The Fiscal Cliff Is A Diversion

The Derivatives Tsunami and the Dollar Bubble

December 17, 2012 | Paul Craig Roberts

The “fiscal cliff” is another hoax designed to shift the attention of policymakers, the media, and the attentive public, if any, from huge problems to small ones.

The fiscal cliff is automatic spending cuts and tax increases in order to reduce the deficit by an insignificant amount over ten years if Congress takes no action itself to cut spending and to raise taxes. In other words, the “fiscal cliff” is going to happen either way.
The problem from the standpoint of conventional economics with the fiscal cliff is that it amounts to a double-barrel dose of austerity delivered to a faltering and recessionary economy. Ever since John Maynard Keynes, most economists have understood that austerity is not the answer to recession or depression.
Regardless, the fiscal cliff is about small numbers compared to the Derivatives Tsunami or to bond market and dollar market bubbles.

The fiscal cliff requires that the federal government cut spending by $1.3 trillion over ten years. The Guardian reports that means the federal deficit has to be reduced about $109 billion per year or 3 percent of the current budget. http://www.guardian.co.uk/world/2012/nov/27/fiscal-cliff-explained-spending-cuts-tax-hikes

More simply, just divide $1.3 trillion by ten and it comes to $130 billion per year. This can be done by simply taking a three month vacation each year from Washington’s wars.
The Derivatives Tsunami and the bond and dollar bubbles are of a different magnitude.
Last June 5 in “Collapse At Hand” http://www.paulcraigroberts.org/2012/06/05/collapse-at-hand/ I pointed out that according to the Office of the Comptroller of the Currency’s fourth quarter report for 2011, about 95% of the $230 trillion in US derivative exposure was held by four US financial institutions: JP Morgan Chase Bank, Bank of America, Citibank, and Goldman Sachs.
Prior to financial deregulation, essentially the repeal of the Glass-Steagall Act and the non-regulation of derivatives–a joint achievement of the Clinton administration and the Republican Party–Chase, Bank of America, and Citibank were commercial banks that took depositors’ deposits and made loans to businesses and consumers and purchased Treasury bonds with any extra reserves.

With the repeal of Glass-Steagall these honest commercial banks became gambling casinos, like the investment bank, Goldman Sachs, betting not only their own money but also depositors money on uncovered bets on interest rates, currency exchange rates, mortgages, and prices of commodities and equities.

These bets soon exceeded many times not only US GDP but world GDP. Indeed, the gambling bets of JP Morgan Chase Bank alone are equal to world Gross Domestic Product.

According to the first quarter 2012 report from the Comptroller of the Currency, total derivative exposure of US banks has fallen insignificantly from the previous quarter to $227 trillion. The exposure of the 4 US banks accounts for almost of all of the exposure and is many multiples of their assets or of their risk capital.

The Derivatives Tsunami is the result of the handful of fools and corrupt public officials who deregulated the US financial system. Today merely four US banks have derivative exposure equal to 3.3 times world Gross Domestic Product. When I was a US Treasury official, such a possibility would have been considered beyond science fiction.

Hopefully, much of the derivative exposure somehow nets out so that the net exposure, while still larger than many countries’ GDPs, is not in the hundreds of trillions of dollars. Still, the situation is so worrying to the Federal Reserve that after announcing a third round of quantitative easing, that is, printing money to buy bonds–both US Treasuries and the banks’ bad assets–the Fed has just announced that it is doubling its QE 3 purchases.

In other words, the entire economic policy of the United States is dedicated to saving four banks that are too large to fail. The banks are too large to fail only because deregulation permitted financial concentration, as if the Anti-Trust Act did not exist.

The purpose of QE is to keep the prices of debt, which supports the banks’ bets, high. The Federal Reserve claims that the purpose of its massive monetization of debt is to help the economy with low interest rates and increased home sales. But the Fed’s policy is hurting the economy by depriving savers, especially the retired, of interest income, forcing them to draw down their savings. Real interest rates paid on CDs, money market funds, and bonds are lower than the rate of inflation.

Moreover, the money that the Fed is creating in order to bail out the four banks is making holders of dollars, both at home and abroad, nervous. If investors desert the dollar and its exchange value falls, the price of the financial instruments that the Fed’s purchases are supporting will also fall, and interest rates will rise. The only way the Fed could support the dollar would be to raise interest rates. In that event, bond holders would be wiped out, and the interest charges on the government’s debt would explode.

With such a catastrophe following the previous stock and real estate collapses, the remains of people’s wealth would be wiped out. Investors have been deserting equities for “safe” US Treasuries. This is why the Fed can keep bond prices so high that the real interest rate is negative.

The hyped threat of the fiscal cliff is immaterial compared to the threat of the derivatives overhang and the threat to the US dollar and bond market of the Federal Reserve’s commitment to save four US banks.

Once again, the media and its master, the US government, hide the real issues behind a fake one. The fiscal cliff has become the way for the Republicans to save the country from bankruptcy by destroying the social safety net put in place during the 1930s, supplemented by Lyndon Johnson’s “Great Society” in the mid-1960s.

Now that there are no jobs, now that real family incomes have been stagnant or declining for decades, and now that wealth and income have been concentrated in few hands is the time, Republicans say, to destroy the social safety net so that we don’t fall over the fiscal cliff.

In human history, such a policy usually produces revolt and revolution, which is what the US so desperately needs.

Perhaps our stupid and corrupt policymakers are doing us a favor after all.

Congress Debates the Federal Reserve: Reform or Abolish?

Wednesday, 09 May 2012
Written by  Alex Newman - New American

In a rare moment of bipartisan unity, lawmakers and economists on both sides of the aisle largely agreed on two points: The Federal Reserve System as it stands is hurting America and something must be done to stop it. Just what exactly needs to happen, however, was the subject of considerable debate during a Subcommittee on Domestic Monetary Policy hearing Tuesday chaired by sound-money advocate and GOP presidential contender Rep. Ron Paul (R-Texas). 

Dr. Paul, of course, has become famous around the world for his tireless efforts to audit, expose, and abolish the central bank. He even published a best-selling book in 2009 entitled End the Fed, a title that has become a rallying cry for millions of Americans angry about the institution’s multi-trillion-dollar bailouts, market manipulations, corruption, and debasement of the currency.

The subcommittee hearing, entitled “The Federal Reserve System: Mend It or End It?”, examined a range of different proposals to reform the nation’s monetary system — it was supposed to look at six different options emanating from both parties. One of the measures on the agenda was Congressman Paul’s own “Federal Reserve Board Abolition Act,” legislation to dismantle the central bank and restore sound money based on market principles.

“More and more people are beginning to understand just how destructive the Federal Reserve's monetary policy has been. I hope that this hearing will kick start a serious discussion on the need to rein in the Fed,” Chairman Paul said in a statement about the event. “A hundred years is far too long for Congress to have taken a hands-off approach. The Fed continues to reward Wall Street banks while destroying the dollar’s purchasing power and driving up the cost of living for average Americans. This reckless behavior must come to an end.”

Several experts who testified before the subcommittee agreed with Paul’s proposals. And while efforts to reform the central bank have persisted for a century, in the wake of the economic crisis — which saw the Fed shower trillions of dollars on domestic and foreign banks — popular outrage has forced the controversy back into the spotlight. 

“The Fed simply does not know the ‘optimal’ supply of money or the ‘optimal’ intervention in the banking system; no one does,” explained Dr. Peter Klein from the University of Missouri during the hearing, noting that central banks do not fight inflation — they create it. “Add the standard problems of bureaucracy — waste, corruption, slack, and other forms of inefficiency well known to students of public administration — and it becomes increasingly difficult to justify control of the monetary system by a single bureaucracy.”

Dr. Jeffrey Herbner of Grove City College, an economist, echoed those concerns, citing a vast body of available data on the effects of central banking. “Economic theory and historical evidence demonstrate that a central bank confers no benefit on society at large,” Prof. Herbner testified, knocking down pro-central bank arguments one by one using facts and logic. “The Fed should be abolished and a market monetary system of commodity money and money certificates should be established.”

Another proposal that was examined during the hearing was the Sound Dollar Act. The legislation, introduced by Republican Rep. Kevin Brady of Texas, seeks to reform the central bank’s mandate to focus only on keeping the value of the currency stable — as opposed to its current mission, which also includes maximizing employment.

Critics argue that the Fed has failed miserably on both counts — unemployment is out of control and the dollar has lost more than 95 percent of its value since the central bank took over. But under Brady’s bill, the Fed would face broad new restrictions in terms of what it could do. Its primary purpose, then, would be to ensure the stability of the currency’s value.

“Except in the very short term, monetary policy cannot boost real output and job creation,” Brady told the subcommittee. “The last four decades of U.S. monetary policy demonstrate the advantages of a rules-based regime over a discretionary one. During the 1970s, the Federal Reserve had ‘go-stop’ policies, in which monetary policy quickly swung from ease to tightness and back again. This incoherence produced a highly volatile real economy and a rising inflation rate.”

Brady later told reporters that he hoped fellow lawmakers would take action on the bill this year, but he acknowledged that his efforts may simply be building the foundation for legislative action on the issue next year. “While the dual mandate may be politically appealing, it makes no sense for Congress to charge the Fed with controlling what it cannot,” he noted.

Stanford economics Prof. John Taylor largely agreed with Brady’s proposal, saying nearly 100 years of experience had shown that giving central banks broad discretion in centrally planning the monetary supply does not work. "Multiple goals enable politicians to lean on the central bank to do their bidding and thereby deviate from a sound money strategy," he explained, calling for a rules-based system.

Democrat Rep. Barney Frank, on the other hand, saw different problems with the Fed — most notably, its domination by powerful financial interests. “The problem you have now is this: the regional Fed bank presidents are picked by bankers,” he told the subcommittee, blasting what he called “private sector government.” Other critics have seized on that point to describe the Fed as a banking cartel with a state-issued monopoly over the nation’s currency.

Frank’s proposal, H.R. 3428, would strip much of the policy-setting power from the 12 regional Fed chiefs by removing their votes on the Federal Open Market Committee (FOMC). The legislation would also give lawmakers and the federal government more oversight authority over the privately owned central banking system, an idea the Fed itself has fiercely resisted under the guise of protecting its “independence.”

“I cannot think of another element of American government where there is formal binding legal power given to the representatives of the industry that’s in question,” Frank complained during his testimony. “I don’t think the American people are aware of the undemocratic nature of this.” Indeed, the Fed banks themselves have acknowledged on numerous occasions that they are owned and run by private banks. 

Other Fed reform bills that were on the agenda Tuesday included the “Democratizing the Federal Reserve System Act” introduced by Rep. Marcy Kaptur and Rep. Dennis Kucinich’s bill known as the “National Emergency Employment Defense Act.” Another piece of related legislation that was considered, H.R. 245, was introduced by Rep. Mike Pence. The bill is similar in some ways to Rep. Brady’s proposal in that it would end the so-called “dual mandate” of the Fed by forcing it to focus only on inflation.

While activists and lawmakers tear into the secrecy shrouding the controversial central bank, however, the Fed has gone to unprecedented lengths in recent years to protect its interests. It has accelerated its distribution of pro-Fed propaganda, for example, going so far as to design “education” lesson plans and comic books for the youth. The central bank also hired a lobbyist, and more recently, announced that it was developing a program to monitor critics online.

Still, despite the institution’s unconventional tactics to drum up support, pressure for change and outrage at the Fed continue to grow across the political spectrum. States are already taking action. Last year, Congress was finally able to obtain an audit — albeit a severely limited one — after the public outcry became deafening. According to polls, about 80 percent of Americans said they supported opening up the Fed’s books. And that, activists say, was just the beginning.   

Begging, Pleading for the Abolishment of Gross Domestic Product

"Rightful liberty is unobstructed action, according to our will, within limits drawn around us by the equal rights of others." ~ Thomas Jefferson

(I don't agree with everything this article says, but I think it's interesting and worth consideration.--jef)

+++++

Oct 27th, 2011 | By John Tammy |
 
Nobel Laureate Robert Mundell long ago observed that the only closed economy is the world economy.  As such, U.S. production (think the globalized manufacture of Apple’s iPad, or Boeing’s 787 Dreamliner) is a function of it ties to economic activity occurring around the world. GDP presumes a countries economy in isolation as well as uniformity between economies.

Worse, what often drives GDP up is far from something that would be considered economically stimulative. Indeed, government measures of inflation are notoriously slow to pick up on the horrors of dollar devaluation. Yet when devaluation leads to higher prices, GDP increases.

Government spending — which has no resources that it hasn’t first extracted from the private sector — also boosts GDP, and then if imports to the U.S. decline (a flashing negative economic signal if there ever was one), this actually registers as growth in the calculation of this most worthless of measures of our economic health.

It’s time to abolish GDP because its existence as the accepted measure of economic activity means that we cannot achieve the necessary reforms that would really allow our economy to grow. With so much of our economy directed towards work of little to no economic value, but which ultimately factors into the GDP calculation, we’re restrained from doing what we need to do to truly advance ourselves.

First up is regulation. As even President Obama acknowledges, regulation frequently serves as a barrier to productivity. We’ll see if he’s ever willing to back up his rhetoric with action (signing the REINs Act would be a big step), but for now regulations serve as a massive hurdle to businesses seeking profits for their shareholders by virtue of giving their customers what they want, along with things they didn’t know they want, but now can’t live without – think Google, Facebook and just about anything Apple produces.

Of course if there occurs a massive regulatory overhaul based on the correct kind of analysis which will show regulations merely inhibit profitable activity at best, and frequently miss corrupt actions at worst (Madoff), many in the U.S. whose livelihood is dependent on either regulating what they cannot, or helping businesses deal with regulators, will find themselves out of work. Their unemployment will in the near-term show up in reduced GDP, but the end result will be undeniably positive.

Looking at the estate tax alone, it discourages the very saving that authors our economic advancement, but its existence is a windfall for the myriad estate planners and attorneys in possession of the skills necessary to help those with estates to avoid the tax. Abolishing the death tax would be a major boon for economic growth for it releasing those reliant on it into worthwhile professions, but for a time their adjustment would detract from GDP “growth.”

Considering the floating dollar itself, the utter chaos caused by the latter has created whole industries meant to soften the blow of a dollar without definition. The currency market alone is a $3 trillion per day exchange as myriad great minds are forced into facilitator roles as traders of needless uncertainty, as opposed to producers. We’d have to invent hedge funds if they didn’t exist, but their growing footprint can to a high degree be laid at the door of President Nixon’s fateful 1971 decision to sever the dollar’s link to gold.

Banks and investment banks on their own have growing compliance staffs in place to deal with all of the rules foisted on them. Abolishing what won’t work in the form of Dodd-Frank, not to mention the stabilization of the dollar such that it becomes the proverbial foot would release countless agile minds from facilitator roles, some who will cure cancer, some who will create the next Microsoft, and some who will render the hell that is commercial air travel to the dustbin of history through making private travel as common as cellphones.

But to achieve the above, there would have to be a “recession” that would drive down GDP early on, but boost it in staggering ways long-term. In a nation brimming with talent, too many of our best and brightest are serving as facilitators to the detriment of real economic growth.

Lastly, a powerful reduction in government spending would surely bring down GDP substantially. Governments can only create jobs and economic activity to the extent that they take from the private sector, so major spending cuts at first would bring great pain to sectors of the economy in and out of government, but wholly reliant on government largesse.

All of the above is true, but then it’s also true that government spending is almost tautologically about capital destruction, as opposed to wealth creation. If this is doubted, ask yourself if any company in the private sector could ever remain in business if it had lost money for decades, with decades more of losses ahead?

But assuming serious downsizing of the government, workers and the capital destroyed to keep them employed would quickly find other, market-driven uses in the private sector. Government spending presently looms large when it comes to boosting GDP, true austerity would as a result reduce nominal GDP substantially up front such that dim economists would scream “recession”, but the long-term and economy-soaring result of such a move would be profoundly good for us all.

The problem now is that so worshipful and fearful of GDP are economists and politicians that reducing regulations in a credible way, stabilizing the dollar and slashing the burden that is government is a distant object to many. It is at least partially because GDP remains the benchmark for our economic health. Let’s abolish it so that we can start growing again.

We're in a Depression--Economic Terror Wins the Day

Meanwhile, Back in the Homeland
By MIKE WHITNEY

On Thursday, Gallup reported that "More than half of Americans say the U.S. economy is in a recession or a depression despite official data that show a moderate recovery.....The April 20-23 Gallup survey... found that only 27 percent said the economy is growing. 29 per cent said the economy is in a depression and 26 per cent said it is in a recession, with another 16 per cent saying it is "slowing down," Gallup said." 

55 percent of Americans believe we are in a depression or a recession a full 5 years after the housing bubble burst (2006) and 3 years after Lehman Brothers collapsed. (2008)  Gallup's findings jibe with other surveys that indicate growing desperation among the public. For example,  Globescan found that a large number of Americans have given up on free-market capitalism altogether, while other polls show dwindling confidence in government institutions, the Federal Reserve, the Congress, the judicial system and the media.

This is from the New York Times:

"Americans are more pessimistic about the nation’s economic outlook and overall direction than they have been at any time since President Obama’s first two months in office, when the country was still officially ensnared in the Great Recession, according to the latest New York Times/CBS News poll....

Capturing what appears to be an abrupt change in attitude, the survey shows that the number of Americans who think the economy is getting worse has jumped 13 percentage points in just one month.....

Frustration with the pace of economic growth has grown since, with 28 percent of respondents in a New York Times/CBS poll in late October saying the economy was getting worse, and 39 percent saying so in the latest poll.  ("Nation’s Mood at Lowest Level in Two Years", Poll Shows, New York Times)

No amount of "Sunny Jim" propaganda has been able to change the public's belief that things are getting worse. And things are getting worse, although not if one happens to be a hedge fund manager or one the lucky few at Goldman Sachs. Then, things have never been better. The Fed has flooded the market with low interest jet-fuel and All's Well in Wall Street's Bubbleworld. But if you're one of the 3 million  less fortunate working slobs; you're probably hanging on by your fingernails hoping like hell that you  haven't hit your credit card limit when you reach the checkstand at the grocery store or you'll have to slither red-faced for the exit.  Here's a quote from the Wall Street Journal which explains what the Fed's been up to:

"Starting essentially last year on Aug. 27—the day Fed Chairman Ben Bernanke laid the groundwork for QE2—investors have flocked to riskier investments. Since Aug. 26 the Standard & Poor's 500-stock index has gained 28 per cent. Smaller, generally riskier stocks have done even better, with the small-company Russell 2000 Index gaining 41 per cent. ...

“Corporate bonds have rallied and commodity prices have risen sharply, too. Gold is up 22 per cent since Aug. 26 and silver is up 143 per cent, both hitting nominal record highs. Even subprime mortgage securities, which were largely blamed for causing the financial crisis, are back in demand." ("Fed Searches for Next Step", Wall Street Journal)

Up, up and away. Everything's up. The S&P's up 28 per cent, the Russell's up 41 per cent, and there's even goldrush on mortgage-backed securities.   Thanks to  Bernanke loosey-goosey monetary policies, the markets are soaring while workers languish in a protracted slump barely able to make ends meet. The disparity between rich and poor is greater now than anytime since the Gilded Age and there's no sign of a reversal. The rich get richer while everyone else slides further into pauperism. 

Meanwhile, the dollar continues its downward trek eroding consumers’ buying power and forcing working people to decide between filling the gas-tank or fixing little Jenny's overbite. Most folks opt for the gas, at least then they can totter off to the factory on Monday for another week hump-busting drudgery. Here's more from the Wall Street Journal:

"The dollar fell to multi-year lows against most major currencies Thursday, undermined by an unpalatable mix of loose U.S. monetary policy and a fiscal imbalance that made investors reluctant to hold the battered greenback.....the primary negative for the dollar has been the Federal Reserve's loose monetary policy. In a market where investors are gravitating to higher-yielding assets, the dollar has been jettisoned by traders who appear more comfortable holding euros--even though Europe is struggling to contain a debt crisis that has raged on for nearly two years.

"The driver is (U.S.) monetary policy and the subtext is fiscal policy. We know there's a train-wreck coming and it makes people uneasy," said Andrew Busch, global currency strategist at BMO Capital Markets." ("Dollar Tumbles With US Monetary, Fiscal Policy In Focus", Wall Street Journal)

"Train-wreck"; that's aptly put. The flagging greenback is causing some real pain for households that find themselves less able to save or pay-down the debts they inherited when the bubble burst and their housing equity dropped into the red. Now they're paying steeper prices at the pump and the grocery store, leaving zero discretionary income for anything else, including medical emergencies. If Sammy falls off the jungle gym at school and snaps his clavicle, it all gets piled onto the VISA, that is, unless you're over your limit. Then you're outta luck.

But the real problem is jobs. There just aren't any, and no one in Washington wants to do a damn thing about it. Here's a clip from Friday's column by Paul Krugman:

"Last month more than 14 million Americans were unemployed by the official definition... Millions more were stuck in part-time work because they couldn’t find full-time jobs. And we’re not talking about temporary hardship. Long-term unemployment, once rare in this country, has become all too normal: More than four million Americans have been out of work for a year or more. ...

“It all adds up to a clear case for more action. Yet Mr. Bernanke indicated that he has done all he’s likely to do. Why?" ("The Intimidated Fed", Paul Krugman, New York Times)

Yes, why? If Bernanke's bond buying program (QE2) was such a rousing success, as Bernanke claims, then why not crank 'er up  one more time and put people back to work? Is that too much to ask? There are 14 million people unemployed, 42 million on food stamps, the homeless shelters are bulging, foreclosures are tipping 2 million per year, and the majority of people believe we're still in a Depression. Do you think we can get a hand here, Benny?

Do you have any idea how bad unemployment really is? Take a look at this from Calculated Risk:

"There are currently 130,738 million payroll jobs in the U.S. (as of March 2011). There were 130,781 million payroll jobs in January 2000. So that is over eleven years with no increase in total payroll jobs.

“And the median household income in constant dollars was $49,777 in 2009. That is barely above the $49,309 in 1997, and below the $51,100 in 1998......

“There are currently 7.25 million fewer payroll jobs than before the recession started in 2007, with 13.5 million Americans currently unemployed. Another 8.4 million are working part time for economic reasons, and about 4 million more workers have left the labor force. Of those unemployed, 6.1 million have been unemployed for six months or more." ("More than a Lost Decade", Calculated Risk)

No new jobs in a decade!  No one is hiring, wages are frozen, and the mushrooming current account deficit provides $500 billion per year to create new jobs overseas. And all Obama wants to do is talk about is slashing the deficits. 

But what about the jobs that are left? At least those are good paying jobs, right? I mean, at least a guy can put food on the table and pay the bills, right?

Not so.

Right now, roughly 65 million of the 130 million jobs in the country pay between $55,000 to $60,000 per year. In other words, they provide a "living wage", so that families don't have to scrape by in abject poverty. The other 65 million people are muddling by with part-time jobs or low-wage donkeywork that pays a lousy  $20,000 to 25,000 per year.

So, here's the deal:  (According to David Stockman) Since 2007, we've lost 6.5 million of these good paying jobs, but added zero during that same period. All the growth has been in low wage jobs.

Stockman says, "For the last decade we have lost 10 per cent of the middle income economy and, so far in this alleged recovery, we've not replaced one of the 6.5 million middle class jobs we've lost..... We've got a real income distribution problem in this economy, and it's getting worse, not better." (David Stockman: Lack of Middle Class Jobs plus Low Growth equals "Alleged Recovery", Yahoo Finance)

A former Reaganite talking about "income distribution"?!?  Now there's a shocker. 

Bottom line: The good-paying jobs are being shipped overseas pushing the middle class to the breaking point.  And the situation is getting worse, because now even the low paying jobs are getting harder to find. Take a look at this, from Bloomberg:

"McDonald’s and its franchisees hired 62,000 people in the U.S. after receiving more than one million applications, the Oak Brook, Illinois-based company said today in an e-mailed statement....." (Bloomberg News)

One million applications to flip burgers. That says it all.

So, even the most servile, demeaning jobs are getting scarcer, which is more proof that we're in a Depression. At the same time, unemployment claims have started inching higher again casting more doubt on the so-called "recovery". New unemployment filings  jumped 25,000 in the third week of April. Businesses are cutting costs to offset the rise in commodities prices which is hurting profits. Once again, claims have tipped the benchmark 400,000 for three weeks straight signaling more softness in the economy.

This from the Wall Street Journal:

"Roughly 1 million people in the U.S. were unable to find work after exhausting their unemployment benefits over the past year, Labor Department data released Thursday suggest....

“About 8.2 million idled workers were receiving unemployment benefits as of the week ended April 9, the Labor Department said in its weekly jobless claims report. This compares with about 10.5 million individuals at the same time last year, resulting in a decline of roughly 2.3 million people." ("One Million exhausted jobless benefits in past year", Wall Street Journal)

This is the cruelest blow of all, and also the most misleading. On the one hand, people who lost their jobs through no fault of their own are being tossed off the unemployment rolls and into a world of grinding poverty. While, on the other hand, their loss of benefits lowers the unemployment numbers, which makes it look like Obama's "do nothing" policy is actually working. So, it's a double whammy.

Finally, this last note on wages from Clinton-era Labor Secretary Robert Reich:

"The most significant economic news from the first quarter of 2011 is the decline in real wages..... In order to keep the jobs they have, millions of Americans are accepting shrinking paychecks. If they’ve been fired, the only way they can land a new job is to accept even smaller ones.

The wage squeeze is putting most households in a double bind. Before the recession, they’d been able to pay the bills because they had two paychecks. Now, they’re likely to have one-and-a half, or just one, and it’s shrinking.....

America’s jobless recovery is becoming a wageless recovery. That puts the odds of another recession greater than the risk of inflation." ("The wageless recovery", Robert Reich's blog)

Did someone say "Double dip"?

Wages are shrinking, jobs are scarce, unemployment benefits are running out, and the greenback is plunging. Is there really any doubt that we're in a Depression?

Mega-Banks and the Next Financial Crisis

Hedge-fund manager Paul Singer recognized the risks of subprime mortgages and bet against them. Now he warns that monetary policy could cripple American banks again.
MARCH 19, 2011

By JAMES FREEMAN

At the height of the housing bubble, hedge-fund manager Paul Singer was shorting subprime mortgages. By the spring of 2007, he was warning regulators on both sides of the Atlantic that the world was facing a major financial crisis.

They ignored him. Now the founder of Elliott Management says the biggest banks are headed for another credit meltdown. Among the likely triggers for the next crisis, Mr. Singer sees one leading candidate: Monetary policy "is extremely risky," he says, "the risk being massive inflation."

In some areas gas prices have reached $4 per gallon, and now Americans must brace themselves for higher grocery bills. This week the Labor Department reported that February wholesale food prices posted their sharpest increase since 1974. News like that has driven Mr. Singer to the history books: He treats visitors to his 5th Avenue office to a copy of a 1931 treatise on German currency debasement, Constantino Bresciani-Turroni's "The Economics of Inflation."

Mr. Singer—who launched Elliott in 1977 and has delivered a 14.3% compound annual return (compared to the S&P 500's 10.9%)—is not comparing today's Federal Reserve to the Reichsbank of the early 1920s. Rather, he's once again warning financial regulators. This time the message is: Don't take for granted investor faith in a major currency.

While at Harvard Law School, Mr. Singer turned down a research job with his intellectual hero, Daniel Patrick Moynihan, to pursue a career in finance. Today, he's still looking for heroes among the stewards of the major currencies. Central bankers, particularly at the Fed but also in Europe, "seem to be acting as if they have unlimited flexibility to ease monetary policy," he says.
He specifically targets the Fed's "unprecedented" policy of sustaining near-zero interest rates and its exercise in money-printing, "Quantitative Easing 2," that has it buying medium- and longer-term securities from the Treasury. "In effect they're treating confidence in fiat money—in paper money—as inexhaustible, that it's a tool that's able to be used not just in the throes of crisis," but also as "a virtually complete substitute for sound fiscal, regulatory and taxing policy."

Fed officials, he adds, "really seem to think that inflation is something they can deal with very easily and very quickly. I don't believe they're right." He notes that, in the late 1970s, inflation was only in the high single digits yet curing it required interest rates of 20% and a collapse of the bond market.

Mr. Singer further warns that investors shouldn't misinterpret apparently bullish signals from a rising market. "Of course printing money is going to support asset prices," but "it's very dangerous" and is not a substitute for trade, tax and regulatory reforms that make America an attractive place for job creation.

"What would a loss of confidence in the dollar actually look like? Gold going absolutely nuts," adds Mr. Singer, who is also a major donor to conservative intellectual causes and think tanks such as the Manhattan Institute. He observes that prices for many commodities are already near all-time highs, even with "kind of a soft recovery" in the U.S. and Europe, and robust growth in Asia. "Imagine if hoarding, speculation, investment positions in [hard assets] accumulate to cause commodities and gold to go rocketing up. Wages, prices will follow," he says.

As destructive as raging inflation would be, why would it hurt the big financial institutions? It could wreak havoc on the ability of big banks' corporate customers to make good on their obligations, Mr. Singer believes—and financial reform did little to reduce risks.

"Dodd-Frank has made the system more brittle and has shaped the next crisis in a very negative way," he warns. "The opacity of financial institution financial statements has not been addressed or changed at all. . . . We have a very large analytical research effort here and we have not found anybody that can parse" the sensitivity of big banks to changes in interest rates, asset prices and the like. "You can't do it."

Even after the crisis, credit ratings "obviously provide no real clue," he says. "Rumor and feeling is all you have. You don't know the financial condition of [Citigroup], JPMorgan, Bank of America, any of them." Mr. Singer believes the big banks still carry too much leverage, and he doesn't trust regulators to monitor them effectively.

The largest financial institutions, he says, are "a random collection of survivors. Almost none of the survivors exist because of their perspicacity, risk controls and sound management—even the ones that are vaunted along those lines. . . . How and why do they exist? Mostly an accident, meaning who got bailed out first and who was saved next and how did people feel and what did people say the weekend Merrill was under pressure [in September 2008]."

Mr. Singer says he does as little business with big banks as possible. "Aside from a large position in Lehman as part of our bankruptcy investing, we have no significant positions in global banks."

"We institutionally have tried to—way before the crisis of '08—tried to insulate ourselves in every way we can from the counterparty problem," i.e. getting involved in a trade with a partner that might not be able to make good on its obligations down the line. But the nature of his business, he says, means that he can't sever all connections. "We've removed as many assets from the Street as we possibly can, and we think we're pretty well insulated. . . . If we could completely avoid being subject to the financial condition of any large financial institution, we would do so."

Most investors don't share this view, of course, and big banks are still able to borrow at lower rates than their smaller competitors. The reason, says Mr. Singer, is that right now the system "is underwritten by the United States government and the governments of Europe. And the system is perceived as underwritten or guaranteed." But, he warns, "at some point that guarantee, in some way that I can't really visualize today, will go away."

Will it really? The authors of Dodd-Frank claim that the law prevents the government from bailing out any particular firm, but the Fed can still provide emergency loans to a failing giant as long as it offers similar financing to other firms.

"It's a very important part of this equation that a few survivors exist in this peculiar relationship with government, having to kowtow to government, make relationships with regulators," says Mr. Singer. "Are they puppets of the government? Are they cronies of the government? Will their lending be affected by the perceived whims or beliefs of the particular government regulators existing at a particular time? Yes."

If the government deems a firm not "systemically important," Mr. Singer forecasts, it could spell its doom. "Small and medium-sized financial institutions may be disadvantaged, may be sacrificed in the next crisis to protect these behemoths," he says.

It gets even worse, Mr. Singer says, if the government ever deems a financial giant "in danger of default"—a judgment that can be made without the consent of the firm or its investors. The business is then taken over by the Federal Deposit Insurance Corporation, with its Orderly Liquidation Authority.

Once in charge of the firm, the government can discriminate among similarly situated creditors and transfer assets out of the business at will. Because of this, says Mr. Singer, creditors and trading counterparties might flee even faster than they would from a firm headed toward bankruptcy, where at least there is established law instead of regulator discretion.

Mr. Singer's fund specializes in distressed debt and bankruptcy situations, so perhaps he has reason to oppose changes to a system he knows so well. But he's also well-qualified to examine the government's reforms.

"You don't know how you will be treated," he says of financial institutions under the new FDIC regime. "If there are companies that are also counterparties alongside you but they've been designated systemically important, that's a clue. It's like a game of treasure hunt. It's a clue that you're going to get disadvantaged compared to them."

So maybe FDIC chairman Sheila Bair and the authors of Dodd-Frank were right about one thing: Perhaps their new process for resolving failing giants really will discourage some people from lending to the biggest banks—but only at the worst possible moment.

The problem, in Mr. Singer's view, will be the jarring shift from one day being an investor in a member of the "systemically important" club, to the next day being a creditor whose claim is determined by bureaucratic whim. This may be welcome news to government pension funds that will want to be bailed out, but certainly not for private investors.

The speed at which a firm will collapse as word gets around that it might be headed to FDIC resolution could be "amazing," says Mr. Singer. And that "speed will drive the size of the losses."

This "atmosphere of unpredictability" is harmful to America's place in the financial world, he says, and "it doesn't make the system any safer. . . . This is nuts to be identifying systemically important institutions." He views it as a poor "substitute for creating soundness and reasonable levels of leverage throughout the system."

Mr. Singer's views on systemic risk are particularly interesting given his prescience about subprime mortgages (to say nothing of his ability to build a firm from zero to $17 billion in assets). In a famous 2006 presentation at a conference hosted by Grant's Interest Rate Observer, he explained in painstaking detail the flaws in subprime-mortgage securitizations, and in the high grades awarded to them by government-anointed credit-rating agencies. In the spring of 2007, he warned the G-7 finance ministers about the grave threat to the banking system, but his words "fell on deaf ears," he says.

Not that Mr. Singer's analytical skills are perfect: In the aftermath of the crisis, he fingered derivatives as a key factor, and he maintains that they will also play a role in the next crisis, even though it's now clear that in 2008 banks were felled by more conventional housing bets, not derivatives. Also, since Elliott largely doesn't play in the derivatives market, Mr. Singer bears few of the costs if that market is regulated more heavily.

Still, Mr. Singer's testimony against Dodd-Frank and Fed monetary policy is compelling.
One reason his firm has survived for 34 years, he says, is that "we try to be very respectful of the unpredictability of markets. We try to at all times at least assume that the world is not being properly run." A safe assumption.

QE2 and Last Rites for the World's Reserve Currency

Dollar in the Dustbin
By MIKE WHITNEY

Millions of Americans have no idea what Quantitative Easing is or how it will effect them personally. That's why Wednesday's announcement that the Fed will purchase another $600 billion in US Treasuries merely reinforced feelings of helplessness and a sense that government spending is out-of-control. Unfortunately, Ben Bernanke's rambling explanation of QE2 in a Washington Post op-ed on Thursday only added to the confusion. The article is loaded with half-truths and omissions that are meant to mislead the public about how the program works and what the Fed's real objectives are. It's another missed opportunity by Bernanke to come clean with the people and let them know what policies are being enacted in their name. Here's an excerpt from the article:

"The Federal Reserve's objectives ---- are to promote a high level of employment and low, stable inflation. Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 percent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer. The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills.....Low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating. The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed.....the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability. Steps taken this week should help us fulfill that obligation."

Bernanke mentions employment/unemployment 5 times in the first 3 paragraphs to give the impression that QE is about creating new jobs. But everyone knows that's baloney. If Bernanke was really worried about jobs, he would have appealed to Congress for a second round of fiscal stimulus in his speech, which he didn't, because he remains hawkish on deficits like his colleagues in the GOP-led congress. 

Also, if QE2 is mainly about jobs, than why not settle on benchmarks to determine whether the program is successful or not? In other words, if unemployment is still hovering at 8 or 9% in June 2011, when the program ends, then we can assume that Bernanke was either wrong in his calculations or deliberately misled the public about what the program really does. 

The truth is, Quantitative Easing will not reduce unemployment, narrow the output gap, or increase aggregate demand. At best, it will lower long-term interest rates (slightly) and buoy asset prices. That may be good for the stock market, but it won't lay the groundwork for a strong recovery. In fact, it might not even be enough to keep the economy from slipping back into recession. As last Friday's report from the Bureau of Economic Analysis indicates, most of 3rd Quarter GDP was from rebuilding inventories. Remove inventory restocking, and final demand was a sickly 0.6%. So, how will Bernanke's bond purchasing program increase final demand?

It won't. If the Fed buys Treasuries, Treasury yields go down which pushes investors into riskier assets (like stocks). That pushes stocks higher, investors feel richer, spending takes off, businesses hire more workers, and the economy grows. It's a great theory, but it doesn't work. Yields are already at record lows and businesses are still not hiring because there's no demand for their products. The problem cannot be fixed from the supply side, which is to say, that it doesn't matter how cheap money is, if no one is borrowing. And no one is borrowing because they are either broke or out-of-work. Bernanke's grand plan doesn't get money to the people who need it, so the economy will continue to sputter. 

Also, Yields on the 10-year and 30-year Treasuries have already dipped in anticipation of QE2, but is there any sign that businesses are planning to start hiring again? Of course not, because low interest rates don't matter in this environment. Case in point; record-low interest rates haven't increased home sales at all. Cheap money doesn't generate demand when personal balance sheets are underwater. Bernanke knows this because he's studied Japan's Lost Decade and understands what happened. They initiated two massive QE programs and got zippo---bank loans and credit continued to go sideways. So, Bernanke is being disingenuous. But why?

The reason is that the Fed is locked in a violent exchange-rate war to push down the value of the dollar. Bernanke wants to trim the current account deficit to boost exports. But he'd rather not tell the American people that he's using their currency as a bludgeon to beat trading partners into submission. It's easier just to scribble some gibberish about "generating jobs" and send it off to the Washington Post. 

The Fed is at war; that's the truth of the matter. Economist Michael Hudson calls Quantitative Easing (QE) "a form of financial aggression." But Hudson probably understates the case; "monetary terrorism" (moneterrorism?) is probably closer to the truth. QE is flooding emerging markets with cheap capital that's forcing their leaders to take defensive action to protect their economies. EM's have already seen the first wave of liquidity surge into their markets raising havoc with prices and forcing central banks to raise rates. But emerging markets aren't taking it laying down. They're throwing up protectionist barriers and monitoring capital flows. If Bernanke's going to print more money, they'll print, too. Mass competitive devaluation will ignite a full-blown currency war that leaves the present trade regime in tatters and the dollar in the dustbin. 

This is from Richard Portes in an article titled "Currency wars and the emerging-market countries":

"If the large developed market countries do more QE, however, then the flow of liquidity to the emerging markets may force the latter to respond. They may try to resist exchange-rate appreciation by intervening in the foreign exchange markets. Here we do have competitive devaluation – the “currency wars”....
This is why we see statements like “The US will win this war: it will either inflate the rest of the world or force their exchange rates up against the dollar” (Wolf 2010). But there is a potential downside for the US. Substantial dollar depreciation will weaken the global position of the dollar, as it did in the late 1970s. (Chinn and Frankel 2007)

The Fed will proceed with QE. It will not accept foreign constraints on its monetary policy, nor will it run an internationally “coordinated” or “cooperative” monetary policy." ("Currency wars and the emerging-market countries", Richard Portes, VOX)

See? This isn't about jobs at all. It's about power. It's about who is going to dictate policy to the rest of the world. Bernanke wants emerging markets to bear the costs of a financial crisis that originated on Wall Street and was nurtured every step of the way by the easy money policies of the Federal Reserve. Rather than accept responsibility for his actions--by restructuring the banking system and forcing them to write down their debts-- Bernanke has decided to create inflation by opening the sluice-gates and releasing a wall of liquidity that will (inevitably) produce asset bubbles and turmoil in foreign markets. The plan will put the dollar under severe pressure and could trigger a flight from dollar-backed assets, particularly US Treasuries. That would spark the Doomsday Scenario; a disorderly unwinding of the dollar and a swift plunge into crisis. That possibility is not as remote as many think. Here's a clip from the UK Telegraph's Ambrose-Evans Pritchard:

"The Fed's "QE2" risks accelerating the demise of the dollar-based currency system... a chorus of Chinese officials and advisers is demanding that China switch reserves into gold or forms of oil. As this anti-dollar revolt gathers momentum worldwide, the US risks losing its "exorbitant privilege" of currency hegemony." (QE risks currency wars and the end of dollar hegemony, Ambrose-Evans Pritchard, Telegraph)

Or, this from Nobel prize winner, Joseph Stiglitz:

"The world is on the verge of moving to another regime of managed exchange rates and fragmented capital markets....A new global reserve system or an expansion of IMF "money" (called special drawing rights, or SDRs) will be central to this co-operative approach. With such a system, poor countries would no longer need to put aside hundreds of billions of dollars to protect themselves from global volatility, and these would add to global aggregate demand.... with such a system, the US would no longer enjoy the extraordinarily cheap borrowing that comes with being the minter of the most important global reserve currency. But the current arrangement is an anomaly. The world is at a critical juncture." (A currency war has no winners, Joseph Stiglitz, The Guardian)

Or this from economist Michael Hudson who believes that the rising powers Brazil, Russia, India and China (BRIC) will challenge the current dollar-dominated regime leading the way to a new multi-polar world order. Here's what he says:

"The most decisive counter-strategy to U.S. QE II policy is to create a full-fledged BRIC-centered currency bloc that would minimize use of the dollar....A BRIC-centered system would reverse the policy of open and unprotected capital markets put in place after World War II. ... In September, China supported a Russian proposal to start direct trading using the yuan and the ruble rather than pricing their trade or taking payment in U.S. dollars or other foreign currencies. China then negotiated a similar deal with Brazil. And on the eve of the IMF meetings in Washington on Friday, Premier Wen stopped off in Istanbul to reach agreement with Turkish Prime Minister Erdogan to use their own currencies in a planned tripling Turkish-Chinese trade to $50 billion over the next five years, effectively excluding the dollar."

It won't happen overnight, but the transition away from the dollar has already begun. The financial crisis has greatly eroded US moral authority and the trust that's needed to preserve America's role as the steward of the world's reserve currency. Bernanke's misguided hyper-monetarism is merely hastening the dollar's decline. QE2 could very well be the straw that breaks the camel's back.

We can't inflate our way out of debt

Why the U.S. can't inflate its way out of debt
Published on 03-13-2010
CNNMoney.com

It's dawning on people that getting a handle on burgeoning U.S. debt will be a long and hard process.

So if lawmakers can't agree on a credible plan, some have suggested that the country could just "inflate its way" out of its fiscal ditch.The idea:

Pursue policies that boost prices and wages and erode the value of the currency

The United States would owe the same amount of actual dollars to its creditors -- but the debt becomes easier to pay off because the dollar becomes less valuable.

That's hardly a good plan, say a bevy of debt experts and economists.

"Many countries have tried this and they've all failed," said Mark Zandi, chief economist at Moody's Economy.com.

It's true that inflation could reduce a small portion of U.S. debt. The International Monetary Fund (IMF) estimates that in advanced economies less than a quarter of the anticipated growth in the debt-to-GDP ratio would be reduced by inflation.

But the mother lode of the country's looming debt burden would remain and the negative effects of inflation could create a whole new set of problems.

For starters, a lot of government spending is tied to inflation. So when inflation rises, so do government obligations, said Donald Marron, a former acting director of the Congressional Budget Office (CBO), in testimony before the Senate Budget Committee.

"[W]e have an enormous number of spending programs, Social Security being the most obvious, that are indexed. If inflation goes up, there's a one-for-one increase in our spending. And that's also true in many of the payment rates in Medicare and other programs," he said.

Inflation would also make future U.S. debt more expensive, because inflation tends to push up interest rates. And the Treasury will have to refinance $5 trillion worth of short-term debt between now and 2015.

"[The debt's] value could go down for a couple of years because of surprise inflation. But then ... the market's going to charge you a premium interest rate and say 'you fooled us once but this time we're going to charge you a much higher rate on your three-year bonds,'" Marron said.

The Treasury is increasing the average term of its debt issuance so it can lock in rates for a longer time and reduce the risk of a sudden spike in borrowing costs. But moving that average higher won't happen overnight. And, in any case, short-term debt will always be part of the mix.

Another potential concern: Treasury inflation-protected securities (TIPS), which have maturities of 5, 10 and 20 years. They make up less than 10% of U.S. debt outstanding currently, but the Government Accountability Office has recommended Treasury offer more TIPS as part of its strategy to lengthen the average maturity on U.S. debt.

The higher inflation goes, of course, the more the Treasury will owe on its TIPS.

Just last week, the CBO noted that interest paid on U.S. debt had risen 39% during the first five months of this fiscal year relative to the same period a year ago. "That increase is largely a result of adjustments for inflation to indexed securities, which were negative early last year," according to the agency's monthly budget review.

What's more, the knock-on effects of inflation are not pretty. A recent report from the IMF outlined some of them: reduced economic growth, increased social and political stress and added strain on the poor -- whose incomes aren't likely to keep pace with the increase in food prices and other basics. That, in turn, could increase pressure on the government to provide aid -- aid which would need to keep pace with inflation.

More viable alternatives

So where does that leave lawmakers? Facing tough choices.

Deficit hawks and market experts have been calling on lawmakers to come up with a strategy to stabilize the growth in U.S. debt, which would be implemented only after the economy recovers more fully.

The idea is to signal to the markets that the country is serious about getting its longer term debt under control so that the burden of paying it back doesn't consume an ever-increasing share of the federal budget.

The recommended exit strategies are pretty basic, if unpopular: tax increases and spending cuts.

Economic growth will play a key role as well -- since a strong economy produces more tax revenue. But the country cannot grow its way out of its problems.

To do that, the economy would have to expand at Herculean rates annually from here on out. And even the most optimistic economist doesn't see that on the horizon.