s hope it does not come to war again to solve these problems.

Addendum:

PhD’s In Distress and the Unsustainable Cost of Education

Mike “Mish” Shedlock

http://globaleconomicanalysis.blogspot.com

Click Here To Scroll Thru My Recent Post List

By Bill Bonner

Since it peaked in 2007, the UK stock market lost 60% of its value. As of yesterday, it had recovered half of what it had lost.

All over the world, the story is about the same. Markets have recovered half or more of what they gave up.

The US is a laggard. While the S&P is up 60%, the Dow isn’t yet at the halfway point. Some foreign markets, meanwhile, have 100% + gains.

Fund managers who missed the rally are kicking themselves. They’ve failed to keep up with the benchmarks.

Even before the market headed up in March we echoed Richard Russell’s words: “One of the surest phenomena in the financial world is the bear market bounce,” he said. We also guessed that the bounce would go to about half the previous losses. We based that on what had happened after the Crash of ’29.

Well, we’re still not there. But an analyst from Morgan Stanley tells us that markets tend to do better than that. The typical bounce is about 70%, says he.

Whew! That’s a pretty serious bounce. If we’d known it was going to be that big we would have encouraged dear readers to bet on it. Instead, we judged it a dangerous countercurrent…like a back eddy or rip tide. Yes, it can take you places…but not necessarily where you want to go!

Our outlook here at The Daily Reckoning is very long term. We don’t like betting on countercurrents…even important ones. Instead, we like to go with the flow…and keep going with it until it arrives at its end.

That’s not as easy as it sounds.

In 1999, it looked like the bull market had come to an end. We thought so. We told readers to get out of stocks…and stay out. Gold was a better place to be.

Investors made nothing in stocks for the next 10 years. In real terms, the stock market decline began in January 2000. Prices went down. They bounced…such a big bounce that it looked like a genuine new bull market. But after inflation, there wasn’t much left. Adjust for purchasing power and investors were worse off every year. Even now, after a 7-month bounce and a 45% gain, Dow investors are still down 30% to 40% from the highs set in 1999.

Dave Rosenberg…

“The only thing we really learned in this extremely flashy, seven-month, 60%, nine-point multiple expansion-led rally, is that momentum investing never did become extinguished this cycle. It is really a fascinating commentary on human behavior that so many ‘investors’ are lamenting about how ‘the train has left the station’ without them. Please, give us a giant break! The train has left the station countless of times in the last 10 years but obviously none of these trips lasted very long because the reality is that equities have failed to generate any positive return over this time interval.

“As for the here and now, there is another reality. Price gains in the stock market have generally occurred with low volume. There are limited buyers – hedge funds and flash traders – but no sellers (not yet, anyway). And, we saw in yesterday’s decline that volume climbed across the board, and the number of high-volume selloffs is a major red flag that should not be ignored.”

The typical major bear market lasts 15-20 years. The last one began in 1966. It wasn’t until 1982 – 16 years later – that the next major bull trend began.

This bear market is already 10 years old. Perhaps it will end in 2015. Maybe in 2020. We don’t know when. We only know how it will end – in misery.

Now, despite 10 years of stinkin’ returns, investors still believe in stocks. They still hope to find the ‘next Google.’ They still punish fund managers who hold back. They still read the financial press. They still watch CNBC. They still want to know what stock to buy.

Yesterday, they bid up the Dow 131 points. The price of stocks to gold is about 10 to 1. When this trend began ten years ago, we predicted that the Dow and gold would go all the way to 1 for 1. We guessed it would happen at the 3,000 to 5,000 level. We’ll stick with that prediction until it proves correct…or it makes us look like a fool.

Government debt? No problem. The net interest paid by the US government is actually about the same – as a percentage of GDP – as it was 40 years ago. It’s only 1.3% of output – nothing to worry about.

But wait…what’s this? The average maturity of that debt has come down from more than 5 years to only 4. And according to the Office of management and Budget, if the US continues on its present course, net interest will rise to 5% of GDP in 2019 and 10% in 2034.

And that assumes there is no big increase in interest rates…and that the economy recovers as planned. If either of those things fails to happen, the situation will degrade fast.

Imagine if the government were forced to refinance debt at double-digit interest rates – as it was in the late ’70s. Net interest could go to 5% of GDP within months.

We’re in a depression, not a recession. Depressions take longer to sort out. But they are also far more treacherous. Because there are always periods when things seem to be going “back to normal,” only to go back down again as soon as investors turn bullish.

Richard Koo, author of The Balance Sheet Recovery, recalls how it was during Japan’s long, dark passage:

“We had these false starts… The economy would begin to improve and then we’d say ‘oh my god, the budget deficit is too large.’ Then we’d cut fiscal stimulus and collapse again. We went through this zigzag for 15 years.”

Koo understands what is going on, more or less. Companies and households are paying off debt. He and Paul Krugman believe the feds have to continue pumping money into the system or they’re going to have a “lost decade,” just like the Japanese.

You have to keep the stimulus money flowing “until the private sector de-leveraging is over,” he says.

By our calculations, it will take 5-10 years for the private sector to de-leverage. By that time, the feds will have added trillions in debt to public finances. Since they can’t finance that much from private domestic savings, and since foreigners will be wary about lending that much even if they had it, the Fed itself will have to pony up the money. This will put the dollar in further danger…along with the entire global financial system.

Koo may be right – as far as his thinking takes him. He should think a little further. The problem is debt. Too much debt in the private sector caused bear markets and a bank crisis. Too much debt in the public sector will cause big problems too – a default…and hyperinflation. Worse than a depression.

How Much Juice is Left in this Bear Market Rally? was originally published in the Daily Reckoning on 23/10/2009.

How Being The Slightest Bit Overqualified Can Cost You A Job

by Michael Shedlock

To say the job market is extremely difficult is quite an understatement.

As unemployment rises, the pool of qualified and overqualified applicants for any listed job rises as well. Making things more difficult, is being even slightly overqualified can cost you the job.

To see how and why being overqualified can cost you, please consider $13 an Hour? 500 Sign Up, 1 Wins a Job.

C.R. England, a nationwide trucking company, needed an administrative assistant for its bustling driver training school here. Responsibilities included data entry, assembling paperwork and making copies.

It was a bona-fide opening at a decent wage, making it the rarest of commodities here in northwest Indiana, where steel industry layoffs have helped drive unemployment to about 10 percent.

When Stacey Ross, C. R. England’s head of corporate recruiting, arrived at her desk at the company’s Salt Lake City headquarters the next Monday, she found about 300 applications in the company’s e-mail inbox. And the fax machine had spit out an inch-and-a-half thick stack of résumés before running out of paper. By the time she pulled the posting off Careerbuilder.com later in the day, she guessed nearly 500 people had applied for the $13-an-hour job. “It was just shocking,” she said. “I had never seen anything so big.”

The 34-year-old recruiter decided the fairest approach was simply to start at the beginning, reviewing résumés in the order in which they came in. When she found a desirable candidate, she called to ask a few preliminary questions, before forwarding the name along to Chris Kelsey, the school’s director.

She dropped significantly overqualified candidates right away, reasoning that they would leave when the economy improved. Among them was a former I.B.M. business analyst with 18 years experience; a former director of human resources; and someone with a master’s degree and 12 years at Deloitte & Touche, the accounting firm.

Mr. Kelsey, 33, had just promoted one of his three administrative assistants, who handle the paperwork needed for drivers to hit the road. He needed a replacement quickly.

To make the task easier, he decided they should be even more rigorous in ruling out anyone who appeared even slightly overqualified.

“We like to get the fair and middling talent that will work for the wages and groom them from within,” he said.

In other words, he said, he did not want the former bank branch manager Ms. Ross had sent, or the woman who had once owned a trucking company, or even the former legal secretary.

[It came down to two candidates both invited back for a second interview].

Mr. Kelsey marched through many of his questions again. Then, trying to gauge ability to be assertive among truck drivers, he added a new hypothetical: if she were in the stands at a baseball game and a foul ball came her way, would she stand up to try to catch it, or wait in her seat and hope it fell her way?

The other finalist had said she would wait. But Ms. Block said immediately that she would jump up to grab it.

Mr. Kelsey decided he had found his hire.

When Applying, Use The Company Website

500 applicants came in a day. To have had any chance one needed to be at the top of the stack.

In that regard, those looking for a job should note how it can help to go straight to the company website rather than fax or email a résumé.

The job in question was simply for an administrative assistant. Responsibilities included data entry, assembling paperwork and making copies. Yet look at what the pool of applicants contained.

Applicant Pool

• I.B.M. business analyst with 18 years experience.
• A former director of human resources.
• Someone with a master’s degree and 12 years at Deloitte & Touche, the accounting firm.
• A former bank branch manager.
• A woman who once owned a trucking company.

All of the above were immediately disqualified as being overqualified.

To land a job you have to be the perfect candidate, near the top of the stack of résumés, neither underqualified nor the slightest bit overqualified and you have to be willing to grab at a fly ball (show eagerness to jump at passing opportunities).

It does not get much harder than that, and there will be no feedback to applicants turned away. Indeed they may have received so many résumés they did not even get to yours.

Dumb Down Guessing Game

Will it help to “dumb down” your résumé when applying for something you are clearly overqualified for? In this case the answer was clearly yes. In general, I am not sure.

One now faces a guessing game of what each individual company’s hiring process is. Adding extra marginal  qualifications to a résumé may or may not be the best thing to do.

Being extremely overqualified though, is likely a kiss of death. Yet, I cannot recommend grossly distorting a résumé hoping for a position.

Some candidates are so overqualified and out of work so long (always a negative factor) that they will never work again. Retraining for news skills hardly seems like it can work. The pool of perfectly qualified applicants with practical on the job actual experience is simply too great.

Addendum:

Over 65 And Needing A Job; Interview Tips For Everyone

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Joining host Dennis McCuistion, Thomas E. Woods, Jr. (Ludwig von Mises Institute) and Doug Casey (“The Casey Report”) focus their discussion on the credit crisis, free markets and limited government.

This video was made available by Dr. Woods, and is posted with permission from McCuistion TV (mccuistiontv.com).