InvestorCentric

Central Banks Snap Up Gold At Historic Levels

2010-03-19T05:59:00.000-07:00

As confidence in fiat currency continues to wane, central banks have been increasing their gold holdings at levels not seen since 1964. The historic significance of 1964 was the shift in monetary policy by the US that resulted in increased money printing that preceded an explosion in gold prices. See the following post from Expected Returns for more on this.

As the fundamental flaws of major currencies become more apparent daily, investors around the world will take on a defensive posture and buy gold. The shift away from a fiat currency system centered around the dollar is well underway, and the window of opportunity to buy gold at reasonable prices is closing. From Bloomberg, Central Bank Gold Holdings Expand at Fastest Clip Since 1964:

Central banks added the most gold to their reserves since 1964 last year amid the longest rally in bullion prices in at least nine decades, data compiled by the World Gold Council show.

Combined holdings rose 425.4 metric tons to 30,116.9 tons, an increase worth $13.3 billion at last year’s average price, according to the data. India, Russia and China said last year they added to reserves. The expansion was the first since 1988, the data from the London-based council show.

Central banks, holding about 18 percent of all gold ever mined, are expanding their holdings for the first time in a generation as investors in exchange-traded funds amass bullion as an alternative to currencies. Holdings in the SPDR Gold Trust, the biggest ETF backed by the metal, are at 1,115.5 tons, more than the holdings of Switzerland.

“There’s clearly been a renaissance of gold in central bankers’ minds,” said Nick Moore, an analyst at Royal Bank of Scotland Group Plc in London. “It’s not just been central banks taking on gold, but a general shift for physical gold in the investment sector.”

In a clear sign of what lies ahead, central banks are adding to their gold reserves at the fastest rate since 1964. In 1964, Charles De Gaulle was calling for a sweeping change in the international monetary system in which the U.S. was allowed to print as many dollars as it wished without affecting its value, at least relative to gold. De Gaulle was, quite justifiably, concerned about the growing trade imbalances between the U.S. and the rest of the world.

Once Charles De Gaulle started exchanging his dollars for gold, central banks around the world started following suit, which led to the eventual breakdown of the Bretton Woods system in 1971. Gold promptly rose from $35 dollars an ounce to $850 dollars.

What's telling about this time period is that economists universally believed that an upward revaluation in gold was unlikely. Remember, most of these economists only understood the de facto gold standard system in which imbalances in trade had no consequences. Most people were caught off guard by the rampant inflation that followed in the next decade.

The same skepticism pervades today as most economists can not fathom a move away from the dollar as global reserve currency. Every economist alive today has only lived through a period when the U.S. was the dominant global player both economically and politically. As such, no one questions the primacy of the dollar, even though gold has already risen from $250 dollars to over $1120 dollars in a stealth debasement of the dollar.

The dollar will eventually be revalued relative to other currencies and gold; there is no other way out of this debt crisis. The only question is how severe this revaluation will be. With Bernanke leading the way, I'm pretty sure there will be a stampede out of the dollar eventually.

This article has been republished from Moses Kim's blog, Expected Returns.

Inflation Remains Low In February

2010-03-19T05:51:00.000-07:00

During February, the US economy posted zero percent inflation due, in large part, to falling costs for energy and apparel. In keeping with trends already in progress, health care and education costs continued to climb, and the year-over-year inflation rate was 2.2 percent. See the following post from The Mess That Greenspan Made.

The Labor Department reported zero inflation for the month of February as rising prices for medical care and education were offset by sharply lower costs for energy and apparel. This comes after a 0.2 percent increase in January and marks the eleventh straight month that the price index did not drop after a series of steep declines beginning in late-2008.

On a year-over-year basis, the overall consumer price index was up 2.2 percent following an annual gain of 2.7 percent the month before, however, we may not have seen the last of rising annual inflation as recently higher gasoline prices are not reflected in the most recent data.

By category, it was a familiar story as health care and education costs continued their relentless advance while prices for many other goods again fell. The closely watched shelter component (within the housing category) was flat in February after a decline of 0.5 percent last month and is now down 0.4 percent on a year-over-year basis.

Energy prices were down 0.5 percent in February after an increase of 2.8 percent the month prior and are now 14.4 percent higher than a year ago. Last month, gasoline prices fell 1.4 percent but they are still almost 37 percent higher than last year at this time.

Recall that gasoline prices did not move much above the $2 a gallon mark last year until May, so there will be a few more months of big energy price increases in the period ahead.

This article has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Rising Debt to GDP Poses Risk To US Creditworthiness

2010-03-18T05:56:00.001-07:00

In a recent statement, Moody's Investors Service, one of the leading bond rating agencies, offered a sobering reminder that the United States' AAA bond rating could be in jeopardy in the future. The increasing level of US debt as a percentage of GDP, coupled with the continuing decline in foreign purchasing of US debt instruments, increases the chances of eventual default. See the following post by Moses Kim from Expected Returns for more on this.

A debt default in America, implicit or explicit, is one of the more obvious things that will happen in the years ahead. I honestly don't think calling for a U.S. debt default is radical- it literally happens all the time, especially following banking crises. Smart investors are trying to figure out how to protect themselves from a coming default; foolish investors are sticking their heads in the sand, just as they always do. From the New York Times, Moody's Warns U.S. Debt Could Test Triple-A Rating:

The gold-plated credit rating of the United States — an article of faith across America and, indeed, around the world — may be at risk in coming years as the nation copes with its growing debts.

That sobering assessment, issued Monday by Moody’s Investors Service, provided a reminder that even Aaa-rated United States Treasury bonds, supposedly the safest of safe investments, could be downgraded one day if Washington failed to manage the federal debt.

Well said. The AAA rating of the U.S. is an article of faith, not logic or facts. There is no law that states that those on top remain on top. In fact, the world seems to be governed by a universal law that guarantees those on top do idiotic things that undermine their country. America is no different.

Below is a graphic that shows the rising debt to GDP ratios in Western economies. Debt to GDP ratios are one of the fundamental metrics to determine creditworthiness.

The Downgrade Effects

A downgrade would affect more than American pride. The bigger risk would be to the country’s ability to keep borrowing money on extremely favorable terms, and therefore to keep spending more money than it takes in from tax revenue.

A credit rating lets lenders and investors know how likely it is that a borrower can pay back a loan. A sterling rating means there is little for lenders to worry about. A lower one typically results in bond investors demanding higher interest rates on debt.

Those higher rates, in turn, add to the country’s overall debt burden and can force the government to reduce spending, increase taxes or both. That difficulty has been well-illustrated recently in Greece and Portugal, with strikes and protests as citizens march in the streets to oppose tough austerity measures that directly reduce entitlements and state benefits.

Without question, foreigners are trying to figure out how to unload their debt at the best possible price. China, the largest investor in U.S. Treasuries, continues to reduce their holdings of U.S. debt. The waning demand from foreigners can only be balanced by direct government monetization (inflation). Our government officials will downplay the risks to monetization and claim that falling demand for our debt is a minor issue since we can "grow" our way out of this debt crisis.

I'm sorry to ruin the party, but we're not growing our way out of anything, especially since this growth will be induced by government spending. Government spending has taken on a mythical quality as something that has helped us avert a Depression. Economists will have you believe the miracle (read: delusion ) known as the Keynesian multiplier effect will allow our economy to magically grow at a torrid pace to infinity- all we have to do is print money and spend it!

This is just plain fiction. Using housing as an example, I'll try to simply explain why government intervention does not work in the real world.

The government is heavily subsidizing the housing market through its various programs. There is no doubt the government has been successful in subduing mortgage rates, most notably through its direct purchases of agency debt. Curious minds will be asking why historically low mortgage rates coupled with heavily discounted prices are not having a measurable effect on housing. The simple answer is because these artificial mortgage rates are not a reflection of true market conditions (i.e. inflation, organic demand for bonds etc.). This means that loans at this level are simply unprofitable for banks. Think about it: by government decree, mortgage rates can be brought down to 0%. But what bank in their right mind would lend in that environment, and what knowledgeable investor would invest when the rules of the game are constantly changing?

Our government officials, who have no idea how the real world works, believe our economy is so simple that if you just tweak one input you will get a measurable output. You are seeing in real-time that this is not the case. Our economy is getting immeasurably worse due to foolhardy government intervention, and I have little hope that this will change.

To close, here's Peter Schiff on CNBC talking about the crisis in U.S. government debt. It's always a joy to hear some of the nonsense spoken by CNBC anchors.

This post has been republished from Moses Kim's blog, Expected Returns.

Housing Prices Are Not Simply A Function Of Supply And Demand

2010-03-18T05:56:00.000-07:00

A recent report issued by Standard and Poor's asserts that the large quantity of delinquent or foreclosed properties on the market will likely undo any potential coming increases in housing prices. However the problem with this argument is that it is based on the assumption that price in the housing market is a function of supply when, in truth, selling price is a function of the amount of income available for borrowers to service their mortgage debt. See the following post by Sean O'Toole from Foreclosure Truth to learn more on this.

While I’ve previously written about the confusion around the term shadow inventory, it is now increasingly used to refer to properties that are delinquent, or in foreclosure, rather than unlisted bank owned homes. Standard & Poors recently posted a well written analysis of shadow inventory, and has jumped to the conclusion it will likely “undo U.S housing price gains”.

They estimate that the current backlog of distressed mortgages will take just under 3 years to clear. They call that estimate conservative… I think it is likely optimistic given that delinquency rates are still climbing. Still it is a reasonable guess. Here in CA we have one million homeowners who are already delinquent, and we seem to be clearing about 25-30k a month based on foreclosures and short sales (which are the only “solutions” that are actually clearing the distress by eliminating negative equity). Divide one million by 30k, and you come to the same 33 month conclusion they reach.

Another interesting part of the report deals with recently cured loans… those no longer delinquent, primarily due to loan modifications. They suggest that these should be included in calculations of shadow inventory, as they have had a nearly 70 percent rate of recidivism – in other words, most become delinquent again because the loan mod failed to address the core problem of negative equity. Seems like a reasonable conclusion to me.

Where I take some issue with Standard & Poors assessment is there conclusion that liquidation will lead to lower housing prices. They come to this conclusion based on the simple idea that an increase in supply will lower prices. There is some truth in that notion. For example we certainly have seen some pricing strength recently due to efforts to slow foreclosures which have clearly constrained supply, while at the same time demand has been stimulated with low interest rates and tax credits.

But this simple supply/demand theory of housing prices fails to adequately consider the fact that housing is highly leveraged, and that price is primarily a function of income and loan terms, and only secondarily supply and demand. Worse, this over-simplistic supply/demand model has led many to believe that foreclosures cause price declines, when in fact it is exactly the opposite… price declines cause foreclosure.

Note that the foreclosure crisis started in earnest in late 2006, however, price declines did not start until lenders removed the ridiculous loan products that enabled people to over pay in August of 2007. At that point we had a precipitous drop in price… not due to foreclosures, but instead due to the fact that people simply couldn’t afford the prices reached during the bubble without those loan products.

Foreclosures and housing supply grew rapidly during the price correction, but those who think the correction was due to either these foreclosures or the growing supply are terribly mistaken. Instead it was simply a correction back to reasonable prices, that buyers could afford based on their incomes and the more traditional loan products that remained available.

Unfortunately the belief that foreclosures and supply caused those declines remains all too common as yet again evidenced by the conclusion of this report. It is a belief that is delaying our recovery as government works to artificially constrain supply by slowing foreclosures, leaving homeowners stranded in prisons of debt, and buyers with little available inventory to choose from.

The reality is that there is a bottom to housing prices. People need a place to live and are willing to spend a certain portion of their income on housing to do so. Investors need to find returns, and there is a point where buying homes as an investment make sense. In many parts of California we’ve returned to those prices levels. And in those areas that have already corrected withholding supply won’t return prices to prior levels… people simply can’t afford it. And contrary to Standard & Poors’ analysis increasing supply is just as unlikely to cause further price declines… people need a place to live, and investors are too desperate for reasonable returns.

This post has been republished from Foreclosure Truth, a foreclosure news and analysis blog.

No End In Sight For Low Interest Rates

2010-03-17T05:55:00.000-07:00

The Federal Reserve kept interest rates extremely low and suggested that this would not change anytime soon. The cheap money is causing anxiety, even within the Fed, as the Kansas City Fed President expressed concerns about building an expectation of low rates for an extended period. See the following post from The Capital Spectator.

The key phrases in today’s FOMC statement from the Fed in reference to the outlook for interest rates: “exceptionally low” and “extended period.” Almost no one expected a change from the current zero-to-0.25% Fed funds target, although there was speculation that the wording might change. Not so. Bernanke and his crew want it understood that they’re going to keep rates low for quite a while, and they really do mean it.

The vote in favor of maintaining the status quo for the target Fed funds rate was nearly unanimous. There was one dissenting vote from Kansas City Fed president Thomas Hoenig. Although he voted against the FOMC’s let ‘er ride policy, the FOMC statement vaguely suggested that the dissent was over wording rather than the actual target rate. Maybe, maybe not. Here’s how the Fed release explained the matter: Hoenig “believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to the buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability.”

Does this mean that dissent on the FOMC has been reduced to debating rhetoric vs. rates? Maybe. In any case, it’s a moot point. Rates continue to hover just above zilch in the U.S. and look set to stay there for, well, an extended period.

Is that warranted? Hoenig seems to have his doubts. So does Joseph Carson, chief economist at AllianceBernstein, who says the Fed’s internal forecast anticipates 4% GDP growth this year and in 2011. “That growth expectation eventually has to follow through to their rate policy," Carson tells CNNMoney.com. "Hoenig's arguments are well founded; staying at a 0% funds rate while the economy is starting to grow will eventually lead to imbalances."

Perhaps, although it’s not top-line GDP growth that’s the problem so much as it is the ongoing weakness in the labor market. That doesn’t give the central bank a pass, of course. Unusually low rates left to roll on for an “extended period” may cause trouble down the road, even if job creation remains weak. In fact, we’d be surprised to find that the cheap money doesn’t come back to haunt the economy at some point. That doesn’t make raising rates any easier given the labor market; nor does it ease the anxiety about keeping the price of money at near zero. But it does remind that there are no easy decisions at the moment in the golden age of easy money.

This post has been republished from James Picerno's blog, The Capital Spectator.

The Great Contraction In Credit Is Hurting Small Business

2010-03-17T05:54:00.000-07:00

The inability for small business to tap the credit markets is playing a significant role in the continuation of the recession. This problem is likely to remain until a number of smaller banks, who have traditionally served the small business sector, work out the bad debt that is still carried on their books. See the following post from Expected Returns.

While our government continues to borrow at a torrid pace to keep this house of cards from collapsing, small businesses and average consumers are experiencing a tight credit environment. This trend must reverse or there is no way we will find our way out of this recession. From the WSJ, Lending Squeeze Thwarts Small-Business Rebound:

For a recovery to take hold, hundreds of thousands of small businesses must find the confidence to expand and create jobs. But when they get to that point, the local banks they depend on—worried about borrowers' financial strength, scrutinized by regulators and slammed by souring real-estate loans—might not be willing or able to provide the credit they need.

While big companies have been able to borrow in bond markets, smaller companies rely mainly on bank credit, which has been shrinking. In 2009, total lending by U.S. banks fell 7.4%, the steepest drop since 1942. In all, the credit pulled out of the economy by banks since the downfall of Lehman Brothers in September 2008 amounts to about $700 billion, more than double the amount so far distributed under President Barack Obama's $787 billion stimulus program.

Small businesses are no doubt feeling the effects of the unprecedented contraction in credit. However, perhaps more telling is the lackluster consumer demand that is justifying the tightness in credit. If small businesses were bringing in robust profits, banks would be lining up to offer them credit.

Commercial Real Estate Bust

Getting banks to lend more won't be easy, given the rising tide of defaults on loans made to finance housing developments, office buildings, shopping malls and other commercial real estate. Deutsche Bank expects banks to suffer at least $250 billion in losses on such loans, with about half coming in the next few years. Together with an estimated $250 billion in further charge-offs on home mortgages, that's more than double banks' current reserves against losses on all types of loans.

The stakes are particularly high for community banks, which tend to be much more active in commercial real estate than their larger counterparts. As of December 2009, such loans comprised about 42% of all loans held by the 7,344 banks with less than $1 billion in assets, compared to about 17% for the hundred or so banks with more than $10 billion in assets.

Banks know something we don't about the toxic waste on their balance sheets. We can infer from their risk aversion that they are sitting on some real lemons that will result in huge losses. From the graph below, you can see that excess reserves are still rising at an unprecedented rate.

Due to the weakness in commercial real estate, no small number of banks will go under. After 140 bank failures last year, we already have had 30 bank failures in 2010. Expect credit to become tighter in the years ahead.

"Vicious Cycle"

"It's kind of a vicious cycle," he says. "Anytime you're in an economic environment like we are, bankers are going to be more conservative."

One of bankers' main concerns is the damage the recession has done to many companies' finances. Values of real estate and other things small business owners can put up as collateral for loans have fallen so far, so fast, that many businesses have little to offer. Also, a year or more of losses have eroded the value of owners' stakes in companies, leaving less of a cushion against bankruptcy.

There are really only two types of economies- those that are growing, and those that are contracting. A contracting credit environment induced by falling asset values used as collateral is evidence of the latter. These types of negative feedback loops are hard to reverse, which explains why the economy remains so weak even with an endless supply of government stimulus.

The government's attempt to stimulate the economy at the small business level has been an abject failure. Ultimately, small businesses will recover when there is an increase in real demand. This will take some time since so many Americans are unemployed, and those that are employed are focused on paying off debt. Our economic leaders must come to grips with the fact that the great secular expansion in credit has turned into a mammoth contraction in credit. These contractions take decades to play out- just take a look at Japan.

This article has been republished from Moses Kim's blog, Expected Returns.

Americans Would Have To Double Income Tax To Close 2010 Deficit

2010-03-16T05:58:00.000-07:00

According to the Tax Foundation, the government would have to more than double income taxes to close the 2010 budget deficit. While an extreme tax hike is very unlikely, these claims show the severe imbalance of government revenue and liabilities. See the following post from The Capital Spectator for more on this.

Supply side economics guru Arthur Laffer co-authored a book recently whose title is anything but subtle: The End of Prosperity: How Higher Taxes Will Doom the Economy--If We Let It Happen. This provocative title came to mind after perusing some freshly minted numbers from the Tax Foundation, which estimates what it would take to close the U.S. government’s fiscal 2010 budget deficit by adjusting federal income tax rates for individuals. That's not going to happen, of course. Not even close. But it's an interesting way to consider what we owe and what it would take to pay off the debt solely on the backs of individual tax payers--in one year. In this make-believe world, the adjustment, of course, would be an increase in tax rates, and by more than a trifling amount. So it goes when liabilities exceed revenue by something approaching biblical proportions.

One can debate the Tax Foundation’s assumptions, of course. And in the real world there are other means of closing the budget deficit. In fact, there’s no legal pressure to close it this year, or any time soon, for that matter. Economic reality imposes its own restrictions and limits, but that’s another matter. Meantime, here’s how the Tax Foundation summarizes its theoretical experiment:

Assuming deductions, exemptions and credits were kept the same as they are now, Congress would have to raise each personal income tax rate by a factor of almost two and a half to erase the 2010 deficit. Even in later years when the President's Budget predicts that the deficit will be "only" in the $700-to-$800 billion range, the rates necessary to close the deficit are untenable.

The CBO projects a budget deficit for fiscal 2010 of $1.3 trillion. According to the Tax Foundation, blotting out that red ink by way of higher personal income taxes—all in one year—would require more than doubling the current tax rates. For the upper income levels, a near tripling of the tax burden would be required, as the table below shows.

The chances of Congress raising tax rates to close the deficit in one year, much less having the President sign off on the idea, is about as likely as waking up on Saturn tomorrow morning. The Beltway boys and girls don’t usually favor politically self-destructive legislation. If anything, they’re partial to the opposite spectrum of legislative activity, which is part of what got us into this deficit trouble in the first place.

Yes, higher tax rates are coming, and may already be bubbling before they're formally announced, as we discussed last week. But higher rates are likely to come quietly in the night, as opposed to dropping out of the blue on Monday morning with a formal press conference announcing the change on the front steps of the Capitol. No doubt there'll be other changes, too, including cutting back on certain spending projects that lack a large and influential constituency, i.e., something other than Medicare, Social Security, etc.

In any case, the Tax Foundation’s quantitative “what if” review is a reminder of just how deep a hole that’s been dug and what it would take to climb out. Assuming we even try. History suggests that printing money is the political path of least resistance. And for good reason: it works, at least until the next election. And even then, there are limits, which is to say that it works until it doesn’t.

For the moment, the bond market has a high level of tolerance for fiscal impropriety. That’s largely a function of the political cover that flows from the deflation/disinflation blowback generated by the Great Recession. But tomorrow, as Scarlett once said, is another day. So too is what passes for tolerance.

This post has been republished from James Picerno's blog, The Capital Spectator.

The Jobs Bill: Too Little, Too Late

2010-03-16T05:56:00.000-07:00

Although the government was able to move quickly to pass legislation to protect large financial institutions, is has, as of yet, not been able to pass legislation to create jobs. Congress' inability to pass the current jobs bill, as small as it may be, has been caused largely by partisan bickering and obstruction on the part of the minority party. See the following post from Economist's View.

Legislation designed to stimulate job creation has been under discussion for months, but so far there hasn't been any action. It was an emergency when the big banks were about to fail, and we managed to put legislation into place relatively quickly in response. But when millions of individual households are failing, households that in total are every bit as important to the economy as a large bank, the sense of urgency isn't there. The fact the these households are struggling to get by until jobs reappear, and that every day that goes by without a job is another day of hardship, doesn't seem to register with legislators who seem more interested in playing political games than in helping people. Now, after all this time -- when it's nearly too late -- a meager, $15 billion dollar jobs bill (and only part of it is devoted to job creation) is about to move forward, but Republicans are threatening to hold it up even longer. I can't give Democrats much credit for a bill that is way too small and way too late to do much good, this should have been done months ago, but Republican attempts to delay it even further (and to oppose measures such as extending unemployment compensation), are inexcusable:

Make 'em Filibuster, Jobs Edition, by Jay Newton-Small: The Senate is bracing for a possible all-nighter as leaders have thus far failed to reach an agreement on the Hiring Incentives to Restore Employment (HIRE) Act. You may remember this as Harry Reid's relatively small $15 billion jobs bill that he introduced after yanking the Baucus/Grassley deal. The House then passed an amended version, and Reid is now hoping to pass this deal and send it to President Obama this week to be signed into law.

As he did the first time around, Reid again has refused to allow amendments (if the bill were to be changed in any way it would have to go back to the House -- resulting in a game of ping pong that has entrapped some pieces of legislation for years). Republicans last time were incensed that they couldn't amend the bill but 13 of them ended up still voting for it on final passage. This time around they are refusing to allow the Senate to proceed to the legislation in protest... This is essentially a GOP filibuster... -- a procedural tactic that will require a 60-vote threshold for a bill everyone knows will pass (the first version passed 70-28) and 30 hours of debate. Usually, such debates are wound out during civilized daylight hours. But, if Republicans refuse to pass the bill tonight, Dems are preparing force them to stay in session all night. ... Not quite a real filibuster, but at least one potential night sans sleep.

This builds on Senator Jim Bunning's five-day one-man filibuster of unemployment benefits. Dems seem increasingly prepared to force Republicans to publicly block popular, bipartisan jobs bills to demonstrate the degree of logjam in the Senate. Republicans, meanwhile, are accusing Dems of playing politics with important legislation. But if this "filibuster" goes anything like Bunnings', Democrats are coming to the table with the upper hand.

This post has been republished from Mark Thoma's blog, Economist's View.

The Economic Recovery Fairy Tale

2010-03-15T05:58:00.000-07:00

Although many government sources have claimed that the economy has been in a recovery period, Moses Kim argues that the economy is an weakened state. Areas of concern are the ongoing government budget deficits, high levels of foreclosures, and low levels of optimism among small business people. See the following article from Expected Returns for more on this.

The propaganda about an economic recovery is reaching epic levels. It has gotten to the point where the government must conjure up ridiculous excuses for our economic perils, such as the pernicious phenomenon known as.... winter.

By my calculations, the phantom economic recovery has been dragging on for a year. In that time frame, economic conditions have clearly worsened. Fundamentally, and perhaps most prosaically, there are no jobs. Yet we are to believe the economy has recovered simply because the government says so. It baffles me that anyone still listens to the same people who led us off the cliff in the first place.

Recent economic reports suggest that the economy is still weak, and that this weakness is likely to persist.

Record Monthly Budget Deficit

The government just announced a record $221 billion dollar deficit for February, which brings the total deficit for the first 5 months of the fiscal year to $651.56 billion dollars. This puts us well on track to exceed last year's record $1.4 trillion dollar deficit. There is no doubt in my mind that we are on our way to fiscal ruin.

Government spending is fine as long as it helps the average person without imposing burdens on the taxpayer that exceed benefits. Unfortunately, the government has irresponsibly spent trillions of dollars of taxpayer money with the only measurable effect being outsized bonuses for bankers. Of course these bonuses were well-deserved, since according to Obama, resident banking gurus Dimon and Blankfein are "savvy investors." Sureeee. Savvy investors that can't survive without billions of dollars in implicit and explicit government guarantees. But I digress.

Foreclosures Slowing?

The latest spin is that foreclosure filings are increasing at a slower rate. Foreclosures were only up 6% from last year in a clear sign that "green shoots" are sprouting left and right.

While the 308,524 foreclosure figure is pretty horrific historically (for some perspective, 405,000 households lost their homes in 2007), the figure is actually skewed since many of the 1 million homeowners who qualified for a temporary modified mortgage under the Home Affordable Modification Program (HAMP) will not receive permanent modifications. We should be seeing many of these homes hit the market in the months ahead.

Unemployment Remains Elevated

Today the Department of Labor announced that 462,000 individuals filed for initial unemployment claims. The 4-week average increased by 5,000 to 475,000 in a sign that the unemployment picture remains weak.

Small Businesses Remain Bearish

The index of small business optimism fell in February to 88, with small business owners citing poor sales as their main concern. Due to the weak sales environment, more firms announced plans to cut jobs than to add jobs.

The optimism index has held below 90 for an unheard of 17 straight months, which in the past has suggested a recessionary environment.

It's logical to pay attention to what small business owners are saying, especially since they are responsible for over half of the employment in America. Because of their effect on hiring in America, and since in the real world a recovery cannot occur without an increase in hiring, small business owner sentiment serves as a reliable leading indicator.

At the very bottom of the 1982 recession, a net 47% of small business owners saw improving business conditions ahead. Currently, a net -9% see improved business conditions in the months ahead. It's pretty clear that the outlook is bearish on main street.

The fairy tale that our economy is improving truly defies logic. While another round of "less bad" economic statistics can potentially create the illusion of a recovery in the months ahead, I believe by the end of 2010 and into 2011, it will be nearly impossible for anyone (besides the government) to deny that we are in one serious economic downturn.

This article has been republished from Moses Kim's blog, Expected Returns.

Economists Confused On Cause Of Recession

2010-03-15T05:53:00.000-07:00

If you ask economists what caused the recent recession you will likely get a wide range of different explanations that often reflect the economist's own world view. This disagreement makes it especially difficult to prevent the same scenario from happening again. See the following post from Economist's View for more on this.

Robert Shiller:

A Crisis of Understanding, by Robert J. Shiller, Commentary, Project Syndicate: Few economists predicted the current economic crisis, and there is little agreement among them about its ultimate causes. So, not surprisingly, economists are not in a good position to forecast how quickly it will end, either.

Of course, we all know the proximate causes of an economic crisis: people are not spending, because their incomes have fallen, their jobs are insecure, or both. But ... where and why did it start? Why did it worsen? What will reverse it? It is to these questions that economists have been unable to offer clear answers.

The state of economic knowledge was just as bad in the Great Depression that followed the 1929 stock market crash. Economists did not predict that event, either. ...

Late in the Great Depression, in August 1938, an article ... in The Christian Science Monitor reported an informal set of interviews with US “professors, banking experts, union leaders, and representatives of business associations and political factions,” all of whom were given the same question: “What causes recessions?” The multiplicity of answers seemed bewildering, and did not inspire confidence that anyone knew what was causing the deepest crisis of capitalism.

The causes given were “distributed widely among government, labor, industry, international politics and policies.” They included misguided government interference with markets, high income and capital gains taxes, mistaken monetary policy, pressures towards high wages, monopoly, overstocked inventories, uncertainty caused by the reorganization plan for the Supreme Court, rearmament in Europe and fear of war, government encouragement of labor disputes, a savings glut because of population shrinkage, the passing of the frontier, and easy credit before the depression.

Although economic theory today is much improved, if we ask people about the cause of the current crisis, we will mostly get the same answers. We would certainly hear some new ones, too: unprecedented real-estate bubbles, a global savings glut, international trade imbalances, exotic financial contracts, sub-prime mortgages, unregulated over-the-counter markets, rating agencies’ errors, compromised real-estate appraisals, and complacency about counterparty risk.

More likely than not, many or most of these people would be mostly or partly right, for the economic crisis was caused by a confluence of many factors, the chance co-occurrence of a lot of bad things...

Consider the question of predicting events like the January 2010 earthquake in Haiti, which killed more than 200,000 people....[I]f one went beyond trying to predict the occurrence of earthquakes to predicting the extent of the damage, one could surely devise a long list of contributing factors – including even political, financial, and insurance factors – that resembles the list of factors that caused the global economic crisis.

Indeed, the crisis knows no end to the list of its causes ... in a complicated economic system that feeds back on itself in many ways...

Weather forecasters cannot forecast far into the future, either, but at least they have precise mathematical models ... derived from the theory of fluid dynamics and thermodynamics. Scientists appear to know the mechanism that generates weather, even if it is inherently difficult to extrapolate very far. ... The mathematical models that macroeconomists have may resemble weather models in some respects, but their structural integrity is not guaranteed by anything like a solid, immutable theory. ...

Unfortunately, in 800 years of financial history, there is only one example of a really massive worldwide contraction, namely the Great Depression of the 1930’s. So it is hard to know exactly what to expect in the current contraction...

This leaves us trying to use patterns from past, dissimilar crises to try to infer the likely prognosis for the current crisis. As a result, we simply do not know if the recovery will be solid or disappointing.

Amazing - a whole column and not a single mention of his book. But that may be because after arguing that we don't know the cause of the crisis, it's kind of hard to promote a book that explains what caused the crisis:

As George Akerlof and I argue in our recent book Animal Spirits, the current financial crisis was driven by speculative bubbles in the housing market, the stock market, and energy and other commodities markets. Bubbles are caused by feedback loops: rising speculative prices encourage optimism, which encourages more buying, and hence further speculative price increases – until the crash comes.

Part of the confusion is the failure to distinguish between the question of what caused the crisis and the factors that made it much worse once it occurred. But it is rather striking that if you ask a simple question, "what is the single most important factor in explaining why the crisis happened," there is very little consistency in the answers given by economists. I find it a bit disturbing that, even after this much time to figure it out, there is little consensus on what caused the problems. Worse, those that hate government seem to find government at fault, those that think that the deregulation movement that began in the 1970s was an error point to regulatory failures, and so on, and so on.

The fact that the evidence always seems to confirm ideological biases doesn't give much confidence. Even among the economists that I trust to be as fair as they can be -- who simply want the truth whatever it might be (which is most of them) -- there doesn't seem to be anything resembling convergence on this issue. In my most pessimistic moments, I wonder if we will ever make progress, particularly since there seems to be a tendency for the explanation given by those who are most powerful in the profession to stick just because they said it. So long as there is some supporting evidence for their positions, evidence pointing in other directions doesn't seem to matter.

The economics profession is in crisis, more so than the leaders in the profession seem to understand (since change might upset their powerful positions, positions that allow them to control the academic discourse by, say, promoting one area of research or class of models over another, they have little incentive to see this). If, as a profession, we can't come to an evidence based consensus on what caused the single most important economic event in recent memory, then what do we have to offer beyond useless "on the one, on the many other hands" explanations that allow people to pick and choose according to their ideological leanings? We need to do better.

This post has been republished from Mark Thoma's blog, Economist's View.

American's Household Assets Growing Again

2010-03-12T05:56:00.000-08:00

In the last year, the total value of household assets has begun to climb again from its low levels in the recent past, according to the Federal Reserve's most recent quarter Flow of Funds reports. Unfortunately, though, the small partial recovery in real estate value is more than dwarfed by the remaining high level of home mortgage debt. See the following post from The Mess That Greenspan Made.

The Federal Reserve released their quarterly Flow of Funds report today that includes data through the fourth quarter of last year and the two charts that have appeared here for a number of years now have been updated and are shown below.

Now a year or so past the worst phase of the financial market crisis, household assets have recovered somewhat but it continues to amaze me how much they declined relative to the asset bubble that burst earlier in the decade.

Thanks to the inflating housing bubble, overall assets never fell between 1999 and 2002 after the stock market bubble burst and then, after 2002, it was "off to the races" again.

This time around, there doesn't yet appear to be a new bubble on the horizon, though technology stocks sure seem to be vying for that position.

As for the American consumer and their mid-decade fascination with real estate, as has been the case for a few years now, the debt seems to linger long after the valuations go away.

After some heavy lifting by the U.S. government in the many ways that they have found to subsidize the housing market, home prices seem to have leveled off, however, the associated debt is coming down only slowly.

While I don't know how the "Home Mortgages" line item above is determined, my guess is that the chart overstates the current amount outstanding due to the hundreds of thousands of borrowers who are now in one form of mortgage limbo or another with their fate already sealed, just the timing needing to be finalized.

Until that time, they still carry a home mortgage at the full amount and the banks still carry the loans at the full amount on their books, otherwise, we'd probably have seen a much larger decline by this point.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Downward Trend In Jobless Claims Appears To Have Stalled Temporarily

2010-03-12T05:48:00.000-08:00

The environment for US jobs continues to improve at a slow but steady pace. The decline in initial jobless claims appears to have stalled temporarily, primarily due to weather conditions. See the following post from The Capital Spectator.

The jury’s still out on the path of least resistance in the trend for initial jobless claims. Today’s weekly update is certainly a step in the right direction, although last week’s meager drop in new filings for jobless benefits falls far short of stellar, or convincing. The sluggish behavior of late in this series has kept us anxious for more than a month, and the number du jour doesn't change much.

Initial claims were 462,000 (seasonally adjusted) for the week through March 6, the Labor Department reported this morning. That’s down slightly from the previous week’s 468,000. But as our chart below reminds, it’s unclear if the broader decline that’s been in place for a year has stalled. In the dark art of reading recent history as a guide to divining the future, one can argue that the risk of a new surge in claims has diminished. If so, that’s encouraging, but we now must confront the more pressing question: When will the decline resume?

This is no trivial matter, considering the value of initial jobless claims as one of several leading indicators for the economic cycle. (For some background, see our previous posts here and here. In addition, you can find some examples of the formal research on the subject here.) The best we can say at this point is that the jury’s still out on the big picture trend. Jobless claims are a volatile series on a weekly basis, and even over longer stretches, as the chart above reminds. But the time is running short when we can look at a sideways-moving trend in claims and dismiss it as statistical noise. All the more so at a time when the labor market's capacity for creating new jobs remains, at best, questionable, as the latest update in nonfarm payrolls shows.

Meanwhile, we take no encouragement from the trend in continuing claims, which tracks the population of folks who’ve been collecting jobless benefits for more than a week. This number is reported with a lag relative to initial claims, but the latest figure reported today supports the case for thinking that we may be moving sideways for some period of time in the job market overall. For the week through February 27, continuing claims rose by 37,000 to 4.558 million (seasonally adjusted). And as our second chart below shows, this series has been going nowhere fast so far this year.

But all’s not lost yet, advises James O’Sullivan, global chief economist at MF Global in New York. "The net rise in the last two months was because of temporary factors, notably weather effects," he tells BusinessWeek today. "Claims will likely have to resume a downward trend if payrolls are to improve, which we think will happen."

Hope springs eternal, or at least until next week's report.

This post has been republished from James Picerno's blog, The Capital Spectator.

Why You Should Bet Against The Dollar

2010-03-11T05:55:00.000-08:00

In the face of a relatively new bull market in the US dollar, contrarian investors may want to consider the effect of the last extreme dollar bull market. Given that the systemic problems in the US economy continue, especially compared with the much milder challenges in Europe and Japan, gold, which has continued to rise in value, appears to be an attractive contrarian play against the dollar. See the following post from Expected Returns.

There's nothing I love more than being a contrarian when sentiment reaches extreme levels. In the case of the dollar, extreme dollar bullishness amongst investors is signalling a potential turn. This is obviously very bullish for gold, which is off only 8% from the inception of the power dollar rally. From Bloomberg:

Investors are the most bullish on the dollar since the collapse of Lehman Brothers Holdings Inc. on speculation the U.S. economy will expand at a faster pace than in Europe and Japan, a survey of Bloomberg users showed.

The world’s reserve currency will rise over the next six months, according to respondents in the Bloomberg Professional Global Confidence Index. Sentiment toward the U.S. economy rose among the 1,612 participants in the survey, even as the outlook for global growth fell for a second consecutive month.

The dollar strengthened this month to the most since May against the euro on concern Greece’s struggles to close the biggest deficit in the European Union as a percentage of gross domestic product will weigh on the region. The Federal Reserve will raise interest rates before the European Central Bank and Bank of Japan, according to the median estimate of more than 30 economists surveyed by Bloomberg.

The high for the index was the 68.86 reading in September 2008, when Lehman’s bankruptcy drove investors to the dollar as a refuge. The Bloomberg Correlation-Weighted Index for the dollar rose the next two months.

Let's see what happened the last time dollar bullishness reached extreme levels in September 2008.

The dollar rallied quite powerfully from 76 to 88 on the dollar index over a 6- month period. As most of you will recall, September 2008 was a very volatile period in markets when companies were falling left and right. "Safety" became paramount, which to investors meant buying U.S. dollars.

The subsequent multi-month decline in the dollar made clear that the structural issues of the dollar haven't been resolved.

Now let's see what gold in this time frame. Since bottoming in September 2008, gold rose about 50% into March 2009, rising along with the dollar. Keep in mind that the stock market and real estate were getting crushed into March 2009.

Gold lived up to its historic role as a safe haven during the worst of this ongoing crisis. However, unlike the dollar, gold continued to rise into 2010.

European Debt Crisis Bullish for Dollar?

The dollar has been touted recently as a safe haven from the problems of the Eurozone. Since the debt problems in Greece are so huge, the Euro has been described as a currency to avoid. After all, Greece accounts for a staggering 2% of the European Union's GDP.

In contrast, the bankrupt state of California accounts for over 13% of America's GDP. New York just recently announced increased borrowing and draconian cuts to plug their huge budget gaps. How can the dollar be a safe haven with these structural fiscal problems from our largest states? Well it's not. The media has simply been successful in creating a convenient red herring.

There will be a time in the next few years when the volatility in the dollar and gold shocks people. We have been shoving the debt problem in America aside for far too long, and the day of reckoning is approaching.

This article has been republished from Moses Kim's blog, Expected Returns.

Is Anger Over Government Spending Warranted?

2010-03-11T05:52:00.000-08:00

The government faces angry constituents on both sides of the government spending issue. One group wants the massive spending to stop, but the other group is unwilling to accept the reduction in benefits they have come to expect. Tim Iacono discusses this dilemma in the following post from The Mess That Greenspan Made.

We live in interesting times, times that are no doubt going to get much more interesting in the years ahead and, unfortunately, probably more violent.

The recent demonstrations on California college campuses following the Tea Party protests of last summer bring up the intriguing possibility that we could actually see protesters against government spending and for government spending face off against each other in the streets.

Just the fact that people are protesting at all is probably a big step in the right direction as we've become a much too docile population over the last 20 years here in the U.S., but, multiple bursting asset bubbles and the realization by millions of parents all across the land that, for the first time in generations, the quality of life experienced by their children may pale in comparison to their own - all of this goes a long way in changing that.

The younger set seems to be pretty angry too.

Now, the little girl in the photo above probably doesn't understand the meaning of the sign she's holding but, in another fifteen years she likely will.

It's hard to say what motivates people to finally take action, but it looks like that's what they're doing now and that's probably a good thing.

The Tea Partiers

The Tea Partiers are a diverse group and, while I don't know this for fact, they are probably a lot less crazy than they are portrayed in much of the mainstream media. From what I've seen, they are mostly an older bunch who, understandably, don't like the way government has been spending money lately and think that we should all try to live within our means, something that hasn't exactly been typical of the U.S. government or its citizens in recent decades.

That appears to be changing.

We've come a long, long way over the last hundred years. Those who were adults during the Great Depression and who are still alive today are too old to get out and protest, however, it seems there are more than enough children of those who were scarred by the Great Depression and who can't figure out why the government has to spend so much money that they feel compelled to do something about it.

Anyone over the age of 50 surely knows hardship better than generations that followed, even if their worst pre-1980 experience was having to wait in gas lines, but, it's not clear whether the younger Tea Partiers really know what they're asking the government to do.

Dramatically reducing government spending on all sorts of things that millions of Americans have come to take for granted will cause untold hardship and, while we, as a nation, seem unprepared to embark on an "austerity program", there seem to be more than a few younger folks willing to give it a try.

We'd probably be better off in the end, but will people be able to endure it?

When you think about how unsustainable the current system is, it might be worth a try.

Budget reform doesn't come easily and, in the U.S. there is no better example of this than in California where the state seems hell bent on spending more than it takes in come what may.

Deep Denial

The fact is, there are millions of people in this country, many of them working in the public sector, who are in deep denial about what the government can and can't do.

The past 15 or 20 years have led many people to assume that things can continue as they've been going indefinitely, but, when you look at the prospects for credit-fueled economic growth over the next 15 or 20 years, you quickly realize that it's about run its course.

We've already entered a new era of slower growth and slower credit creation, both of which mean that the government has to spend less.

The notion that governments around the world (and particularly the U.S. government that is now in hock by many trillions of dollars with dozens of trillions more when you include unfunded liabilities) can continue to borrow and spend money at an ever increasing pace in perpetuity is, on its face, illogical and unacceptable to most people.

Sure, an argument can be made that governments will always have some level of debt that grows in a relatively stable relationship with the level of economic activity but, lately, we seem to be approaching escape velocity for that metric.

The result we see today is that people figure they can't spend more money than they make indefinitely and then they wonder why the government should think that it can.

Unless the folks in Washington and on Wall Street can figure out how to inflate another gigantic asset bubble that will make Americans think that they're getting wealthier again, we stand little chance of "growing our way out" of the current mess.

The Campus Protesters

But, the funny thing lately is that, in some parts of the country at the state and local level, the government is spending less and - surprise, surprise - people don't seem to like it. Those who benefit from government largess don't want the spending to stop.

You see these sort of protests in Greece and in other parts of Europe where the public has become conditioned to expect a certain level of benefits from the state and they don't really know or care where the money comes from.

I'll never forget that conversation a few years back with a retired schoolteacher who said that virtually all of the nation's problems can be easily solved by reducing classroom size by half. When queried as to how this would be paid for, the Pavlovian response was "raise taxes".

Just today, we received a note from the Census Department advising us that our 2010 Census form will be coming in the mail next week. Now, how much it costs to mail out this advance notice and whether it's effective in getting a better response next week is unknown, but, what is clear is that the text of the letter has some scary overtones (emphasis added).

Your response is important. Results from the 2010 Census will be used to help each community get its fair share of government funds for highways, schools, health facilities, and many other programs you and your neighbors need. Without a complete, accurate census, your community may not receive its fair share.

The part about an accurate census being important for divvying up government money makes sense, but the use of the phrase "government funds" and the word "need" makes it sound like the little guy doesn't have much of a choice in the matter - if the government thinks the little guy needs something, he'll get it.

This is surely not what the original foe of big government, Thomas Jefferson, had in mind when he oversaw the first census in 1790 required by the brand spankin' new Constitution.

On the Meaning of Austerity

It's still way too early in the process here in the U.S. to get a good read on this but, interestingly, despite all the recent protests in Greece about cuts in government spending and the new "austerity program" that has been forced upon the public, opinion polls show that the population at large would rather see the Greek government dial back on spending for the greater good.

My guess is that you'd find the same consensus here if the public were asked, though, it's unclear what the response would be if the question were to be stated in a way that identified the sacrifice that they, as an individual, would have to make. For example, if you asked social security recipients if they'd be willing to take a 10 percent cut this year to help steady the government's finances, would they be willing to do so?

As a side note, we've yet to hear the widespread use of the term "austerity program" in this country, but they sure seem to use it a lot overseas. It strikes me that they're really using the wrong word here because there is nothing about raising the retirement age from 61 to 63 by 2015 that should, in any way, be interpreted as being "austere".

Austere is not a relative term as in, things are pretty austere as compared to when the average life expectancy equaled the age at which you could start receiving retirement money from the government.

From Merriam Webster we get:

1 a : stern and cold in appearance or manner b : somber, grave
2 : morally strict : ascetic
3 : markedly simple or unadorned
4 : giving little or no scope for pleasure

"Austere" is definitely the wrong word here.

You Can't Get There from Here

The simple fact remains that people know in their gut that there's something fundamentally wrong in the world today when it comes to what governments are doing with their money and, even if they work in the public sector, they probably know that it's just plain wrong to borrow and spend so much with so little hope of paying it back.

Of course, when it's your family's livelihood that's at stake, you're much more likely to protest alongside the college kids than the Tea Partiers - that's just human nature.

The sad thing about the entire situation is that, realistically, both sides would be well served to lower their expectations for the kind of change they are seeking.

Conventional wisdom has it that developed nations don't really start getting into trouble until their budget deficit is 10 percent of their GDP or their debt service accounts for 10 percent of their overall spending. Here in the U.S. we've eclipsed the first measure and, with any appreciable rise in interest rates back to less-freakishly-low levels, we'll quickly surpass the second one too, due in no small part to the trillions of dollars in debt the folks in Washington have added in just the last few years.

But, that doesn't mean that the D.C. crowd will act any differently than they do now.

The status quo and entrenched interests in a two-party system dictate that the sort of change that is now needed won't come voluntarily and, no matter which party is in power, when it comes to spending, they'll both keep doing what they've been doing until the system just stops working.

The two sides on the debate over spending - the Tea Partiers and the college kids - should probably get used to the idea that neither will get what they want. The first group faces a generation of incumbents who only seem to care about the next election and the second group doesn't yet realize that, in the world today, they are asking for the impossible.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Is China Bluffing About Being Wary About Gold?

2010-03-10T05:58:00.000-08:00

Although a recent article appeared to indicate that China was looking to reduce its aggressive gold acquisition program while reaffirming its commitment to the purchase of US government-issued debt, the actual reality in the market may be significantly different. Given the perceived risk of long-term investment in US Treasuries, it is likely that their purchasing activity will continue to put positive pressure on gold prices in the future. See the following post from Expected Returns.

This is one of the more amusing articles I've read in some time. From the headline of the Reuters article, China says committed to U.S. debt, wary on gold, I was sure China announced some kind of monumental shift in policy. But alas, upon reading the article, I realized China was playing the same game Soros did when he called gold "the ultimate bubble"- before, of course, doubling his holdings of gold and investing $75 million dollars on a gold mining company. From Reuters:

"The U.S. Treasury market is the world's largest government bond market. Our foreign exchange reserves are huge, so you can imagine that the U.S. Treasury market is an important one to us," Yi Gang, head of the State Administration of Foreign Exchange (SAFE), told a news conference.

Yi dampened hopes of gold bulls that China might be itching to add to the 1,054 tonnes of the metal in its reserves.

On a 30-year horizon gold was not a great investment, he said, and China would simply drive up prices if it piled into the market.

"It is, in fact, impossible for gold to become a major investment channel for China'sBold foreign exchange reserves. I have 1,000 tonnes now, and even if I doubled that holding, according to current prices, that would be about $30 billion," Yi said.

Yi Gang is actually wrong. Gold was a horrible investment for a 20-year period, not 30. He should know, since China has increased their gold reserves from 454 to 1054 tons since 2003- a period in which gold has risen from $340 dollars an ounce to $1,120 dollars an ounce. Indeed, what a "horrible" investment.

I don't know what Yi Gang told us that we don't already know. Of course gold, which currently makes up 1.5% of China's forex reserves, can't make up a significant portion of China's portfolio. (For some perspective, France and Germany hold over 64% of their reserves in gold). But that's exactly what makes the outlook for gold so bullish, since even a modest increase of gold's allocation in China's portfolio would send gold prices to the stratosphere.

It's interesting that people are so quick to latch on to what China says, and not what it does. China is not only adding to its gold reserves, but it has pared its holdings of U.S. treasuries. No one in their right mind would own U.S. debt for the long run. It's going to be pretty clear in the years ahead that gold trumps U.S. Treasuries as an investment.

This post has been republished from Moses Kim's blog, Expected Returns.

Central Bank Warns Of Long-Term Job Problems

2010-03-10T05:57:00.000-08:00

The head of the Chicago Federal Reserve Bank recently indicated that the Fed will likely maintain its bias towards low interest rates due to the continuing lack of job growth in the economy. Furthermore, with this high unemployment, workers are taking longer to find work, which can ultimately lead to permanent income reductions for some workers as well as an extended period for the economy's job market woes to subside. See the following article from The Capital Spectator.

We've heard this before but we need to hear it again. Today the message comes from Charles Evans, president of the Chicago Federal Reserve Bank. "A number of labor market issues… lead me to think this accommodation will likely be appropriate for some time," he said in prepared remarks delivered at a speech in Washington. In other words, the central bank will keep interest rates low for the foreseeable future. The lack of job growth is the main catalyst. How long will the easy money last? "I think six months is a good time period to say I think we'll have accommodative policy like we have today."

If this is what passes for optimism, and arguably it is, there's a case for thinking that the crowd needs to recalibrate its expectations. Indeed, there's more at stake than speculating on when the price of money will rise. Low rates this time are a reflection of structural problems in the economy, and even looking out six months doesn't necessarily change all that much, even if rates start to move higher by that point. Evans laid out the ugly details in his talk today:

The rise in long-term unemployment may have ramifications for the economy going forward. The likelihood of finding a job tends to decline as an individual remains out of work for a longer period. Partly this reflects the fact that those who typically have a difficult time finding work will tend to be unemployed longer. In this case, longer spells are a symptom rather than the source of an underlying problem. However, a long unemployment spell could itself cause deterioration in a worker’s skills, leaving some of the long-term unemployed with less bright job prospects even as the economy begins to revive. This could contribute to high average unemployment duration for some time.

One of the smoking guns for thinking this is the future that awaits comes by way of the duration of unemployment. "In February," Evans explains, "over 40% of the unemployed were in the midst of a spell lasting more than six months, by far the highest proportion in the post-World War II era."

The trend of rising duration this time around was graphically shown in a chart Evans used in his talk, which is reproduced below. The graph plots the jobless rate (horizontal bar) vs. the average length, or duration, of unemployment since 1947. The basic trend is that duration rises as the unemployment rate increases. When the Great Recession began, the jobless rate was roughly 5% and duration was around 17 weeks. In other words, we began the current contraction in a weakened state that was substantially worse than usual. And it's deteriorated ever since.

Indeed, the red dots in the chart above show the monthly statistics for 2008 and 2009. The bottom line: the jobless rate and the average length of unemployment are at the highest in more than 60 years. This is disturbing for obvious reasons, along with some not-so obvious ones. As Evans said, "The likelihood of finding a job tends to decline as an individual remains out of work for a longer period." The not-so-astonishing implication:

…long-term unemployment tends to lead to permanent earnings losses, particularly for those who have previously invested heavily in job- or industry-specific skills. So, high unemployment durations could have long-lasting effects on consumer confidence and demand.

In other words, there's a heightened risk "that the recovery in labor markets could be slow even as output returns to a well-established growth path," he said.

You didn't necessarily hear it here first, but rarely has the warning been so loud and clear from the central bank's upper ranks.

This article has been republished from James Picerno's blog, The Capital Spectator.

CBO Says White House Budget Deficit Projection Too Low

2010-03-09T05:58:00.000-08:00

The record budget deficit may be even larger over the next decade than originally projected by the Obama Administration. While the citizenry of the country is concerned about its impact, the bond market has not yet expressed a clear opinion on the long-term effects of the large quantity of debt that the government has taken on, and on how that debt should be priced in the future. See the following post from The Capital Spectator.

It's all about deficits these days. The challenge is figuring out what it all means for the markets, the economy, the man on the street and for politics in Washington. What's crystal clear at the moment is that there's a bull market in red ink. That's hardly a surprise, although the debt estimates continue to creep higher. That latest example comes from the Congressional Budget Office, which published a new analysis on Friday of President Obama's budget outlook. The CBO concludes that the projected deficit for the decade ahead will be $1.2 trillion more than the White House predicts.

The reaction from the Republicans is predictable. "The news today from CBO is clear: The president’s budget will continue to lead our nation into a fiscal catastrophe—an ever worse one than the president’s own numbers suggest," says Paul Ryan (R-Wisconsin), a Republican on the House Budget Committee, via BusinessWeek.

The White House begs to differ, of course, arguing that it's making the best of a bad situation. "That is why even as we increased our short-term deficit to rescue the economy, we have refused to go along with business as usual, taking responsibility for every dollar we spend, eliminating what we don’t need, and making the programs we do need more efficient," the administration's Office of Management and Budget asserted when it released its forecast last month.

Perhaps the question is whether the budget plans are too heavily focused on spending, or weak on raising sufficient revenue to pay for the plans. The answer depends on your perspective. Consider this excerpt from CNNMoney.com:

The CBO cited two big contributors to the jump in debt.

One is the president's proposal to extend the 2001 and 2003 tax cuts for the majority of Americans. The other is the proposal to protect middle- and upper-middle-income families from having to pay the Alternative Minimum Tax (AMT).

Together those proposals would cost $3 trillion between 2011 and 2020.

"It points out the unwillingness of the administration to raise the revenues to pay for the size of government being proposed," said Robert Bixby, executive director of the Concord Coalition, a deficit watchdog group.

Is the Obama administration a victim of its own optimism? Not necessarily, says Jim Horney of the Center on Budget and Policy Priorities. "It's not that the administration has a rosy scenario, but the CBO is a little less optimistic about income growth," he tells The Hill.

Regardless of one's political views, the rising level of debt is affecting the public's attitude. "More than twice as many U.S. adults (58%) say that debt owed to China is a more serious threat to the long-term security and well-being of the U.S than is terrorism from radical Islamic terrorists (27%)," according to a new a new Zogby poll. What's more, there was little variation by political affiliation. Democrats, Republicans and independents were in agreement by a wide margin that debt was the number-one threat.

The big question is when (if) the bond market's views will change. The benchmark 10-year Treasury remains in the upper 3% range, where it's been since last summer.

The muted outlook on economic recovery is one reason. But the real issue is deciding how long the fixed-income set will stay calm and give the government the benefit of the doubt. There's a compelling argument for thinking that the price of money should stay low in a time of diminished expectations. Unfortunately, that's just an assumption and it's not clear that it's written in stone.

This article has been republished from James Picerno's blog, The Capital Spectator.

Why There Is Resistance For Government Creating Jobs

2010-03-08T05:59:00.000-08:00

Why do we hesitate to create jobs when we know people are struggling and could use some help? One reasons is that it can be difficult to reconcile helping a stranger who you will never meet by hiring him to do work that may not benefit you. Mark Thoma from Economist's View discusses the resistance for more government spending to create needed jobs.

In a town in a country suffering through a recession, a wealthy person just happens to live next door to an unemployed worker. The worker has experience in a variety of trades, and is quite competent, but despite his skill and reputation, there are no jobs to be found. And it isn't for lack of trying.

Seeing this, and having a kind heart, the wealthier of the two -- much, much wealthier -- decides his neighbor needs a job, so he sets about creating one. The first option he considers is just to find something for him to do, it doesn't much matter what, digging holes and then filling them up, whatever. He decides that if he goes this route he will ask his neighbor -- wink wink -- to watch his grass grow. Both of them know this is a ruse, a made up job to justify the payment, but somehow having the ruse in place allows the unemployed neighbor to keep his dignity in a way a direct cash payment would not. It's a job not a hand out -- he does have to look out his window a few times a day to make sure it the grass is growing like it's supposed to. But practically it's a means of support for the neighbor and his family that allows him to continue his diligent search for a job.

But then the wealthy neighbor thinks, why not hire the unemployed neighbor to do something useful with his talents? Sure, it will make it harder for him to look for another job if he's working hard here all day, but he's a good builder and there must be something I need. Maybe, for example, the fence could be replaced. He was going to replace it in a few years anyway and, although it would last a bit longer, why not fix it now and take advantage of the fact that the neighbor can be hired for much less than it would take to hire a fencing company? The quality of the work will be just as good. And there must be other things that could be done both inside and outside the house as well.

There is one problem, he realizes, with the fence building option. Unlike the watching the grass grow job which could have started the next day, it will take him awhile to pick out the fence style he wants, to plan it, to get the materials for the neighbor (who can't finance it himself since he's unemployed), and so on, but maybe not too long if he gets on it right away. But it is a close call - the family is hurting - and any delay makes it worse.

Still, building the fence turns out to be the solution chosen. It's a generous arrangement, and everyone feels as though they are getting something. And it dispels any myth that jobs cannot be created. By hiring a neighbor to do something, especially something productive, a job is created that wouldn't have existed otherwise. Since the payment for the fence materials and the fence work comes out of saving, saving that would not have been spent until a few years later, it also increased the demand for goods and services overall, perhaps just enough to save a job at one of the places where the money is spent or even help to create a new job. (The money is just sitting in the banks doing nothing due to all the fear and loathing about loaning it out, i.e. the money spent on the fence is not being used by the bank to finance alternative investment. It's as though the money was hidden in the house in a cookie jar or something. It would have been used later, but is being used now instead and that generates extra demand.)

So here's the question. Why does having government involved make any difference? Government can act as an intermediary, take the money from the wealthy person, and use it to finance projects such as new infrastructure. This type of social insurance creates jobs just the same as someone can create a job when they hire a neighbor to build a new fence or repair one that is falling down.

One difference is that the money goes for the social good, not the individual good. Suppose the money is used to build a fence at a local park. The wealthy person might not object if he or she uses the park frequently and would somehow benefit from a fence. But if the money goes to finance something that the person doesn't want or don't need, there might be quite a bit of resistance.

But that is a question about the social benefits from how the money is used, it has little to do with the question of whether jobs can be created. Just as the wealthy neighbor can hire the unemployed worker next door to build a needed fence or to watch the grass grow, government can do the same, and do it with the same motivation -- empathy for those who are struggling to make it through the recession. If those paying taxes don't share that empathy -- if the people paying the bills don't think those receiving the money deserve it according to some moral code, if they can't see much direct of indirect value for themselves from the expenditure they are forced to finance, and if they don't think this is their responsibility -- there will likely be strong resistance to paying the bill (partly because the personal relationships needed to generate empathy aren't there).

So yes, to the extent possible, job creation projects should be used to finance needed infrastructure so that we do not have to rely on empathy. When the benefits are large and obvious to all, the resistance to such spending is minimized.

But that may not be possible. If the wealthy neighbor doesn't need anything done or doesn't have enough projects to keep the unemployed neighbor busy -- he had just hired people to fix his fence last week and can't think of anything else he needs, or the things that are needed would take to long to get started, what then if he still wants to help? He will have to find what he can for the unemployed neighbor to do -- there's usually something that is needed. And if, in the end, it comes down to the equivalent of watching grass grow (and it's very clear the neighbor is trying as heard as he can to find a permanent job), then it may be time to give a wink and do just that. The alternative is to simply say I'm sorry, there's nothing I can think of to hire you to do, neighbors aren't my responsibility anyway -- I hardly know you people -- and then turn and walk away leaving the neighbor and his family to continue struggling. And maybe that is the right answer. That is, it's the right answer until the day comes when you lose all your wealth in the Great Crash of 2015 and your neighbor, who has done extraordinarily well and has never forgotten the help you gave him, steps in to return the favor.

Of course, not all of us are lucky enough to have rich, empathetic neighbors willing to help out when we are down on our luck, nor can we necessarily expect reciprocity when we are in need. But that's OK, we do have fiscal policy -- a form of social insurance -- and other types of social insurance to play this role.

Fiscal policy can create jobs and provide other types of help just like a wealthy, benevolent neighbor. Yes, if you are able, if you are one of the fortunate ones, the presence of social insurance requires you to pay to help those who in need. But even if the money isn't used to finance something you want, or if it is essentially given away through make-work to people you don't think deserve it, people that you care nothing about and that aren't your responsibility in any case, you will still benefit. Because even though you are certain it could never happen to you, in fact it can happen to you, and if it ever does social insurance, including job creation, will be there for you too. Only then will you truly understand the real value that this insurance provides.

This post has been republished from Mark Thoma's blog, Economist's View.

Will China Finally Allow The Yuan To Rise Against The Dollar?

2010-03-08T05:52:00.000-08:00

Yesterday, the head of China's central bank suggested that China may allow the value of the yuan to increase relative to the dollar, but he refrained from indicating when this major change would be allowed to occur. A change in policy could increase US interest rates and lower the trade deficit. See the following post from The Capital Spectator.

Is China's undervalued currency set to rise? That depends on how you interpret yesterday's comments from the governor of China's central bank.

"The chief of China's central bank reportedly suggested Saturday that the nation may decide to let its currency rise vs. the dollar, but he gave no clues as to when that might happen," TheStreet.com reported. Meantime, The New York Times tells us: "China’s Bank Chief Says Currency Is Unlikely to Rise."

No matter how you interpret Zhou Xiaochuan's comments yesterday, there was enough innuendo and implication to support almost any forecast. Consider this tantalizing remark via The Telegraph: “If we are to exit from irregular policies and return to ordinary economic policies, we must be extremely prudent about our choice of timing,” Zhou said. “This also includes the [yuan] exchange rate policy.”

Such oblique observations will keep the rumor mills rolling and the forex traders trading. In any case, the stakes could hardly be much bigger for the global economy, and the U.S. in particular. The Middle Kingdom’s GDP (at purchasing power parity) is second only to the U.S., or third if you consider the European Union a single country, according to the CIA World Factbook. And while large economies tend to expand at relatively low rates compared with smaller nations, that doesn’t yet apply to China, which is estimated to have grown at a real rate of 8.4% last year, according to the CIA—exceeded only by four other countries, all of which are tiny by comparison.

“A country’s exchange rate cannot be a concern for it alone, since it must also affect its trading partners,” the FT’s Martin Wolf recently argued. “But this is particularly true for big economies. So, whether China likes it or not, its heavily managed exchange rate regime is a legitimate concern of its trading partners. Its exports are now larger than those of any other country. The liberty of insignificance has vanished.”

That’s a diplomatic interpretation of how America views China and its currency. Robert Lawrence Kuhn, an international investment banker and longtime adviser to the Chinese government, summarizes the American perspective in somewhat harsher tones. "China is seen as a mercantile predator which keeps its currency artificially low to boost exports and steal jobs…", he writes in his new book How China's Leaders Think: The Inside Story of China's Reform and What This Means for the Future. Beijing begs to differ, Kuhn acknowledges. "China's leaders, of course, do not deny that their policies benefit their own people. But they assert that, in an integrated global economy, China's stability and development is essential for world peace and prosperity."

For good or ill, the global ramifications are huge. Keeping the yuan undervalued boosts China's exports, a major reason for America's trade deficit, which in turn creates an incentive for China to buy U.S. Treasuries as a tool for keeping its currency cheap relative to prices implied by trade flows. One result of this policy is that U.S. interest rates have been lower, perhaps a lot lower than they otherwise would have been. Economist Robert Barbera, writing in The Cost of Capitalism, explains the linkage in recent years:

Low mortgage rates, booming housing refinance, and strong consumer spending defined 2002-2005. Much of the spending was on products made in China. Incredibly, over the first five years of the new decade, China's exports to the United States rose from 4 to 11 percent of nonauto U.S. retail spending. China's excitement about this export boom led directly to its strategy for conducting monetary policy. Central bank authorities were willing buyers of the U.S. dollar in order to make sure that there was very little change in the dollar/Chinese yuan exchange rate.

Accordingly, they bought the U.S. dollars that Chinese manufacturers collected for their exports. They bought the dollars that U.S. multinational corporations spent as they built factories in China. They bought the dollars U.S. investors funneled into Chinese real estate. In total, these purchases led to China's accumulating trillions of dollars' worth of U.S. Treasuries in a remarkably short period. If we accept the assertion that China's bond buying kept mortgage rates low in the United States, we come to an interesting conclusion. China kept U.S. long rates low by lending trillions to the United States. Low mortgage rates allowed Americas to borrow against their homes and use the proceeds to spend. And, increasingly, they bought products that were made in China—vendor financial on a trillion-dollar scale.

The benefits, and repercussions, from the low rates are, of course, well known at this point. But while most of the world we knew under the regime of the Great Moderation is gone, one of its basic building blocks remains intact. But is China's undervalued currency finally living on borrowed time?

The yuan is essentially unchanged in dollar terms since mid-2008. Almost everything else in the global economy has changed, been repriced or reassessed. Will the status quo as it relates to China's currency roll on?

"It is encouraging that Gov. Zhou's statement suggests that the move to a managed float of the renminbi will be resumed once the global recovery firms up," Eswar Prasad, a professor of trade policy at Cornell University, told The Wall Street Journal yesterday. "Maintaining an undervalued exchange rate certainly benefits China, but at the expense of other countries that lose their relative competitiveness in foreign trade."

As complicated as all this is, the reality is even more Byzantine. Trade policy is but one slice of the U.S.-China relationship. The challenge is deciding how one corner influences another. Washington's stance on Taiwan, for instance, and China's reaction (including the latest announcement from Beijing), is one of many reminders that the game's is three-dimensional chess.

"Just as the nineteenth century belonged to England the twentieth century to America, so the twenty-first century will be China's turn to set the agenda and rule the roost," Jim Rogers advised in A Bull in China. Figuring out what that means in geopolitical and macroeconomic terms has only just begun.

This post has been republished from James Picerno's blog, The Capital Spectator.

Government To Subsidize Short Sales

2010-03-08T03:52:00.000-08:00

Starting April 5, the government will begin offering a small benefit to both homeowners and lenders to engage in short sales instead of foreclosing on properties in default. The effect of this program may force properties to be sold at discounted prices, thereby continuing the downward spiral in property values. See the following post from Expected Returns.

From Obama's plan to ban foreclosures to the perpetual extension of "temporary" homebuyer tax-credits, I think it's safe to say government intervention in housing is getting ridiculous. In the latest example of government largesse at the expense of taxpayers, the government is proposing to dole out cash to all parties to incentivize short sales. From the New York Times, Short-Sale Program Will Pay Homeowners to Sell at Loss:

In an effort to end the foreclosure crisis, the Obama administration has been trying to keep defaulting owners in their homes. Now it will take a new approach: paying some of them to leave.

This latest program, which will allow owners to sell for less than they owe and will give them a little cash to speed them on their way, is one of the administration’s most aggressive attempts to grapple with a problem that has defied solutions.

For the administration, there is also the concern that millions of foreclosures could
delay or even reverse the economy’s tentative recovery — the last thing it wants in an election year.

Taking effect on April 5, the program could encourage hundreds of thousands of delinquent borrowers who have not been rescued by the loan modification program to shed their houses through a process known as a short sale, in which property is sold for less than the balance of the mortgage. Lenders will be compelled to accept that arrangement, forgiving the difference between the market price of the property and what they are owed.

What the government doesn't realize is that incentivized short sales will, ironically, bring down home prices. Essentially, short sales "lock in" lower home prices, pressuring surrounding home prices in the process. If the sole purpose of government intervention is to keep home prices elevated, then the government should take on a hands off approach, since banks are already doing such a great job of perpetuating the myth of stabilizing home prices.

What Benefits?

Under the new program, the servicing bank, as with all modifications, will get $1,000. Another $1,000 can go toward a second loan, if there is one. And for the first time the government would give money to the distressed homeowners themselves. They will get $1,500 in “relocation assistance.”

Should the incentives prove successful, the short sales program could have multiple
benefits. For the investment pools that own many home loans, there is the prospect of getting more money with a sale than with a foreclosure.

This doesn't make sense to me. Short sales by definition are more beneficial to servicing banks than foreclosures- that's the whole logic behind them. It's doubtful that $1,000 dollars will have much effect on banks' incentive to complete short sales on homes that are worth, on average, hundreds of thousands of dollars.

What will likely happen is that the government will be handing out money to multiple parties on short sales that would have occurred anyway, which is idiotic, but entirely in line with what I've come to expect from the government.

It's interesting that the government has essentially reversed its policy of forestalling foreclosures. It's pretty clear the government now realizes there won't be a rebound in home prices anytime soon. If the government thought home prices would recover, they would be doing everything to keep people in their homes so that the rise in home values would improve equity positions. A supposedly improving employment picture would further decrease the likelihood that homeowners would foreclose.

All of these projections are straight from fantasy land, and the government knows it, since they're the ones who manipulate government statistics. Read between the lines and realize that a housing recovery is not forthcoming.

This article has been republished from Moses Kim's blog, Expected Returns.

Homes Sales Disappoint As Housing Stimulus Fades

2010-03-05T05:53:00.000-08:00

The number of buyers placing homes under contract fell in January across the country due to what the media described as weather-related issues, obscuring the larger economic issues in place. As the economy continues to stutter without job creation and with the effect of government stimulus programs fading, the tight lending environment is preventing people from purchasing homes. See the following post from Expected Returns.

The short-lived economic "recovery" sure is running out of steam. I guess over $10 trillion dollars in in stimulus and pledges on behalf of taxpayers just doesn't buy what it used to. From Finance Yahoo, Pending home sales fall 7.6 percent in January:

The number of buyers who agreed to purchase a home fell sharply in January, a sign that demand for housing is sinking this winter as stormy weather slammed Eastern states.

Record snowstorms in January and February had many Americans shoveling sidewalks and driveways instead of combing through listings for open houses. Partly as result, seasonally adjusted index of sales agreements fell 7.6 percent from December to a January reading of 90.4, the National Association of Realtors said Thursday.

It was the lowest reading since last April and a disappointment to economists, who had expected it would rise to 97.6.

The weakness, however, was not confined to the wintry Northeast. The biggest month-to-month drop was in the West, where sales fell 13 percent. Sales fell almost 9 percent in the Northeast and Midwest and 2 percent in the South.

From the way the media spins things, you would think a couple of blizzards are doing more damage to our economy than decades of unsustainable debt accumulation. It's pretty comical, especially since the biggest month-to-month drop in home sales came in the West coast. But hey, let's not let facts get in the way.

The reason home sales are cratering is a matter of simple economics. The government merely shifted demand forward via its first-time homebuyer tax-credit, which provided a temporary boost to sales. There really is no free lunch- the tax-credit induced spike in demand must be balanced by weakness in demand in subsequent months.

Furthermore, without job creation, there can be no sustainable recovery in housing. Anyone who thinks otherwise is living in fantasy land.

The weather isn't the only culprit, wrote Jennifer Lee, an economist with BMOCapital Markets. "The impact of government incentives ... appears to be running out of steam, which is, frankly, a scary thought," she wrote.

The index is considered a barometer for future sales because typically there is a one- to two-month lag between a signed sales contract and a completed deal. A reading of 100 is equal to the average level of sales activity in 2001, when the index started.

The index has declined for two out of the past three months because home shoppers feel less rushed after a deadline for a homebuyer tax credit was extended from Nov. 30 to April 30.

Home shoppers aren't feeling "less rushed" because of the recent extension of the homebuyer tax credit- they're feeling "less rushed" because they're dead broke and have no access to credit. Please refer to the chart below, which shows real estate loans are contracting at an epic clip.

Notice how real estate loans stabilized and turned up in every single economic recovery since WWII. Apparently "this time is different" and the economy is magically recovering while access to credit is absolutely cratering. Sorry, but I'm not buying it.

This post has been republished from Moses Kim's blog, Expected Returns.

The Expectation Is That Job Expansion Is Near

2010-03-05T05:48:00.000-08:00

The last weekly update on economic claims contained a glimmer of hope with a decrease in new unemployment filings. The trend of declining new jobless claims is often a leading indicator of the return of job growth as firms anticipate improving economic conditions. See the following post from Capital Spectator.

Today’s weekly update on new jobless claims offers a reprieve on the darker visions conjured on these pages in recent weeks, including here. New filings for unemployment benefits dropped last week to by 29,000 to 469,000. Whew, that was a close one! But the risk for this series that we’ve been discussing lately is still with us, even if the latest report offers some breathing room for thinking positively.

The good news is that there was no follow-through on the recent rise in new jobless claims, at least not yet, as our chart below shows. The charitable interpretation, bolstered by today’s number, is that it was all a statistical quirk; a February fluke caused by the heavy snows last month. Or maybe it was the normal short-term volatility that tends to plague this dataset. But while there’s a slightly stronger case for arguing that jobless claims aren’t set to rise, there remains the more pressing question of when this series will resume falling?

It’s going to take weeks to answer that question. In the meantime, we’re left to wonder if jobless claims have hit a floor, temporary or otherwise. If that proves to be the case, that’s almost as troubling as watching claims rise because it would suggest that the labor market’s recovery, already weak if not feeble, may be facing more stress than previously realized.

Watching jobless claims, while hardly a silver bullet, is among the early warning signs of things to come. Recent history appears to back up the idea that initial claims offer a clue of what’s coming for the business cycle and the labor market. The fact that jobless claims were falling for much of last year was a sign that job destruction in nonfarm payrolls was slowing and that the GDP contraction had ended. That's hardly unique to the present cycle, as we've discussed. The forward-looking ability in jobless claims is well understood in the dismal science, as noted, for instance, in a St. Louis Fed report from a few years ago. Meanwhile, economics professor Todd Knoop explains in Recessions and Depressions,

Initial unemployment claims are more sensitive to changes in the business cycle than total unemployment. Unlike total unemployment, which lags peaks and troughs because of lags in the hiring process, initial unemployment claims are a leading indicator because firms anticipate changes in economic conditions and increase layoffs before production and decrease layoffs before conditions improve.

Where does that leave us with the latest numbers? Watching, waiting and worrying. Initial jobless claims appear to be at a crossroads. "Firing activity has largely tapered off, but new hiring has yet to pick up, Zach Pandl, an economist at Nomura Securities International, tells Reuters. That's not inherently troubling, except when you consider the current context: an unusually long stretch of non-recovery in the labor market, i.e., job growth.

Ethan Harris, head of economics for North America at Bank of America/Merrill Lynch, opines in a Bloomberg TV interview that “we are in this limbo state where it is not clear if job growth has started yet.” But he's hopeful and predicts that the limbo will give way to expansion, explaining: “Many companies say they over-reacted and fired a lot of people, more than they needed to, with the news of the recession. So, we’re expecting broad-based re-hiring.”

But the future is one thing, and the here and now is something else. At the moment, the labor market seems to be betwixt and between, neither contracting nor growing. The expectation is that expansion is near. We'll learn in tomorrow's jobs report for February if near is now.

This post has been republished from James Picerno's blog, The Capital Spectator.

More Red Ink For The Job Market In February

2010-03-04T05:46:00.000-08:00

Unofficial job reports from ADP and Challenger, Gray & Christmas show another month of net job losses in February. While the losses continue to shrink, a huge number of new jobs will be needed to put a dent in the 8 million jobs lost since the recession began. See the following post from The Capital Spectator.

Two new private-sector reviews of last month’s labor market show that the economy is still shedding jobs. The only good news is that the rate of loss continues to slow. But a loss is still a loss at this late date in the economic cycle, and today’s numbers suggest that Friday’s monthly update on jobs from the government may suffer another round of red ink, albeit in relatively mild form.

The ADP National Employment Report advises that nonfarm private payrolls in the U.S. slipped by 20,000 last month. "The February employment decline was the smallest since employment began falling in February of 2008," according to the accompanying press release.

Was winter weather to blame? Perhaps, although ADP minimizes that gremlin. Again quoting from the company's press release:

Two large blizzards smothered parts of the east coast during the reference period for the BLS establishment survey. The adverse weather had only a very small effect on today’s ADP Report due to the methodology used to construct it. However, the adverse weather is widely expected to depress the BLS estimate of the monthly change in employment for February, but boost it for March. Therefore, it would not be unreasonable to expect the BLS estimate for February (due out this Friday) to be less than today’s ADP Report even though the BLS estimate will include the hiring of temporary Census workers not captured in the ADP Report.

It's come to this: hoping for salvation from the Census Department. So it goes at a time when any scrap of good news, temporary or otherwise, is pounced upon as a pinpoint of light in the dark tunnel of job creation.

Meanwhile, another report from employment services firm Challenger, Gray & Christmas reports more than 40,000 jobs were eliminated last month. That's comfortably below January's 70,000-plus cuts, the firm notes via CNNMoney.com. Nonetheless, it's hard not to notice that two independent reports today indicate the same general trend: another round of job losses for February.

If the Labor Department's update on Friday makes it three, February's retreat will mark nonfarm payrolls' net decline in 25 of the previous 26 months, according to the official government tally. Yes, it's getting better, which is to say the losses are diminishing, but the question still remains: When is net job growth coming? As we wrote last month, "the longer this drags on, the higher the odds that we're facing an even weaker post-recession job recovery than previously anticipated."

With each passing month of loss, the stakes are higher for the necessity of minting jobs. The real challenge isn't one of simply seeing a net gain on the payrolls ledger. That's coming, and perhaps soon. But what's needed is more than a statistical change, i.e., a lengthy stretch of large gains on the order of 200,000, 300,000, and more a month. Unfortunately, almost no one expects that's imminent. Yes, seeing 10,000, 50,000 or even 100,000 net new jobs will be refreshing (when it actually arrives), but that thimble of repair is no match for the tidal wave of 8 million-plus lost jobs since the Great Recession began in December 2007.

As troubling as this is, it's all the more problematic in a world that's just coming to terms with the debt and deleveraging that's weighing on the global economy. Greece and, increasingly, Britain are only the beginning of new world order. The U.S. is part of this infamous club too. And let's not forget the veteran of debt and deleveraging: Japan.

What are the implications for all this red ink? History suggests remaining humble in forecasting a quick and easy solution.

This post has been republished from James Picerno's blog, The Capital Spectator.

Will Too Much Government Intervention Prevent An Economic Upturn?

2010-03-03T05:53:00.000-08:00

The key problem with government's relationship to the larger economy is how to harness the power of a capitalist system to drive growth and prosperity while smoothing out the bumps caused by the reversals which are a natural part of the business cycle. As the government moves back to a Keynesian model calling for high levels of intervention, it risks over-regulating and, in an attempt to smooth out the downturn, it could actually prevent an upturn in the economy. See the following post from The Capital Spectator.

Everyone has a prescription for managing the business cycle these days, but no one has a solution. That’s because there are none, at least nothing that passes the smell test of a workable system that can deliver nirvana: maintaining capitalism’s power to drive economic growth while eliminating its tendency for stumbling from time to time.

Bridging these two facets, which are inextricably linked, is at the center of the debate. Obvious solutions, however, are elusive, and probably always will be. The fact that a range of policies have been tried over the decades, and delivered mixed results, is testament to the idea that there's always a cost to every "solution."

No less a critic of unfettered capitalism than Hyman Minsky recognized the limits of pushing too far on one end without biting too deeply into the benefits on the other side. “We need to embark on a program of serious change even as we need to be aware that a once-and-for-all resolution of the flaws in capitalism cannot be achieved,” Minsky wrote in Stabilizing an Unstable Economy. "Even if a program of reform is successful, the success will be transitory. Innovations, particularly in finance, assure that problems of instability will continue to crop up; the result will be equivalent but not identical bouts of instability to those that are so evident in history."

Finding the middle ground won't be easy this time, but it should be tried, argues economist Bob Barbera in last year's The Cost of Capitalism. He wisely notes that "one cannot forget that the essential driver in free market capitalism is the risk-taking entrepreneur, bankrolled by the world of finance. Enlightened societies, therefore, need to embrace free market capitalism, coupled with policies aimed at increasing margins of safety and tempering flights of fancy."

The challenge is figuring out exactly where productive policy prescriptions end and self-defeating market regulation begins. In fact, much of the political and economic debate since the 1930s in the U.S. has been focused on that question, and the results to date are still mixed.

Keynesian intervention of one sort or another is widely embraced as the general framework for finding this sweet spot these days, but past missteps and excesses in applying the principles outlined in The General Theory of Employment, Interest and Money should give one pause for expecting too much. In the 1970s, an active fiscal policy intent on maintaining full employment backfired with stagflation.

Some say the errors in the '70s was less about Keynesian failure vs. an oil price shock and loose monetary policy. In any case, defenders of aggressively managing the business cycle fell out of favor. In the wake of the downfall rose the neo-classical economists led by Milton Friedman. Although Friedman's insights and opinions ranged far and wide, his basic prescription was one of favoring markets and recognizing the power of monetary policy for good or ill. As he and Anna Schwartz argued so persuasively in A Monetary History of the United States, 1867-1960, the central bank's printing presses are a critical and often overlooked factor in the ebb and flow of economic fluctuations.

But there's a case to make that the Fed ignored the lessons of history and kept monetary policy too loose for too long for much of the first decade of the new century. Are we doomed to repeat history? Even when the lessons are clear?

Now the pendulum is swinging back toward a Keynesian view of the world, or perhaps a Keynesian/Minsky interpretation, and not without cause. Certainly there's a case for seeing the banking sector as something unique in the economic sphere. There's a limit to letting free market forces have their way with banks, which is part of the reasoning for central banking. The lender of last resort is a concept that arose out of necessity. Letting banks fail runs the risk of allowing a bank run to terrorize the economy.

At the same time, there's a limit to how much government can do to minimize the risk of financial failure. As Jean-Charles Rochet explains in Why Are There So Many Banking Crises? The Politics and Policy of Bank Regulation, "supervision [of banks] and market discipline are more complements than substitutes: one cannot work efficiently without the other."

Government management of economic cycles is arguably necessary to some degree but also dangerous if it goes too far and costs too much. It's too early to say what's excessive in the current climate, but some early clues suggest that countries that have boldly embraced Keynesian policies are setting themselves up for failure, as a recent Bloomberg article suggests:

The U.K. has produced notable economists over the years, but John Maynard Keynes, the guru of government intervention, was one of truly global significance.

So it may be fitting that the U.K. will also become the deathbed of Keynesian economics.

Britain has been following the mainstream prescriptions of his followers more than any developed nation. It has cut interest rates, pumped up government spending, printed money like crazy, and nationalized almost half the banking industry.

Short of digging Karl Marx out of his London grave, and putting him in charge, it is hard to see how the state could get more involved in the economy.

The results will be dire. The economy is flat on its back, unemployment is rising, the pound is sinking, and the bond markets are bracketing the country with Greece and Portugal in the category marked “bankruptcy imminent.” At some point soon, even the most loyal disciples of Keynes will have to admit defeat, and accept that a radical change of direction is needed.

Finding the balance between enlightened regulation that maximizes the benefits of free market capitalism is akin to searching for the optimal balance between democracy and sidestepping the tyranny of the majority. The definitions, standards and results are forever in flux, which means that there are no true solutions. The idea that a market economy can be "tamed" is naïve, but so too is the expectation that an uncritical embrace of free markets will be politically acceptable and economically viable. Somewhere between those two extremes lies a reasonable balance. Exactly where, and on what terms, is debatable, now and forever.

The great challenge is coming to terms with two halves of the same economic coin: The business cycle can't be tamed, but neither can it be left untended. If this sounds like a paradox wrapped in a contradiction, you're right--it is. Welcome to macroeconomics.

This post has been republished from James Picerno's blog, The Capital Spectator.

Despite Claims, Economy Is On The Verge Of Depression

2010-03-03T05:48:00.000-08:00

Although many sources continue to claim that the United States economy is in recovery, in the face of continued high unemployment a strong argument can be made that the economy is, in fact, still on the verge of a depression. Moses Kim supports this argument with the fact that unemployment is still double that at the beginning of the recession with long-term unemployment still climbing. See the following post from Expected Returns.

Doublethink means the power of holding two contradictory beliefs in one's mind simultaneously, and accepting both of them. - George Orwell

"Jobless recovery" anyone?

We truly live in interesting times when the public can so thoroughly be fooled about an economic recovery that has no basis in reality. If people would turn off their TVs for a second, they would have a much different view of the economy. At the very least, we are mired in a deep recession- although it is very likely we are in a depression.

No matter what times you live in, it is virtually guaranteed that a proportion of the population will always blindly believe any lies that are fed to them. Economic depressions are difficult to forecast since there are so many "dead cat bounces", which are always misdiagnosed as economic recoveries, on the journey to the abyss.

Unemployment

If the recession is truly over, then logically, there should be some kind of real improvement in unemployment data. However, a comparison between December 2007 (when the recession officially began) with today shows that unemployment is deteriorating.

Our unemployment rate has doubled from the start of the recession, and somehow, magically, we are out of the recession? What an insult to any thinking adult's intelligence.

Long-term Unemployment

Long-term unemployment, or unemployment with a duration of more than 27 weeks, is still rising, and poses huge obstacles to a potential recovery. Although it looks as though legislation will be passed to extend unemployment benefits, the fact remains that states have no money. The Federal government is broke too. In order for a true recovery to materialize, we need to create private sector jobs and end the entitlement mentality that has silently penetrated the psyche of Americans.

I don't know about you, but it looks to me as if the unemployment situation is far worse than it was in December 2007.

Housing Downturn Resumes

At this point it should be clear that the Obama administration has no power to reverse the downward spiral in housing. I've lost track, but I believe people have been calling the bottom in housing for what, 2 years now?

Arguments for a recovery in housing that never arrives go something like this: housing has already gone down 20%, it can't possibly go any lower. Then housing goes down another 10%, and the same logically deficient arguments for a housing recovery continue.

Let's try to detach ourselves emotionally for second and just look at some key data points that will help determine where housing is going in the future.

New Home Sales Cratering

Right around March and April, everyone was calling for the bottom in housing. By August, there was outright euphoria about the "worst being over." Utter nonsense at the time, although it was hard to talk sense to people who didn't understand the bigger picture.

Now that new home sales have "unexpectedly" cratered to a record low, cheerleaders have gone back into hiding. Think about how amazing this is for a second. We have mortgage rates at record lows, first-time homebuyer tax credits, and lax lending standards courtesy of the FHA- yet home sales are way down. I'm telling you, when the government backs off to prevent an utter disaster in the bond and currency markets (although this is no guarantee given the stupidity of our leaders) this is going to get nasty.

Inventories on the Rise

Plunging new home sales exacerbate the crisis of excess inventories, and this doesn't even include the growing shadow inventory of homes lingering on banks' balance sheets. There is a hidden foreclosure crisis in America that will become apparent in 2010. I don't see how housing prices can recover at the same time inventories, mortgage rates, and unemployment rise.

The downward spiral in housing was first a subprime and mortgage backed security crisis. We are now entering a period where the housing crisis is synonymous with the unemployment crisis. The coming wave of foreclosures will be driven by levels of unemployment we haven't seen in generations. The government can manipulate unemployment statistics all they want, but sooner or later, the real unemployment situation will be reflected in tremendous weakness in economic activity.

Our economic system is so dynamic that adding just one new variable to the equation has massive consequences. I don't know exactly what the catalyst will be, but there are way too many bullets for us to dodge in housing for me to be bullish.

This article has been republished from Moses Kim's blog, Expected Returns.