Recession without Romance

[EJ]

Recession without Romance

Even smart contrarians are confused about our predicament

Paul B. Farrell, one of my favorite economics writers at MarketWatch, published 17 reasons America needs a recession today to make the case, "Yes, America needs a recession. Bernanke and Paulson won't admit it. And investors hate them. We're all trapped in outdated 1990s wishful thinking about a 'new economy' and 'perpetual growth.'"

While I appreciate the sentiment and have expressed similar views such as in Upside Down to Right Side Up, fact is the U.S. cannot have the kind of recession Farrell describes this time around because the antecedents preclude it. The problem is rooted in both the source of our current economic challenges and the political mandate to mitigate them that far predates the 1990s. The moral hazard of reflation became embedded in U.S. economic policy after The Great Depression; the mandate became "No more Great Depressions."

The Fed, Treasury, and Congress have been fighting the recession we forecast last fall as due to start in Q4 2007, led by the housing market correction. Throwing the dollar under the bus to briefly boost exports and bring plane loads of tourists into the U.S. has helped avert a far more blatant recession from occurring than the subtle one we're already in. With inflation rising as quickly as the U.S. economy is slowing, picking the exact month or quarter when the real (inflation-adjusted) GDP growth recession starts–or started–will not be possible until after the inevitably revised GDP and inflation figures come in. We expect to see confirmation June 2008 at the earliest.

As for an economic contraction that "cleanses the system" with debt defaults, bankruptcies, and high unemployment–well, that's coming, too. Sort of. But it won't lead to the hoped for economic and political structural reforms outlined in Farrell's romanticized vision of recession.

1. Purge the excesses of the housing boom
No, it's not heartless. Not like wartime calculations of "acceptable collateral damage." Yes, The Economist admits "the economic and social costs of recession are painful: unemployment, lower wages and profits, and bankruptcy." But we can't reverse Greenspan's excessive rate cuts that created the housing/credit crisis. It'll be painful for everyone, especially millions of unlucky, mislead homeowners who must bear the brunt of Wall Street's greed and Washington's policy failures.

You don't need a recession to see housing bubble excesses purged. It's happening before the recession. In fact, the correction in the housing market is the primary cause of the recession we forecast a year ago to start this quarter.

The housing market is highly correlated to employment. Regional home prices rarely if ever fall during periods of high or rising employment, and home prices have not fallen nationally even during national recessions since the Great Depression. Since 2006, national home prices have been declining even as the economy expanded and the labor market was relatively strong. What's going to happen to the real estate market when the U.S. goes into recession? The U.S. economic policy makers are not eager to find out, especially in an election year, so first they are going to try to prevent one happening, first using dollar depreciation and doling out of short term loans at the Fed's Discount Window, then later with rate cuts, then deeper Federal deficit spending, then state deficit spending (yes, the laws will be changed), and on and on. Think post bubble Japan except inflationary versus deflationary.

2. U.S. dollar wake-up call
Reverse the dollar's free fall and revive our global credibility. Warnings from China, France, Iran, Venezuela and supermodel Gisele haven't fazed Washington. Recession will.

In our floating exchange rate currency system, relative economic performance is the main determinant of currency values. A U.S. recession will only lead to dollar strengthening if the economies of U.S. trade partners contract even faster than the U.S. economy does. We have since 2005 forecast the next U.S. recession to be U.S. centric, meaning more severe in the U.S. than among some U.S. trade partners with lesser internal and external liabilities. You don't have to swallow the whole global decoupling theory hook, line, and sinker to see that. All you have to do is note the USA's external liabilities relative to its trade partners and ask how U.S. creditors are likely to respond when U.S. national income drops. Think the dollar is tanking today? Wait until the U.S. goes into the next recession. It'll be a dollar wake-up call alright.

3. Write-offs
Expose Wall Street's shadow-banking system. They're playing with $300 trillion in derivatives and still hiding over $100 billion of toxic off-balance sheet asset-backed securities, plus another $300 billion hidden worldwide. A lack of transparency is killing our international credibility. Write it all off, now!

Agree whole heartedly with the sentiment. A market is only as good as the market institutions that support it, including regulators and credit rating agencies. U.S. regulatory and rating institutions have recently revealed themselves to be less effective than those in many third world countries. However, according to our best sources Martin Mayer and Dr. Peter Warburton–who are arguably the most credible experts on the topic of credit derivatives–the market for these instruments will be gone for years, and when it comes back it will be nothing like it is today. Asking for these to be written off all at once is like asking a vet to shoot a sick dog. The dog is going to be out for a long while as it is.

4. Budgeting
Force fiscal restraint back into government. America has been living way beyond its means for years: A recession will cut back revenues at all levels of government and cutbacks will encourage balanced budgeting.

The exact opposite is true. Washington is filled with brave talking free market economists during boom times but they quickly morph into Keynesian softies during busts. It has always been thus:

1%-Off
TIME Magazine
Nov. 25, 1929

On the day last week's stockmarket plunked to the bottom President Hoover let his Secretary of the Treasury, Andrew William Mellon, make an announcement which the President had been saving up as the Big-News-Item for his own first message to Congress next month, an announcement of immediate tax reduction.

... into the Treasury trooped Senators Smoot, Reed, Simmons, Harrison—potent majority and minority members of the Senate Finance Committee. At their heels followed Speaker Longworth, Chairman Hawley of the Ways & Means Committee.

Already tardy, [Treasury] Secretary Mellon hurried off to keep a dinner engagement at his home with New York bankers. Into the hands of eager pressmen went the Mellon announcement:

"The Secretary of the Treasury considers the [Budget] estimates have reached the point where tax reduction should be recommended to the Congress at the coming session. . . ."

Democrats in Congress dropped their plan for a $300,000,000 tax reduction to join with Republicans in promises to pass the Mellon proposal, if possible, before Christmas. Even Chairman Smoot of the Finance Committee, long an outspoken opponent of immediate tax reduction, swung into line, pledged prompt action.

Declared Congressman Garner, chief Democratic member of the House Ways & Means Committee and minority leader of the House: "I look at the proposal from the point of view of the good of the country and I shall support it. . . . Even though a business crash might aid in placing the Democratic party in power, the price would be too great to pay for party success."

In other words, the Democrats figured the stimulus of the Republican tax cut was going to help prevent a recession from occurring after the stock market crashed. If they opposed it and no tax cut passed, the economy was sure to go into recession and they'd win the upcoming elections. Good for the Democrats but bad for the nation.

As it turns out, even though Congress was on the tax cut economic stimulus case right after the stock market crash, tax cuts didn't help much because tax rates were already so low that stimulus from cutting them didn't make much difference.

Point is, recessions bring on less fiscal restraint, not more. U.S. economic policy makers should have been raising taxes along with interest rates during the 2003 to 2006 recovery to balance the budget. They didn't for impractical, politically motivated ideological reasons so now we head into this next recession with huge deficits, a hangover from the last reflation. Soon we will have plummeting tax revenues. This will not encourage balanced budgeting. Substitute Paulson for Mellon and you see how little things change.

5. Overconfidence
A recession will wake up short-term investors playing the market. In bull markets traders ride the rising tide, gaining false confidence that they're financial geniuses. Downturns bruise egos but encourage rational long-term strategies.

It's not a recession but the financial market crash that leads to the recession that takes the speculators out of the stock market, just as the collapsing housing bubble has taken the house flippers out and is causing this recession. However, since Keynesian recession-fighting reflation policies are a sure bet, speculators will move the party to a new arena, to whatever asset class reflation bubbles up.

In 2001 we figured one beneficiary of 2001 recession reflation would be commodities, including gold. We missed predicting the housing bubble. Call us stupid, but real estate bubbles after they eventually collapse are notoriously dangerous to a nation's macro economy, banking system, and financial markets, so we assumed the Fed was going to stick to the program they followed in the 1970s and 1980s when they came down hard with rate hikes and regulatory action to stop housing froth. Silly us. (The lesson we learned is that you cannot underestimate the arrogance and stupidity of the supposed stewards of our economy. In fact, it's sufficiently predictable as to be tradable.)

Most of the increase in commodity prices we expected was due at first to dollar depreciation. That was followed by coordinated global central bank currency depreciation. Besides currency depreciation, other reflation efforts included credit expansion. Most of the credit creation that was needed to peel the economy off the floor after the year 2000 stock market crash was developed using sales of credit derivatives to foreign pension funds and central banks. By keeping credit creation off the balance sheets of commercial banks, the money supply that fueled the housing bubble did not show up in traditional measures of the money supply, and thus was not commodity inflationary, although it was properly asset price inflationary.

That game is over. Am I sure? When's the last time you heard of a big private equity deal closing? Not since the summer when the CLO machine broke that had been feeding the LBO bubble. Without the fancy credit machine to create the credit to inflate these assets, what's left to expand credit and money but the good old fashioned printing press? Is it any wonder that gold prices are rising? The investment banks may have something else up their sleeve. I'll let you know if I find out what because if they do, it may be time to lighten up on the reflation hedges.

6. Ratings
Rating agencies have massive conflicts of interest; they aren't doing their job. They're supposed to represent the investors, but favor Corporate America, which pays for the reports. Shake them up.

Our contacts tell us they're getting shaken up quite well even without a recession, thank you very much. A recession might make matters worse but only marginally.

7. China
Trigger an internal recession in China. Make it realize America's not going into debt forever to finance China's domestic growth and military war machine. A recession will also slow recycling their reserves through sovereign funds to our equities.

This is already happening.

The alarm bells begin to ring in China
Nov. 21, 2007 (Times Online)

The Pollyanna economists think it is all different now, a view espoused by the World Bank in its most recent report on East Asian economic growth. China is creating its own demand, “decoupling” from the US economy, it says.

Only a day after the World Bank released its fug of warm air, Beijing’s Commerce Ministry raised the alarm, giving warning that things had reached a “turning point” and Chinese exporters could be “devastated” if US demand continues to fall.

Exports account for a third of China’s growth and America is the destination for a fifth of the stuff. “The risks of economic slowdown in the US . . . plague our export prospects,” the Commerce Ministry said.

But why assume a recession will be worse for China than for the U.S.? A reduction in China's exports demands an equal reduction in China's import of U.S. financial assets. China has repeatedly stated a desire to diversity out of, that is, sell U.S. financial assets and government debt anyway. The only reason they have not is because U.S. consumers are buying Chinese exports and China balances the trade by purchasing treasury bonds, agency debt, and other dollar denominated assets. That's the deal.

China's trade with the world, per 2005 and 2006 World Trade Organization data. N. America includes Canada.
China's exports to the U.S. alone is estimated at 1/5th of all Chinese exports.

About 20% of China's export trade comes from the U.S. Can China take a major hit in U.S. export trade income? Yes, but not without the economy slowing and the CCP experiencing political challenges. Can the U.S. take a big a cut in China's lending? Yes, but not without economic and political consequences. The U.S. will have to find an alternate, someone else to grab the hot potato.

In proportion to size of economy, European nations do not purchase U.S. treasury debt at the level of
Asian goods exporters. Germany specifically, a larger goods exporter than the U.S. and with a positive
trade balance, purchases little U.S. sovereign and agency debt relative to GDP.

As you can see from the above, not all U.S. trade partners are "pulling their weight" buying U.S. debt. With treasury purchases scaled to the size of each county's economy, you can see that countries that either need U.S. military support or U.S. consumer demand for their exports buy the most significant dollar volumes of U.S. debt. China surely doesn't need U.S. military "protection." If the U.S. doesn't continue to import Chinese lead covered toys and pesticide infused ginger at an ever increasing rate, what motive does China have to buy more U.S. financial assets?

I'm confused by Farrell's assertion that the U.S. funds China's military by borrowing from China. That's backwards. China is diverting national savings into reserves that might otherwise be used to build its military. From China's perspective:

US-China relations are influenced by a wide array of issues from Taiwan to trade relations and human rights. More recently, the nexus of the relationship has centered on the so-called "Bretton Woods II" arrangement, a continuation by other means of the dollar-centered international order that prevailed in the postwar decades. This monetary status quo, based on structural current account deficits in the U.S. and structural current account surpluses in Asia, in which Asian current account surpluses are recycled to provide cheap financing for the US current account deficits, largely explains why the US dollar has not collapsed despite the country's increasingly parlous debt build-up. It has been characterized by PIMCO's Paul McCulley as a "stable disequilibrium".

But Bretton Woods II is increasingly beset with internal contradictions: the Chinese have in effect initiated a dollar reserve accumulation policy that acts as a quasi oil reserve, given that oil is priced in dollars. But in so doing, they have helped to fund an increasingly confrontational and militaristic US, which in turn threatens China's energy security. How long before this circular relationship, which underpins the stability of today's global markets, breaks down?

China's Dollars Versus America's Guns
Japan Policy Research Institute - Marshall Auerback - February 2007

We coined the term Economic Mutually Assured Destruction to describe the relationship. Whatever you want to call it, a recession helps China's position more than the U.S. position. In a global recession, the net goods exporters tend to weather the storm better than the net financial assets exporters. The global quest for yield is replaced by the desire to avoid losses and preserve purchasing power, as Marc Faber recently cleverly put it, "a shift from return on investment to a return of investment." This decreases demand for financial assets by exporters generally and demand for goods decreases by goods importers as well but not as much, and demand tends to shift from luxuries to necessities.

8. Oil
Force the energy and auto industries to get serious about emission standards and reducing oil dependency.

Recession will have the opposite result unless Farrell is expecting, as we are, that the dollar will fall even faster than oil demand. That means the U.S. may find itself with 2/3 of pre-recession oil import demand but each unit of demand will be inflated by another 50% reduction in the value of the monetary unit, the dollar. As energy prices rise and the energy purchasing power of income falls, cars will get a whole lot smaller. The same result is achieved in Europe via taxation; dollar depreciation acts as a politically expedient regressive domestic tax on energy consumption.

9. Inflation
Expose the "core inflation" farce Washington uses to sugarcoat reality.

How will recession expose the "core inflation" farce? Reflation, which is inevitable, will make inflation worse, and don't expect the analysis and reporting to improve if the facts are against the house.

10. Moral hazard
Slow the Fed from cutting interest rates to bail out speculators.

When the U.S. goes into recession, the Fed will cut rates. The only way to keep the Fed from bailing out speculators is for the Fed to not allow speculators to get into the position of needing to get bailed out. Too late for that.

11. War costs
Force Washington to get honest about how it's going to pay for our wars, other than supplemental bills that are worse than Enron-style debt financing.

What Enron did wrong was report debt as operating income. Here in the USA, we depend on foreign borrowing for GDP growth.

Besides, here we are, no official recession yet, and Congress can't even cut spending on current wars without the DoD making political threats of election year layoffs and instigating economic havok: 200,000 layoffs between now and Christmas is a formidable stick to use to beat Republican members of Congress into voting "the right way."

Pentagon Warns of Civilian Layoffs If Congress Delays War Funding
Nov. 21, 2007 (Jonathan Weisman and Ann Scott Tyson - Washington Post)

Democrats Are Firm on Link to Troop Withdrawals From Iraq

The Defense Department warned yesterday that as many as 200,000 contractors and civilian employees will begin receiving layoff warnings by Christmas unless Congress acts on President Bush's $196 billion war request, but senior Democrats said no war funds will be approved until Bush accepts a shift in his Iraq policy.

And there are plenty more such sticks where that came from, such as this threat–I mean–warning from Goldman Sachs that without further assistance from the Fed and others, the U.S. faces a $2 trillion "lending shock" during an election year.

This is precisely the dynamic of inflationary, politically motivated government spending in the face of recession that our Ka-Poom Theory anticipates. As the inflationary recession progresses, each political standoff between Congress and various political groups ends in additional spending. The end result is predictable: even more inflation. Expect the unions get into the act in 2008, and when they do don't forget where it all came from, no matter what you hear from the conservative media which will spin rising wage inflation as being caused by the unions: the initial decision to allow inflation to rise to forestall recession in 2001 planted the political seeds of further inflation as various groups fight to make up for the lost purchasing power of income suffered by their respective constituencies.

Rather than reveal the true source of war financing, a recession may just as well drive it farther underground by creating additional impetus for war. Recessions particularly preceded by credit booms have historically led to unpleasant unintended consequences; if a country can't spend its way out of recession peacefully, it may do so militarily.

12. CEO pay
Further expose CEO compensation that's now about five hundred times the salaries of workers, compared with about 40 times a generation ago.

It's already overexposed. What's missing is the will to do anything about it. That's up to shareholders. When the DOW is trading either nominally or in real terms near half where it is today, shareholders may get more militant. As long as inflation via share buy-backs, balance sheet engineering and other tricks supports share prices, shareholders will remain tolerant of this nonsense.

13. Privatization
Stop the privatization of our federal government to no-bid contractors and high-priced mercenary armies fighting our wars.

Recession means more deficit spending means more pork means more privatization not less.

14. Entitlements
Force Congress to get serious about the coming Social Security/Medicare disaster. With boomers now retiring, this problem can only get worse: A recession now could avoid a depression later.

Recessions put further burdens on government not less.

15. Consumers
Yes, we're all living way beyond our means, piling up excessive credit-card debt, encouraged by government leaders who tell us "deficits don't matter." Recessions will pressure individuals to reduce spending and increase savings.

I'll say.

In a recession as unemployment rises, the majority of Americans (read: voters) will not have enough liquid net worth to fund expenses without increasing debt and/or selling assets. Median duration of unemployment has increased from seven to nine months this year. At the same time, secured credit (mortgage and HELOC) conditions are tightening. What does that leave to fund household expenses? Evidence is that demand for credit card debt is rising and assets are being sold.

We have surveyed a group of coin and jewelry dealers across the U.S. since 1999. For the past six months in particular it's been a tale of two markets. Working families are selling to raise money, liquidating coin collections and jewelry to raise cash. At the same time high net worth families have been buying gold and rare coins to hedge inflation fueled by dollar depreciation. As a result, the spread between bullion and rare gold coins prices has increased from around $20 where it had been for years to over $80 in the past few months. Prices of very rare coins are going through the roof.

If you can afford to hedge inflation, you do. For everyone else, there's Mastercard.

Credit card debt is also rising and, like everything else, it is not so evenly distributed. Average household debt was 91% of net worth for the middle 20% wealth group in 2004, 10% of wealth for the top 10% group.

Families in the top net worth groups don't have much debt so when recessions come around, the ratio of debt to net worth hardly changes. As you can see above, that is not the case for the bottom 40%. Note that during recessions accompanied by tight credit, such as during the early 1980s and in 2001, debts are paid off and savings increase. In the early 1980s, debt to wealth ratio for the bottom 40% dropped in line with the top 10%. Meanwhile, the top 40% was relatively unaffected.

Our warnings about wealth and debt inequality over the years are rooted in our concerns about the political backlash that historically follows from economic distress in the context of such imbalances–a return to greater government interference in small business and the capital markets that support them. We fear a rolling back of gains since the 1980s that have made the U.S. a mecca for entrepreneurs and inventors. Here at iTulip our motto is: "We like capitalism–don't break it." A major recession that follows on the heels of widespread financial system abuses, preferential taxation, and lack of enforcement of regulations inevitably causes the political system to gear up to throw the baby out with the bathwater.

The U.S. economy has built up not only historic wealth inequality since 2001 but massive disparities of liquid net worth and debt. In a recession, these will create a political nightmare as unemployment rises and credit tightens. A recession will be bad for the rich and middle class, but will hammer the poor and push segments of the middle class into the ranks of the poor. We've long expected a political reflex to these circumstances in our Ka-Poom Theory. If the U.S. ever gets a populist, socialistic president it will follow from of the kind of recession Farrell is hoping for.

16. Regulation
Lobbyists have replaced regulation. Extreme theories of unrestrained free trade plus zero regulation just don't work; proven by our credit crisis, hedge funds' nondisclosures, private-equity taxation, rating agencies failures, junk home mortgages, and more. Get real, folks.

For economic reasons, trade needs to be unrestrained during periods of recession, more managed during expansions. Of course, politics usually forces the opposite to happen.

Remember my example above from 1929? Two of the characters from that play return in 1930 to do real damage. Senators Smoot and Ways & Means Committee Chairman Hawley were the brains behind the Smoot-Hawley Tariff Act that set off a trade war that cut global trade by 14%. Unemployment was at 9% in June 1930 when the Smoot-Hawley tariff was passed, but it jumped to 16% the next year and 25% two years after that. Nice going. We don't need a repeat but if we experience a severe recession given current economic and political antecedents, and the dynamics of the U.S. political process, a repeat is what we'll get.

17. Sacrifice
"We have not seen a nationwide decline in housing like this since the Great Depression," says Wells Fargo CEO John Stumpf. As individuals and as a nation Americans have always performed best in crises, like the Depression or WWII, times when we're all asked to make sacrifices. Pampering us with interest-rate cuts and tax cuts during the Iraq and Afghan wars may have stimulated the economy temporarily, but they delayed the real damage of the '90s stock bubble while setting the stage for this new subprime/credit crisis.

I'll respond to this one with a comment made to our interview with James Scurlock.

"Did you guys know, the bankrupcy laws changed? You cannot declare bankruptcy anymore. In the near future, we may have debtors prisons. When we have a war with Iran, Syria, Russia, and China, you know who will be recruited. They will give you a choice, pay off your debts or we will throw you in prison. If you don't want to go to jail, you join the military for 8 years."

What if 20 million voters share the same vision? How are they likely to vote? The political bed we've made is not conducive to constructive change in an economic crisis.

We'll get a recession alright, but it won't improve anything. There will be nothing romantic or cleansing about it.

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[GRG55]

Re: Recession without Romance

Recession without Romance

Even the smart contrarians are confused by our predicament





...In many ways, the next recession will be worse for the U.S. as the 2001 recession. It will happen, but it will not bring about the benefits Farrell hopes for...

...2. U.S. dollar wake-up call

Reverse the dollar's free fall and revive our global credibility. Warnings from China, France, Iran, Venezuela and supermodel Gisele haven't fazed Washington. Recession will.

In our floating exchange rate currency system, relative economic performance is the main determinant of currency values. A U.S. recession will only lead to dollar strengthening if the economies of U.S. trade partners contract even faster than the U.S. economy does. We have since 2005 forecast the next U.S. recession to be U.S. centric, meaning more severe in the U.S. than among some U.S. trade partners with lesser internal and external liabilities. You don't have to swallow the whole global decoupling theory hook, line, and sinker to see that. All you have to do is note the USA's external liabilities relative to its trade partners and ask how U.S. creditors are likely to respond when U.S. national income drops. Think the dollar is tanking today? Wait until the U.S. goes into the next recession. It'll be a dollar wake-up call alright....

The problem with living over here is I wake up and get to start my day with these little sunshine posts of EJ's .

EJ, Finster... A question: I was reading through the Fed minutes released yesterday (We are truly desperate for entertainment here in the desert. If any of you are unfortunate enough to be in a similar situation you can access the minutes here: http://www.federalreserve.gov/moneta...es20071031.pdf )

I noticed on page 9 the following: "Participants read last summer's benchmark revisions to the national income and product accounts as suggesting a somewhat slower rate of trend growth than previously thought."

Reading a bit further, the distribution of GDP projections shown on page 14 clearly indicate a material downward revision for 2008 from June expections (no real surprise), but much more interesting, projections now converge around 2.4%-2.5% annual GDP growth for 2009 and 2010. This would suggest that the Fed itself is now anticipating a structural (NOT cyclical) shift downward in US potential GDP. Chart 1 at the top of page 11 seems to indicate the same.

Is my conclusion reasonable? Or am I mis-understanding what the Fed is telling us?

If I am interpreting this correctly, would it also be correct to assume that the Fed has, or will, also also adjust it's expectation of the "neutral" Fed funds rate downward in years to come (and therefore the potential for chronic historically low administered rates for very extended periods of time, especially if already lowered GDP projections prove optimistic)?

[trex]

Re: Recession without Romance

A few questions about China. Won't the plunging Dollar (and dollar pegged RMB) cause exports from China to Europe to skyrocket? At the same time, doesn't the price of Chinese goods gain considerable import cost advantages into the USA over the goods from countries with floating rate currencies with the result that China will gain a bigger piece of the pie and at least partially offset the impact of a shrinking USA pie? In other words, won't China benefit from the weak dollar policy as much or more than the USA?

[jk]

Re: Recession without Romance

great piece. 2 comments:

1. re the dollar- i expect the dollar to go up [at least temporarily] as financial markets tank. this is due to the unwinding of leveraged trades and the [perhaps forced] repatriation of u.s.-based investments from abroad. the dollar will rise against other currencies except the funding currencies - the yen and, to a lesser degree, the swiss franc.

2. a lot of intra-asian trade is in intermediate goods that then end up in exports to the oecd countries. thus the dependence of china on exports to the u.s. in understated in the chart of chinese regional trade flows.

[touchring]

Re: Recession without Romance

A few questions about China. Won't the plunging Dollar (and dollar pegged RMB) cause exports from China to Europe to skyrocket? At the same time, doesn't the price of Chinese goods gain considerable import cost advantages into the USA over the goods from countries with floating rate currencies with the result that China will gain a bigger piece of the pie and at least partially offset the impact of a shrinking USA pie? In other words, won't China benefit from the weak dollar policy as much or more than the USA?

If you got 1 trillion bonas of treasury, will you benefit?

I think the biggest benefiter of an American recession are countries like Iran, Russia and Venezuela - the inflationary policies directly lead to a commodity and oil boom that allows these countries to enrich and thereby rearm themselves.

No wonder bush talked about WWIII, he is not wrong - he sowed the seeds. :eek:

[dbarberic]

Re: Recession without Romance

Without the fancy credit machine to create the credit to inflate these assets, what's left to expand credit and money but the good old fashioned printing press? Is it any wonder that gold prices are rising? The investment banks may have something else up their sleeve. I'll let you know if I find out what because if they do, it may be time to lighten up on the reflation hedges.

Come on EJ.... what are you thinking the banks may do that will dis-inflationary to gold? Inquiring minds want to know. I'm thinking the receint drop below $800 is a good opportunity to stock up on more ounces.

[zoog]

Re: Recession without Romance

...Point is, recessions bring on less fiscal restraint, not more. U.S. economic policy makers should have been raising taxes along with interest rates during the 2003 to 2006 recovery to balance the budget. They didn't for impractical, politically motivated ideological reasons so now we head into this next recession with huge deficits, a hangover from the last reflation. Soon we will have plummeting tax revenues. This will not encourage balanced budgeting. Substitute Paulson for Mellon and you see how little things change. ...

Hmm, cut corporate taxes but make all of us pay national sales tax to make up for it? With retail sales falling, I'm not sure that additional taxes on consumers would balance lost taxes on corporations.

A U.S. Treasury report on ways to cut corporate taxes will include discussion of a national sales tax, a senior Treasury official told CNBC.

The U.S. currently has no national sales tax, also known as a value added tax, or VAT, though many states do. The tax would be one option to help offset revenue lost from lowering corporate taxes. The report is due in the coming weeks.

The top corporate tax rate is now 35 percent, and the official said that if exemptions are eliminated, a 27 percent rate would be revenue-neutral. Besides a national sales tax, the Treasury report will also discuss accelerating depreciation and expensing, to as much 35 percent of the value of new investments in the first year.

The Treasury official said the document would make no choice as to the best option, but would note that the "best bang for the buck" for growing the economy will come from accelerated expensing.

The Treasury document is partly an attempt to counter a proposal by Charles Rangel, the Democratic chairman of the House Ways and Means Committee, to cut the corporate rate to 30.5 percent from 35 percent. Rangel’s bill contains proposals to offset his tax cuts with the elimination of special tax breaks for corporations.

But the Treasury document will also discuss cutting corporate taxes and not offsetting them because, the official said, of the urgency to bring U.S. rates in line with competing nations. Both developed and developing nations are cutting corporate taxes to the point where the U.S. rate is no longer competitive, the official said.

[medved]

Re: Recession without Romance

Come on EJ.... what are you thinking the banks may do that will dis-inflationary to gold? Inquiring minds want to know. I'm thinking the receint drop below $800 is a good opportunity to stock up on more ounces.

One of the things they can do is pretend to solve the currency problem. Here is the scenario:

1. G7 gets together and "reveals" to the world, the $US is not a good reserve currency anymore.

2. International community happily engages in US-bashing and comes up with fancy do-gooder solutions for international harmony. G8 solemnly promises to solve the currency problems and appoints multiple commitees to study the issue. $US stabilizes, gold drops a bit (it is reasonable to assume, its price is around the old $850 peak). I am selling.

3. The experts release their recommendations. That includes internationally-managed currency basket with the wide participation of the countries like Russia and China. US agrees to sell, at least, *some* *real* assets to its creditors. US-bashing continues, $US stable, gold drops some more, I am still selling.

4. G8.5 gets together in some historical setting (Bretton-Woods resort?) and establishes the new agreement. International community goes wild, celebrations around the world remind (and exceed) those induced by the fall of Berlin wall. US-bashing is at its peak, wallpaper made out of $US notes is a hot item in the Middle East, China and Venezuela.

5.Central banks sign new Washington agreement and promise to sell much more gold. Gold drops like a stone, I am buying.

6. This bashful rejoicing continues some more, until everybody begins to realize, they solved nothing. International banks and politicians are just as dumb and crooked as their US counterparts. They hate the free market just as much, and their currencies are just as fake. The currency problems and trade wars return with the vengeance. $US goes up, gold takes off and breaks $1000 barrier.

m.

[jk]

Re: Recession without Romance

One of the things they can do is pretend to solve the currency problem. Here is the scenario:

1. G7 gets together and "reveals" to the world, the $US is not a good reserve currency anymore.

the shock!

2. International community happily engages in US-bashing and comes up with fancy do-gooder solutions for international harmony. G8 solemnly promises to solve the currency problems and appoints multiple commitees to study the issue. $US stabilizes, gold drops a bit (it is reasonable to assume, its price is around the old $850 peak). I am selling.

no, if the world announces a "study" of the role of the u.s dollar in the international system, the dollar drops like a rock. the role of the dollar can only diminish - when you're number one the only direction is down. a "study" can only pontificate on the status quo or recommend a change, and any change has to be an even quicker diminution of the role of the dollar.

[EJ]

Re: Recession without Romance

The problem with living over here is I wake up and get to start my day with these little sunshine posts of EJ's .

EJ, Finster... A question: I was reading through the Fed minutes released yesterday (We are truly desperate for entertainment here in the desert. If any of you are unfortunate enough to be in a similar situation you can access the minutes here: http://www.federalreserve.gov/moneta...es20071031.pdf )

I noticed on page 9 the following: "Participants read last summer's benchmark revisions to the national income and product accounts as suggesting a somewhat slower rate of trend growth than previously thought."

Reading a bit further, the distribution of GDP projections shown on page 14 clearly indicate a material downward revision for 2008 from June expections (no real surprise), but much more interesting, projections now converge around 2.4%-2.5% annual GDP growth for 2009 and 2010. This would suggest that the Fed itself is now anticipating a structural (NOT cyclical) shift downward in US potential GDP. Chart 1 at the top of page 11 seems to indicate the same.

Is my conclusion reasonable? Or am I mis-understanding what the Fed is telling us?

If I am interpreting this correctly, would it also be correct to assume that the Fed has, or will, also also adjust it's expectation of the "neutral" Fed funds rate downward in years to come (and therefore the potential for chronic historically low administered rates for very extended periods of time, especially if already lowered GDP projections prove optimistic)?

I'd take all of these projections with a grain of salt, especially now. The following is instructive.

Federal Reserve Bank of Minneapolis Quarterly Review (pdf)
Vol. ol. 22, No. 4, Fall 1998, pp. 3–12
Revisionist History: How Data Revisions Distort Economic Policy Research
David E. Runkle, Research Officer, Research Department
Federal Reserve Bank of Minneapolis

The paper has the usual disclaimer:

The views expressed herein are those of the author and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.

However, our most successful forecasts of future Fed behavior is based on these papers. In spite of the disclaimers, you can assume that these research papers mostly reflect official policy.

Apparently worried that the BEA staff might be offended by his conclusions, the author offers the following note:

I do not mean to be critical of the data collection and processing efforts of the BEA or of the policy making efforts of the FOMC. Both institutions do the best they can, given the available information. Naturally, more information about the economy becomes available over time.

His conclusion:

...data revisions can have a large effect on the perceived history of real growth and inflation in the United States. Data revisions can be large, and initial estimates of real growth and inflation are not rational forecasts of final estimates.

After watching this process for over ten years, my advice is that as we go into a period of flux, the economic data are going to become increasingly volatile, unreliable, and irrelevant. As happened in the early 1930s, as the fundamental structure of the economy and financial markets had changed, the Fed will be looking at and reacting to the wrong data. This is why we have repeating the following since 1999, because it will apply to the future period of change which is now, eight years later, upon us:

It is of the utmost importance to realize this: given the actual facts which it was then possible for either businessman or economists to observe, those diagnoses -- or even the prognosis that, with the existing structure of debt, those facts plus a drastic fall in price level would cause major trouble but that nothing else would -- were not simply wrong. What nobody saw, though some people may have felt it, was that those fundamental data from which diagnoses and prognoses were made, were themselves in a state of flux and that they would be swamped by the torrents of a process of readjustment corresponding in magnitude to the extent of the industrial revolution of the preceding 30 years. People, for the most part, stood their ground firmly. But that ground itself was about to give way.

- Joseph A. Schumpeter -- Business Cycles, 1939

For the foreseeable future, no data are going to be as reliable as what the community collectively pulls together by looking out the window and reporting what we see.

[Chris Coles]

Re: Recession without Romance

the shock!


no, if the world announces a "study" of the role of the u.s dollar in the international system, the dollar drops like a rock. the role of the dollar can only diminish - when you're number one the only direction is down. a "study" can only pontificate on the status quo or recommend a change, and any change has to be an even quicker diminution of the role of the dollar.

There are a number of points that I want to make. The first comes from a brief conversation I had in London in the 1980's when I had asked a banker out of Nomura about his interest in investment in the likes of new high technology start ups, (such as I was trying to get going at the time). His answer stuck in my mind ever since:

"No! We only deal in intergovernmental purchases of securities".

This came to mind the day before yesterday when here in the UK we heard that a science related long term research project was suddenly not being funded. There had been no consultation on the decision, the withdrawal of funding simply dropped out of the blue. It took a while and then it hit me. What if the government itself is in exactly the same situation as everybody else?

So the first question is. With banking in crisis caused by defective money markets it is surely relevant to ask; what is the governments exposure to the same? Now, my first thought was to ask this about the UK, but then it surely also applies to the US as well?

Is the US government as deeply up to its neck in dodgy CDO's as every other major borrower on the planet?

Here in the UK we have seen the Bank of England lay on the line a very large sum of money to support Northern Rock. In dollar terms, it is beginning to look like as much as $80 billion. Now, I ask: Has the decision to support Northern Rock inadvertently done immense damage to their bottom line? Is the UK Government now in exactly the same situation as Northern Rock? Loan commitments made long, (to Northern Rock and others), that cffice:smarttags" />annot be covered on the external money markets simply because those money markets are locked out, even to them?

And, if the entire world money market system is in crisis; what is the potential for the same conclusion to apply to the USA? If banks are not lending to each other; why should we believe it is any different for the "intergovernmental purchases of securities"?

Turning to the ongoing development of the dollar crisis, by pure chance, (what a wonderful thing pure chance is sometimes?), this arrived in my in-box. It comes from a friend and fellow glider pilot, Brian Catt. As he asked us to pass it on I do so here in full but less his contact details.

Hi
This is for Europeans only. As I currently don't have enough fun and have a bit more time I am now making a nuisance of myself.
I just made a rather startling discovery, freely available to any serious commentator but "unpromoted".
- The price of crude has remained largely flat in Euros and Sterling for over a year.
- Iranian oil is actually cheaper in Euros than a year ago. (Reports from the current OPEC meeting/ FT commodities index confirms).
- Petrol is refined in Europe at a Euro cost, which cannot have changed much as the plant is built, labour costs and wage inflation small as a % and distribution ditto, albeit they use their own overpriced fuel.
- In summary wholesale pre tax cost of petrol f.o.b. the depot should be much the same as a year ago.
- The price of petrol has risen by over 30% in a year- in line with and justified by the irrelevant hike in the price of crude in devaluing dollars.
- We are being massively ripped off by the oil companies on a spurious but unchallenged justification.
- There appears to be an anti-competitive oligopoly of downstream petrol retailers that the EC should have taken on under anti-trust laws we already have. There is certainly no aggressive competition to gain share by sacrificing some of this massive artificial margin.
- Yet every time the price goes up no one asks the simple question WHY - then questions the answer? There is no substantive cost justification.
- Who benefits? The oil companies and the government through higher tax take
- hardly a way to manage inflation or an economy.
For the first time in my life I ask you to forward this to your list as its clear there is a massive and cynical rip off going on, politicians are complicit and the mainstream media compliant with it or incompetent to recognise and/or challenge it - so we will get no help unless the problem is aired outside the corridors of power - who would no doubt prefer we didn't have a forum to discuss this.
Of course if you find fault with my facts or analysis then I'll happily withdraw or correct it.
If you agree I think it should be given "the oxygen of publicity".
Best,
Brian Catt

As you see, there is much going on in the background that gives me the thought that we have seen nothing yet, the worst is very much yet to come for if this is correct, then the collapse of the dollar may well be under way and truly unstoppable.

[qwerty]

HM Gov. short of cash

Chris, are you saying that if depositors started taking money out of National Savings accounts, they might find it more difficult in future, because they might be strapped for cash?

If one transfers 1000 pounds from a National Savings account to a Barclays Bank account is it just like a regular bank transfer? The NS money comes from a Bank of England account though, right? So don't they just print some more gilts and give them to the BoE. (Thus if the BoE/NS/UK Govt is bust, pound notes are worth a fortune until such time as they print some more?)

I am keenly interested in this idea that sterling lender of last resort not being able to pay up.

[GRG55]

Re: Recession without Romance

- There appears to be an anti-competitive oligopoly of downstream petrol retailers that the EC should have taken on under anti-trust laws we already have. There is certainly no aggressive competition to gain share by sacrificing some of this massive artificial margin.

Chris: The primary reason there is limited competition in petroleum refining and retailing in the developed economies is because for decades it has been an abysmal business - extremely high capital investment, regulated by multiple layers and departments of government, slow market growth, and persistently poor margins (some similar characteristics to the volatile air transport business where the companies swing between thin profits and large losses, on the way to the next restructuring). Despite what the public wants to think, in a typical decade the downstream petroleum business usually has one obscenely profitable year (which gets all the attention), two years that are decent, and the biblical 7 bad years to round it out.

The national oil companies (NOC's) like Saudi Aramco, UAE, Kuwait, etc have more crude oil production than refining capacity. The non-NOC refining companies (like Shell and Exxon) do not produce anywhere near enough oil to supply their own refining capacity, and therefore have to purchase large amounts of crude on the open market. Given this situation, it is no longer a necessity to have proprietary upstream crude production in order to enter and be able to compete in the refining business with the Shells or BP's - anyone can build a refinery and anyone can buy the oil to supply it. In the USA this has occurred. If you think its a good business have a look at a 10 year chart for Valero (VLO:NYSE) and superimpose it on the Nasdaq circa 1990-2000. What do you think is going to happen next?

If it really was a highly profitable business there would have been lots of new entrants - during the recent "free money" years the investment banks and hedgies were funding anything and everything that might make a buck (or Pound in your case). Notice they didn't have any appetite to enter the refining and gasoline retailing business. If "massive artificial margins" are so easy to come by, as your friend apparently believes, then how is it that this business never attracted the attention of the Private Equity masters-of-the-universe? At the very least they should have come in and overpaid to buy out a few refining companies and then jacked up prices enough to really give us something to complain about. Didn't happen, did it?

When somebody figures out how to create a low-cost "Easyjet" business model equivalent for refining & marketing, then perhaps there will be some competition. Don't hold your breath.

[Chris Coles]

Re: Recession without Romance

GRG,

You have missed my point. The matter of the difference between the price of refined petroleum may be worrying my friend, but his concern about the price was not of interest to me. I looked over the top of his report to see something I believe to be much more significant.

Which is that, the difference between the Euro and Dollar price contains a signal that on the one hand the Euro price is stable and on the other the Dollar price is constantly moving. I say that that constant movement marks the slide away from using the dollar as THE currency with which to do business internationally.

If that continues, then everyone that had once wanted to trade in other than a dollar can now start to do so. And, once that happens, then for every barrel of oil, or whatever else the US wishes to purchase, the US will have to, in turn, purchase Euro's and cannot print more dollars to dig themselves out of the mess they are in.

If the dollar becomes unusable to trade, who will purchase it?

So then, the question becomes, what can the US sell to purchase Euro's if the dollar will not be accepted?

So another signal will be if you suddenly see the UK government deciding they want to become a part of the Euro. The UK pound might be stable now, but if the flight from the dollar continues, there will come a time when the old dream of the UK pound returning to its former glory, pre Breton Woods, and becoming the replacement currency will evaporate and the flight from the UK Pound will also start. Personally, I suspect that is already a point of discussion here.

I believe that we are watching the greatest seismic event in economics ever, all in nice slow motion. The dollar mountain is collapsing; and who knows where this will end?

[Chris Coles]

Re: HM Gov. short of cash

Chris, are you saying that if depositors started taking money out of National Savings accounts, they might find it more difficult in future, because they might be strapped for cash?

If one transfers 1000 pounds from a National Savings account to a Barclays Bank account is it just like a regular bank transfer? The NS money comes from a Bank of England account though, right? So don't they just print some more gilts and give them to the BoE. (Thus if the BoE/NS/UK Govt is bust, pound notes are worth a fortune until such time as they print some more?)

I am keenly interested in this idea that sterling lender of last resort not being able to pay up.

Querty,

Again, I am not concerned with the man or woman in the street and their national savings. I am concerned that the UK government is constrained from trading "intergovernmental purchases of securities". That they are as "locked in" as all the banks, that they are in the same boat and unable to trade their liabilities. That the intergovernmental trading of securities has also come to a complete halt.

Also, going back to my previous point. If you want to sell gilts, what do you take in return? More dodgy CDO's? That is not possible simply because it is to cover the dodgy CDO's the loans to the banks are being, or have been made in the first place. Most seem to have forgotten that even a government can run out of money and will need to turn to the markets for a top up. But the markets are fatally damaged and locked up. That is my point.

Further, as this dollar collapse continues, instead of the disadvantages of a strong currency leading to depressing trade, during the collapse, the strongest currency is King. We have a good example here in the UK with Northern Rock. It turns out that the banks with the strongest balance sheets are now raking in deposits from the customers of ANY bank under even the slightest suspicion.

Cash is King in a Downwave and the strongest King is the strongest currency. We have seen nothing yet..... the best is yet to come.