Fin/Inv

Colorado minimum wages are indexed to the Consumer Price Index. With the decline in the CPI, minimum wages are poised to go lower. Please consider Colorado minimum wage to drop as living costs fall.

Colorado will become the first state to reduce its minimum wage because of a falling cost of living. The state Department of Labor and Employment ordered the wage down to $7.24 from $7.28. That's lower than the federal minimum wage of $7.25, so most minimum wage workers would lose only 3 cents an hour.

Colorado is one of 10 states where the minimum wage is tied to inflation. The indexing is thought to protect low-wage workers from having flat wages as the cost of living goes up.

But because Colorado's provision allows wage declines, the minimum wage will drop because of a falling consumer price index. It will be the first decrease in any state since the federal minimum wage law was passed in 1938.

In Florida, deflation would reduce the minimum wage to $7.21, but the state's minimum wage already matches the federal wage, so Florida workers' paychecks won't change.

Other states with minimum wages that rise with inflation are Arizona, Missouri, Montana, Nevada, Oregon, Vermont and Washington.

Ben Hanna, Colorado organizer for the Association of Community Organizations for Reform Now, or ACORN, said the difference is small but significant for poor workers.

"I can't imagine many employers would see this as an opportunity to lower wages," Hanna said in August.

Minimum wage laws discourage hiring. Moreover, proposals to make health care mandatory do the same thing.

Small businesses, the lifeblood of any recovery, have significant reasons not to go on hiring sprees in this deflationary environment.

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

I am speaking at the CMRE Annual Fall Dinner on Thursday, October 15, 2009:

More details here:

In a zero-rate world, conventional indicators lose their usual meaning.

Health care reform is getting close to the finish line.

Anna here again gang.

Well INTC beat by gangbusters, and right now the NQ futs are up by almost 16 points!!! I said (as well as Mole/Berk) that OPX week normally is very bullish. We were forming a right shoulder on the Inverse H&S. Expect higher highs tomorrow. 1090 is what I look for next.  The bear is sad for now.

Well maybe my new Halloween costume will bring us some luck!  Yes this is a bear costume

Program Trading Update:

geronimo/ES: +2.5 (1 winning trade)

Watch this:

CNN Leaves It There

The Daily Show With Jon Stewart	Mon – Thurs 11p / 10c
CNN Leaves It There
www.thedailyshow.com
Daily Show Full Episodes Political Humor Ron Paul Interview

>

~~~

Then watch this:

Steve Forbes, Forbes CEO, shares his thoughts on health care reform.

Pretty amusing!

Fed Vice Chairman Donald Kohn spoke at the National Association for Business Economics conference in St. Louis, Missouri today: The Economic Outlook

Kohn outlines why he expects a moderate recovery (not V-shaped), and why he believes the risks to inflation are on the downside ...

A few excerpts:

All told, I expect that the recovery in U.S. economic activity will proceed at a moderate pace in the second half of this year before strengthening some in 2010. As we move into and through next year, inventory investment is likely to play a smaller role in supporting the growth of output, and aggregate activity should increasingly be propelled by stronger gains in final demand ...

[W]hy do I expect a gradual strengthening of economic activity? The fiscal stimulus program enacted earlier this year is likely playing a role, and it will continue to do so for a while as the states spend their stimulus funds to pay for infrastructure projects, hire more teachers, and finance other types of spending. But what will support economic activity as fiscal stimulus wanes?

Most importantly, support for private demand should come from a continuation of the improvements we've seen lately in overall financial conditions. Low market interest rates should continue to induce savers to diversify into riskier assets, which would contribute to a further reversal in the flight to liquidity and safety that has characterized the past few years. As the economy improves and credit losses become easier to size, banks will be able to build capital from earnings and outside investors, making them more able and willing to extend credit--in effect, allowing the low market interest rates to show through to the cost of capital for more borrowers. A more stable economic environment and greater availability of credit should contribute to the restoration of business and household confidence, further spurring spending.

An encouraging aspect of the improvement in economic and financial conditions in recent months has been the firming in house prices that I mentioned earlier. House prices can affect economic activity through several channels. One channel is through the influence of house prices on the net worth of households and, thereby, on consumer spending. Another channel is through the effect of anticipated capital gains or losses from investing in residential real estate on the demand for housing. Finally, greater stability in house prices should help reduce the uncertainty about the value of mortgages and mortgage-related securities held on the balance sheets of banks and other financial institutions, which should have a positive effect on their willingness to lend. This circumstance should nourish a constructive feedback loop between the financial sector and the real activity.

Given this possibility, another reasonable question might be, Why do I expect the economic recovery to be so moderate? To be sure, many times in the past, a deep recession has been followed by a sharp recovery. But, for a number of reasons, I don't think a V-shaped recovery is the most likely outcome this time around. First, although financial conditions are improving and market interest rates are very low, credit remains tight for many borrowers. In particular, the supply of bank credit remains very tight, and many securitization markets that do not enjoy support from the Federal Reserve or other government agencies are still impaired. Consumers as well as small and medium-sized businesses are especially feeling the effects of constraints on credit availability. Banks are still rebuilding their capital positions, and their lending will be held back by the need to work through the embedded losses in their portfolios of consumer and commercial real estate loans. Over time, as I already have noted, bank balance sheets should improve, and the supply of bank credit should ease. But the financial headwinds are likely to abate slowly, restraining the economic recovery.

In addition, I do not anticipate that the recovery in homebuilding will exhibit its typical cyclical pattern. Even though the decline in residential construction began well in advance of the overall contraction in real activity, the sector continues to have an oversupply of vacant homes. To be sure, by August, the inventory of unsold, newly built single-family houses had fallen appreciably from its peak level in the summer of 2006. Nonetheless, when compared with still low levels of sales, the supply of new houses remains elevated. In addition, the overhang of vacant houses on the market for existing homesis sizable, and the pace of foreclosures is likely to remain very elevated for a while, which should further add to that overhang. Thus, even with affordability quite favorable and house price expectations brighter, I anticipate a relatively subdued pickup in housing starts over the coming year.

In the business sector, the extraordinary amount of excess capacity is likely to be another factor tempering the rate of recovery. In manufacturing, the utilization rate currently is below 67 percent--noticeably less than the low points reached in prior post-World War II recessions. I expect that the wide margin of unused capacity, combined with the tight credit conditions faced by firms that have to rely primarily on bank lending, will lead many businesses to be quite cautious about the pace at which they increase their capital spending.

In part, the gradual pace I expect in the recovery of the economy toward full employment reflects the process of shifting the composition of aggregate demand and the way it is financed in response to the events of the past few years. In particular, consumers probably will do more saving out of their income, reflecting the likelihood that household net worth will be lower relative to income than over the past decade or so and that credit, appropriately, will be somewhat less available than during the boom that preceded the crisis. In addition, housing is almost certainly going to be a smaller part of the economy than it was earlier in this decade, as financial institutions maintain tighter underwriting standards that also more adequately reflect underlying risks. Such an increase in private saving propensities and a reduced demand for residential capital should prompt movements in relative prices and other factors that will, in turn, make room for a larger role for business investment and net exports in overall economic activity.

The transition to full employment and the complete emergence of this new configuration will take time, in part because the rebalancing of the economy involves repairs to balance sheets, the movement of capital and labor across sectors of the economy, and shifts in the global pattern of production and consumption--adjustments that are likely to be gradual under any conditions. Current circumstances, however, may slow the re-equilibration process more than might otherwise be the case because of the essential role of changes in the relative cost of finance in the adjustment process. But with the nominal federal funds rate essentially constrained at zero, and spreads in markets already having narrowed, reductions in the effective cost of capital will mainly take place as conditions at financial institutions improve and lenders ease borrowing standards, which as I have already discussed I expect to happen gradually.

As noted earlier, I expect that inflation will likely be subdued, and that, for a while, the risk of further declines in underlying rates of inflation will be greater than the risk of increases. That outlook rests importantly on two judgments: First, that the economy will be producing well below its potential for some time, which will directly restrain production costs and profit margins; and second, that inflation expectations are more likely to fall than rise over time as the level of real activity remains persistently less than its potential and actual inflation remains low.
...
But it's not the current level of inflation or of output that figure into our policy decisions directly--rather, it is the expected level some quarters out, after the lags in the effects of policy actions have worked themselves out. In that regard, the projection of only a gradual strengthening of demand and subdued inflation imply that that these gaps--of inflation and output below our objectives--are likely to persist for quite some time. In these circumstances, at its last meeting, the FOMC was of the view that economic conditions were likely to warrant unusually low levels of interest rates for an extended period.
emphasis added

A few interesting reads for your Tuesday:

• Goldman Sachs: U.S. Stocks Primed for Takeovers (Bloomberg)

• Climbing the Golden Wall of Worry (Barron’s)

• Zen Lessons in Market Analysis (Hussman)

• Home rescue plan delaying, not solving crisis (Reuters)

• End the war on drugs, start the legalization (Marketwatch)

• The Years of Magical Thinking (NYT)

• Vitriol, invective at the speed of light (Associated Press)

• The Appraisal Process Moves Front and Center (Matrix)

• In handy spreadsheet form, a complete listing of the always stimulating TED Talks

• Credit Report Card: A Truly Free Look at Your Credit Record (Credit Bloggers)

• Thanks for all the great comments on car buying!

>

What are you reading?

I still am mostly in cash (my largest account has only 12% of its buying power deployed into positions, and that includes the longs). I really, really want to get past this earnings mine field before getting aggressive.

Just remember what happened to INTC last time they did earnings. The stock was up about 25% in a matter of just a couple of weeks! This is an hourly bar graph of INTC from July, zoomed in for detail and with the post-earnings gap tinted. (By the time some folks read this, INTC will have announced...........)

Vice Chairman Donald L. Kohn

At the National Association for Business Economics, St. Louis, Missouri
October 13, 2009

The Economic Outlook

I’m pleased to be here at the National Association for Business Economics. Most of you are in the business of making or using economic forecasts to inform the strategies of your organizations as they try to meet their objectives. So am I, and I thought this would be a good opportunity to discuss my view of the outlook and the implications that I draw for monetary policy. I’ll start with a brief overview of recent developments and the near-term outlook. Then I’ll turn to a few of the issues that bear on the medium to longer-run outlook. I emphasize that the views you are about to hear are my own and not necessarily those of my colleagues on the Federal Open Market Committee.¹

In broad terms, the data that we have in hand indicate that economic activity turned up in the third quarter. To some extent, the pickup in activity in recent months reflects the dissipation of some of the forces that had been exerting downward pressure on the economy during the preceding several quarters. Perhaps the most important of these downward forces was the turmoil in financial markets that began in late 2007, which not only tightened credit availability and reduced wealth, but also undermined confidence, especially when conditions took a decided turn for the worse in the fall of 2008. The stabilization, and more recently the improvement, in risk appetites and financial conditions, in part responding to actions by the Federal Reserve and other authorities, has been a critical factor in allowing the economy to begin to move higher after a very deep recession.

A turn in the inventory cycle is another key element in the recent firming in aggregate activity. During the second half of 2008, many firms were apparently surprised at the sharp falloff in demand. In response to a buildup of unwanted inventories, they began aggressively liquidating stocks by slashing production well below the level of sales. The pace of liquidation intensified through the middle of this year. More recently, however, with inventories now less burdensome, firms have begun boosting production to slow the pace of inventory destocking and bring output into closer alignment with expected final sales. This process is particularly evident in the motor vehicle industry, where the stock of cars and trucks on dealers’ lots had become extremely lean, prompting increases in assemblies from the very low levels seen at midyear. More broadly, the slower pace of inventory liquidation likely provided an appreciable boost to manufacturing production in July and August, and should continue to push up factory output further in the near-term.

But, more importantly for sustained recovery, final sales began to stabilize earlier this year and have shown some tentative signs of picking up more recently. Improvement has been most evident in the housing sector. After three years of steep declines in residential construction, the recent news on housing has been encouraging, given the central role that this sector has played in the recession. Sales of new and existing homes have been on an uptrend since early this year, and the rise in sales has pared the inventory of unsold new homes substantially. As demand has strengthened and inventories of new homes have come down, construction of single-family homes has risen markedly in recent months. Meanwhile, several measures of house prices, after tumbling for the past two to three years, have increased in the past few months. Moreover, survey data suggest that an increasing number of potential homebuyers seem to think that house prices are near their bottoms and will increase over the coming year. And, based on prices from admittedly thinly traded futures, financial market participants appear to have become more optimistic about house prices as well. In light of these developments, I expect housing starts to continue to improve gradually in coming months.

In the consumer sector, spending fell sharply in the second half of 2008 as households raised their saving in response to reduced net worth, tighter credit conditions, and increasing uncertainty about job and income prospects. Following the steep declines in spending late last year, outlays were essentially flat on average during the first half of this year, and the saving rate leveled out. Expenditures appear to have increased in the third quarter, boosted during July and August by the cash for clunkers program and by increased dealer incentives. In addition, the latest figures suggest that real outlays for other consumer goods and services rose considerably in August. The recent firming of consumer spending likely has been aided by the fiscal stimulus package, which lowered taxes and increased transfer payments. However, with the labor market still quite weak and income gains subdued, advances in consumption spending in the coming months likely will be muted.

In the business sector, fixed investment plummeted late last year and early this year as current and expected sales tumbled–the typical accelerator effect–and credit conditions tightened. Lately, however, real spending on equipment and software appears to be stabilizing. The improvement is particularly visible for business purchases of cars and trucks. But the demand for high-tech equipment also appears to have firmed, while demand for other types of equipment seems to have flattened out. New orders have been choppy, but, in sharp contrast to their plunge over the preceding year, they seem to have improved on balance since the spring.

In contrast to spending for equipment and software, the contraction in business outlays for most types of nonresidential structures–for example, office and commercial buildings–appear to have fallen sharply over the first three quarters of the year. The widespread weakness reflects high and rising vacancy rates, an extremely tight financing environment, and sinking property prices that reduce the expected profitability of new projects. Because of the lumpy nature of these investments and the long time that it takes to plan and develop new projects, movements in outlays for nonresidential structures often lag movements in overall output, and, given the strong headwinds in this sector, I expect that any recovery in this area will be particularly slow to emerge.

The recession was global, and so too have been the recent signs of recovery. As a consequence, the demand for U.S. exports has been increasing lately after falling sharply in the first half of the year. However, with the firming of domestic demand, imports have also begun to increase, and, on net, the external sector appears to be a roughly neutral influence on overall economic activity at present.

All told, I expect that the recovery in U.S. economic activity will proceed at a moderate pace in the second half of this year before strengthening some in 2010. As we move into and through next year, inventory investment is likely to play a smaller role in supporting the growth of output, and aggregate activity should increasingly be propelled by stronger gains in final demand for reasons that I will discuss shortly.

Recovery in the labor market typically lags that in output, and the employment situation remains quite weak. Although the contraction in payroll employment has lessened since earlier in the year, monthly losses in private-sector jobs still averaged more than 200,000 per month last quarter. And, while the unemployment rate has not been rising as rapidly since midyear as it did over the preceding year, it could well reach 10 percent by early 2010. The difficult conditions in labor markets and the consequent implications for household incomes are important reasons for my expectation that the recovery in overall economic activity moving into next year will be restrained.

The substantial rise in the unemployment rate and the plunge in capacity utilization suggest that the margin of slack in labor and product markets is considerable. The resulting competitive pressures on workers and firms have contributed to a substantial decline in inflation, with both headline and core personal consumption expenditures (PCE) prices decelerating significantly over the past year. Although this year’s backup in energy prices has boosted headline consumer price inflation, the levels of broad measures of consumer prices are still below where they were a year ago. Core PCE prices are estimated to have risen 1.3 percent during the 12 months ending in August, compared with an increase of 2.7 percent over the preceding 12 months. To be sure, this deceleration has probably been exaggerated by a sharp decline in the so-called nonmarket component of PCE prices, which tends not to be a reliable indicator of inflation trends. But market-based price increases have also moved lower in an environment of weak demand.

At the same time, businesses have been aggressively cutting costs not only by eliminating jobs, but also by cutting back increases in labor compensation. For example, the employment cost index–a broad measure of wage and benefit costs in private industry–rose at an annual rate of just 3/4 percent over the six months ending in June. An alternative measure–nominal hourly compensation for the nonfarm business sector–is reported to have actually fallen at an annual rate of 2-1/4 percent, on average, during the first half of 2009. Moreover, businesses have been so aggressive in cutting labor input that productivity rose noticeably in the first half of the year. As a consequence, unit labor costs fell sharply in recent quarters.

Meanwhile, shorter-term inflation expectations have risen and fallen with recent fluctuations in actual inflation. But longer-term inflation expectations–whether measured in surveys of households and economists or inferred from financial markets–have been quite stable.

Even as the economy begins to recover, substantial slack in resource utilization is likely to continue to damp cost pressures and maintain a competitive pricing environment. I expect that the persistence of economic slack, accompanied by stable longer-term inflation expectations, will keep inflation subdued for some time. Indeed, if inflation expectations were to begin to ratchet down toward the actual inflation rates that we have experienced recently, inflation could move appreciably lower.

Having done this quick tour of the recent economic news, I would now like to address a few broader macroeconomic questions. First, why do I expect a gradual strengthening of economic activity? The fiscal stimulus program enacted earlier this year is likely playing a role, and it will continue to do so for a while as the states spend their stimulus funds to pay for infrastructure projects, hire more teachers, and finance other types of spending. But what will support economic activity as fiscal stimulus wanes?

Most importantly, support for private demand should come from a continuation of the improvements we’ve seen lately in overall financial conditions. Low market interest rates should continue to induce savers to diversify into riskier assets, which would contribute to a further reversal in the flight to liquidity and safety that has characterized the past few years. As the economy improves and credit losses become easier to size, banks will be able to build capital from earnings and outside investors, making them more able and willing to extend credit–in effect, allowing the low market interest rates to show through to the cost of capital for more borrowers. A more stable economic environment and greater availability of credit should contribute to the restoration of business and household confidence, further spurring spending.

An encouraging aspect of the improvement in economic and financial conditions in recent months has been the firming in house prices that I mentioned earlier. House prices can affect economic activity through several channels. One channel is through the influence of house prices on the net worth of households and, thereby, on consumer spending. Another channel is through the effect of anticipated capital gains or losses from investing in residential real estate on the demand for housing. Finally, greater stability in house prices should help reduce the uncertainty about the value of mortgages and mortgage-related securities held on the balance sheets of banks and other financial institutions, which should have a positive effect on their willingness to lend. This circumstance should nourish a constructive feedback loop between the financial sector and the real activity.

Given this possibility, another reasonable question might be, Why do I expect the economic recovery to be so moderate? To be sure, many times in the past, a deep recession has been followed by a sharp recovery. But, for a number of reasons, I don’t think a V-shaped recovery is the most likely outcome this time around. First, although financial conditions are improving and market interest rates are very low, credit remains tight for many borrowers. In particular, the supply of bank credit remains very tight, and many securitization markets that do not enjoy support from the Federal Reserve or other government agencies are still impaired. Consumers as well as small and medium-sized businesses are especially feeling the effects of constraints on credit availability. Banks are still rebuilding their capital positions, and their lending will be held back by the need to work through the embedded losses in their portfolios of consumer and commercial real estate loans. Over time, as I already have noted, bank balance sheets should improve, and the supply of bank credit should ease. But the financial headwinds are likely to abate slowly, restraining the economic recovery.

In addition, I do not anticipate that the recovery in homebuilding will exhibit its typical cyclical pattern. Even though the decline in residential construction began well in advance of the overall contraction in real activity, the sector continues to have an oversupply of vacant homes. To be sure, by August, the inventory of unsold, newly built single-family houses had fallen appreciably from its peak level in the summer of 2006. Nonetheless, when compared with still low levels of sales, the supply of new houses remains elevated. In addition, the overhang of vacant houses on the market for existing homesis sizable, and the pace of foreclosures is likely to remain very elevated for a while, which should further add to that overhang. Thus, even with affordability quite favorable and house price expectations brighter, I anticipate a relatively subdued pickup in housing starts over the coming year.

In the business sector, the extraordinary amount of excess capacity is likely to be another factor tempering the rate of recovery. In manufacturing, the utilization rate currently is below 67 percent–noticeably less than the low points reached in prior post-World War II recessions. I expect that the wide margin of unused capacity, combined with the tight credit conditions faced by firms that have to rely primarily on bank lending, will lead many businesses to be quite cautious about the pace at which they increase their capital spending.

In part, the gradual pace I expect in the recovery of the economy toward full employment reflects the process of shifting the composition of aggregate demand and the way it is financed in response to the events of the past few years. In particular, consumers probably will do more saving out of their income, reflecting the likelihood that household net worth will be lower relative to income than over the past decade or so and that credit, appropriately, will be somewhat less available than during the boom that preceded the crisis. In addition, housing is almost certainly going to be a smaller part of the economy than it was earlier in this decade, as financial institutions maintain tighter underwriting standards that also more adequately reflect underlying risks. Such an increase in private saving propensities and a reduced demand for residential capital should prompt movements in relative prices and other factors that will, in turn, make room for a larger role for business investment and net exports in overall economic activity.

The transition to full employment and the complete emergence of this new configuration will take time, in part because the rebalancing of the economy involves repairs to balance sheets, the movement of capital and labor across sectors of the economy, and shifts in the global pattern of production and consumption–adjustments that are likely to be gradual under any conditions. Current circumstances, however, may slow the re-equilibration process more than might otherwise be the case because of the essential role of changes in the relative cost of finance in the adjustment process. But with the nominal federal funds rate essentially constrained at zero, and spreads in markets already having narrowed, reductions in the effective cost of capital will mainly take place as conditions at financial institutions improve and lenders ease borrowing standards, which as I have already discussed I expect to happen gradually.

As noted earlier, I expect that inflation will likely be subdued, and that, for a while, the risk of further declines in underlying rates of inflation will be greater than the risk of increases. That outlook rests importantly on two judgments: First, that the economy will be producing well below its potential for some time, which will directly restrain production costs and profit margins; and second, that inflation expectations are more likely to fall than rise over time as the level of real activity remains persistently less than its potential and actual inflation remains low.

We can never directly observe the level of economic potential–it is largely inferred from the behavior of related variables, like output, productivity, costs and prices. In that regard, a widely discussed upside inflation risk is the possibility that as a result of the financial turmoil and deep recession, the extent of economic slack in the economy is not as great as is commonly estimated. One possibility is that the steep drop in investment has caused a decline in capital services that could damp the rise in productivity. Another possibility is that the needed reallocation of resources away from a number of sectors–including finance, construction, and motor vehicles–will have a restraining influence on potential output for a time. In addition, prolonged periods of unemployment could have adverse effects on the skills of workers and their attachment to the labor force.

The financial crisis may also have affected potential output by reducing the ability of financial markets to effectively lubricate the flow of credit throughout the economy–and to allocate capital resources to their most productive uses. The deterioration in the health of the financial system conceivably may have disrupted the credit allocation system enough to seriously impair the efficiency of business operations, and this impaired efficiency could show up at some point in more meager gains in productivity. And, some have argued, as governments seek to build more stable financial and economic systems, they may impede innovation and efficiency.

Each of these arguments contains a grain of truth, and they are worthy of further research. But in my view, the cumulative reduction in aggregate demand has been much greater than any possible cutback in potential supply. The unemployment rate has risen by 5 percentage points in a very short period, and capacity utilization in industry hovers just above its lowest level in the history of the series, dating back to 1948. The downward pressures on both prices and labor compensation reinforce my impression that our economy is operating well below its productive potential. And, if anything, productivity has been surprisingly strong, not weak, in recent quarters.

The improving picture for financial markets and the economy since last spring has meant that the Federal Open Market Committee (FOMC) has not undertaken any new initiatives to ease financial conditions and stimulate demand at its past several meetings. We have left the unusually accommodative posture of policy–in terms of our plans for our balance sheet and the level of our policy interest rates–in place. It’s important to judge this posture against how the economy is likely to evolve against our objectives in the future. Importantly, our objectives in the Federal Reserve Act are in terms of levels–the level of inflation relative to effective price stability and the level of output relative to the economy’s potential to produce over the long run. Right now, smoothing through the short-run fluctuations in energy prices, inflation seems to be running a little below the 2 percent objective for PCE prices that I have seen as best promoting our dual mandate of maximum employment and stable prices. And, as I indicated, employment and output seem to be substantially below plausible estimates of their potential.

But it’s not the current level of inflation or of output that figure into our policy decisions directly–rather, it is the expected level some quarters out, after the lags in the effects of policy actions have worked themselves out. In that regard, the projection of only a gradual strengthening of demand and subdued inflation imply that that these gaps–of inflation and output below our objectives–are likely to persist for quite some time. In these circumstances, at its last meeting, the FOMC was of the view that economic conditions were likely to warrant unusually low levels of interest rates for an extended period.

This assessment and my outlook do not mean that my colleagues and I will not also be looking carefully at any evidence that portends a potential pick up of inflation. Uncertainty about the course of the economy is a lot lower than it was just a few short months ago. But we cannot lose sight that this uncertainty remains quite high; we are still in largely uncharted waters when it comes to fully understanding how our economy will recover from the severe recession and financial disruptions of the past several years and how that recovery and inflation will be affected by the extraordinary actions we took. We need to base policy on our best estimate of the evolution of inflation and output relative to our objectives, but we also need to be ready to adjust our plans if events don’t turn out as predicted in either direction. We have the tools to exit our unusual policies when the time comes. And we must act well before demand pressures or inflation expectations threaten price stability.

In circumstances like these, we will be carefully watching the forecasts and economic evaluations of people like yourselves–indeed, perhaps as carefully as you will be watching the evolution of our thinking. In that regard, I’m glad to have had the opportunity to share some thoughts on these issues with you today.

---

Footnotes

1. Larry Slifman and Joyce Zickler of the Board’s staff contributed to these remarks.   Return to text

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As MIT economics professor and former IMF chief economist Simon Johnson points out today, the official White House position is that:

(1) The government created the mega-giants, and they are not the product of free market competition

(2) The White House needs to "regulate and oversee them", even though it is clear that the government has no real plans to regulate or oversee the banking behemoths

(3) Giant banks are good for the economy

In response to the latest claims by the government, let me recap the real reason the government doesn't want to break up the too big to fails.

We Need Them To Help the Economy Recover?

Do we need the Too Big to Fails to help the economy recover?

No.

The following top economists and financial experts believe that the economy cannot recover unless the big, insolvent banks are broken up in an orderly fashion:

• Nobel prize-winning economist, Joseph Stiglitz

• Nobel prize-winning economist, Ed Prescott

• Former chairman of the Federal Reserve, Alan Greenspan

• Dean and professor of finance and economics at Columbia Business School, and chairman of the Council of Economic Advisers under President George W. Bush, R. Glenn Hubbard

• Simon Johnson (and see this)

• President of the Federal Reserve Bank of Kansas City, Thomas Hoenig (and see this)

• Deputy Treasury Secretary, Neal S. Wolin

• The President of the Independent Community Bankers of America, a Washington-based trade group with about 5,000 members, Camden R. Fine

• The Congressional panel overseeing the bailout (and see this)

• The head of the FDIC, Sheila Bair

• The leading monetary economist and co-author with Milton Friedman of the leading treatise on the Great Depression, Anna Schwartz

• Economics professor and senior regulator during the S & L crisis, William K. Black

• Economics professor, Nouriel Roubini

• Economist, Marc Faber

• Professor of entrepreneurship and finance at the Chicago Booth School of Business, Luigi Zingales

• Economics professor, Thomas F. Cooley

• Former investment banker, Philip Augar

• Chairman of the Commons Treasury, John McFall

Others, like Nobel prize-winning economist Paul Krugman, think that the giant insolvent banks may need to be temporarily nationalized.

In addition, many top economists and financial experts, including Bank of Israel Governor Stanley Fischer - who was Ben Bernanke’s thesis adviser at MIT - say that - at the very least - the size of the financial giants should be limited.

Even the Bank of International Settlements - the "Central Banks' Central Bank" - has slammed too big to fail. As summarized by the Financial Times:

The report was particularly scathing in its assessment of governments’ attempts to clean up their banks. “The reluctance of officials to quickly clean up the banks, many of which are now owned in large part by governments, may well delay recovery,” it said, adding that government interventions had ingrained the belief that some banks were too big or too interconnected to fail.

This was dangerous because it reinforced the risks of moral hazard which might lead to an even bigger financial crisis in future.

If We Break 'Em Up, No One Will Lend?

Do we need to keep the TBTFs to make sure that loans are made?

Nope.

Fortune pointed out in February that smaller banks are stepping in to fill the lending void left by the giant banks' current hesitancy to make loans. Indeed, the article points out that the only reason that smaller banks haven't been able to expand and thrive is that the too-big-to-fails have decreased competition:

Growth for the nation's smaller banks represents a reversal of trends from the last twenty years, when the biggest banks got much bigger and many of the smallest players were gobbled up or driven under...

As big banks struggle to find a way forward and rising loan losses threaten to punish poorly run banks of all sizes, smaller but well capitalized institutions have a long-awaited chance to expand.

BusinessWeek noted in January:

As big banks struggle, community banks are stepping in to offer loans and lines of credit to small business owners...

At a congressional hearing on small business and the economic recovery earlier this month, economist Paul Merski, of the Independent Community Bankers of America, a Washington (D.C.) trade group, told lawmakers that community banks make 20% of all small-business loans, even though they represent only about 12% of all bank assets. Furthermore, he said that about 50% of all small-business loans under $100,000 are made by community banks...

Indeed, for the past two years, small-business lending among community banks has grown at a faster rate than from larger institutions, according to Aite Group, a Boston banking consultancy. "Community banks are quickly taking on more market share not only from the top five banks but from some of the regional banks," says Christine Barry, Aite's research director. "They are focusing more attention on small businesses than before. They are seeing revenue opportunities and deploying the right solutions in place to serve these customers."

And Fed Governor Daniel K. Tarullo said in June:

The importance of traditional financial intermediation services, and hence of the smaller banks that typically specialize in providing those services, tends to increase during times of financial stress. Indeed, the crisis has highlighted the important continuing role of community banks...

For example, while the number of credit unions has declined by 42 percent since 1989, credit union deposits have more than quadrupled, and credit unions have increased their share of national deposits from 4.7 percent to 8.5 percent. In addition, some credit unions have shifted from the traditional membership based on a common interest to membership that encompasses anyone who lives or works within one or more local banking markets. In the last few years, some credit unions have also moved beyond their traditional focus on consumer services to provide services to small businesses, increasing the extent to which they compete with community banks.

Indeed, some very smart people say that the big banks aren't really focusing as much on the lending business as smaller banks.

Specifically since Glass-Steagall was repealed in 1999, the giant banks have made much of their money in trading assets, securities, derivatives and other speculative bets, the banks' own paper and securities, and in other money-making activities which have nothing to do with traditional depository functions.

Now that the economy has crashed, the big banks are making very few loans to consumers or small businesses because they still have trillions in bad derivatives gambling debts to pay off, and so they are only loaning to the biggest players and those who don't really need credit in the first place. See this and this.

So we don't really need these giant gamblers. We don't really need JP Morgan, Citi, Bank of America, Goldman Sachs or Morgan Stanley. What we need are dedicated lenders.

The Fortune article discussed above points out that the banking giants are not necessarily more efficient than smaller banks:

The largest banks often don't show the greatest efficiency. This now seems unsurprising given the deep problems that the biggest institutions have faced over the past year.

"They actually experience diseconomies of scale," Narter wrote of the biggest banks. "There are so many large autonomous divisions of the bank that the complexity of connecting them overwhelms the advantage of size."

And Governor Tarullo points out some of the benefits of small community banks over the giant banks:

Many community banks have thrived, in large part because their local presence and personal interactions give them an advantage in meeting the financial needs of many households, small businesses, and agricultural firms. Their business model is based on an important economic explanation of the role of financial intermediaries--to develop and apply expertise that allows a lender to make better judgments about the creditworthiness of potential borrowers than could be made by a potential lender with less information about the borrowers.

A small, but growing, body of research suggests that the financial services provided by large banks are less-than-perfect substitutes for those provided by community banks.

It is simply not true that we need the mega-banks. In fact, as many top economists and financial analysts have said, the "too big to fails" are actually stifling competition from smaller lenders and credit unions, and dragging the entire economy down into a black hole.

The Giant Banks Have Recovered, And Are No Longer Insolvent?

Have the TBTFs recovered, so that they are no longer insolvent?

Negatory.

The giant banks have still not put the toxic assets hidden in their SIVs back on their books.

The tsunamis of commercial real estate, Alt-A, option arm and other loan defaults have not yet hit.

The overhang of derivatives is still looming out there, and still dwarfs the size of the rest of the global economy. Credit default swaps have arguably still not been tamed (see this).

Indeed, Nobel prize winning economist Joseph Stiglitz said recently:

The U.S. has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of Lehman Brothers Holdings Inc.

“In the U.S. and many other countries, the too-big-to-fail banks have become even bigger,” Stiglitz said in an interview today in Paris. “The problems are worse than they were in 2007 before the crisis.”

Stiglitz’s views echo those of former Federal Reserve Chairman Paul Volcker, who has advised President Barack Obama's administration to curtail the size of banks, and Bank of Israel Governor Stanley Fischer, who suggested last month that governments may want to discourage financial institutions from growing “excessively.”

While the big boys have certainly reported some impressive profits in the last couple of months, some or all of those profits may have been due to "creative accounting", such as Goldman "skipping" December 2008, suspension of mark-to-market (which may or may not be a good thing), and assistance from the government.

Some very smart people say that the big banks - even after many billions in bailouts and other government help - have still not repaired their balance sheets. Tyler Durden, Reggie Middleton, Mish and others have looked at the balance sheets of the big boys much more recently than I have, and have more details than I do.

But the bottom line is this: If the banks are no longer insolvent, they should prove it. If they can't prove they are solvent, they should be broken up.

The Government Lacks the Power to Break Them Up?

Does the government lack the power to break up the TBTFs?

Wrong.

One of the world's leading economic historians - Niall Ferguson - argues in a current article in Newsweek:

[Geithner is proposing that] there should be a new "resolution authority" for the swift closing down of big banks that fail. But such an authority already exists and was used when Continental Illinois failed in 1984.

Indeed, even the FDIC mentions Continental Illinois in the same breadth as "too big to fail" banks.

And William K. Black (remember, he was the senior regulator during the S&L crisis, and is a Professor of both Economics and Law) - says that the Prompt Corrective Action Law (PCA), 12 U.S.C. § 1831o, not only authorizes the government to seize insolvent banks, it mandates it, and that the Bush and Obama administrations broke the law by refusing to close insolvent banks.

Whether or not the banks' holding companies can be broken up using the PCA, the banks themselves could be. See this.

And no one can doubt that the government could find a way to break up even the holdign companies if it wanted.

FDR seized gold during the Great Depression under the Trading With The Enemies Act.

Geithner and Bernanke have been using one loophole and "creative" legal interpretation after another to rationalize their various multi-trillion dollar programs in the face of opposition from the public and Congress (see this, for example).

And the government could use 100-year old antitrust laws to break them up.

So don't give me any of this "our hands are tied" malarkey. The Obama administration could break the "too bigs" up in a heartbeat if it wanted to, and then justify it after the fact using PCA or another legal argument.

Is Temporarily Nationalizing the Giant Banks Socialism?

Many argue that it would be wrong for the government to break up the banks, because we would have to take over the banks in order to break them up.

That may be true. But government regulators in the U.S., Sweden and other countries which have broken up insolvent banks say that the government only has to take over banks for around 6 months before breaking them up.

In contrast, the Bush and Obama administrations' actions mean that the government is becoming the majority shareholder in the financial giants more or less permanently. That is - truly - socialism.

Breaking them up and selling off the parts to the highest bidder efficiently and in an orderly fashion would get us back to a semblance of free market capitalism much quicker.

The Real Reason the Giant Banks Aren't Being Broken Up

So what is the real reason that the TBTFs aren't being broken up?

Certainly, there is regulatory capture, cowardice and corruption:

• Joseph Stiglitz (the Nobel prize winning economist) said recently that the U.S. government is wary of challenging the financial industry because it is politically difficult, and that he hopes the Group of 20 leaders will cajole the U.S. into tougher action

• Economic historian Niall Ferguson asks:

  Guess which institutions are among the biggest lobbyists and campaign-finance contributors? Surprise! None other than the TBTFs [too big to fails].

• Manhattan Institute senior fellow Nicole Gelinas agrees:

  The too-big-to-fail financial industry has been good to elected officials and former elected officials of both parties over its 25-year life span

• Investment analyst and financial writer Yves Smith says:

  Major financial players [have gained] control over the all-important over-the-counter debt markets...

  It is pretty hard to regulate someone who has a knife at your throat.

• William K. Black says:

  There has been no honest examination of the crisis because it would embarrass C.E.O.s and politicians . . .
  

  Instead, the Treasury and the Fed are urging us not to examine the crisis and to believe that all will soon be well. There have been no prosecutions of the chief executives of the large nonprime lenders that would expose the “epidemic” of fraudulent mortgage lending that drove the crisis. There has been no accountability...

  The Obama administration and Fed Chairman Ben Bernanke have refused to investigate the nature and causes of the crisis. And the administration selected Timothy Geithner, who with then Treasury Secretary Paulson bungled the bailout of A.I.G. and other favored “too big to fail” institutions, to head up Treasury.

  Now Lawrence Summers, head of the White House National Economic Council, and Mr. Geithner argue that no fundamental change in finance is needed. They want to recreate a secondary market in the subprime mortgages that caused trillions of dollars of losses.

  Traditional neo-classical economic theory, particularly “modern finance theory,” has been proven false but economists have failed to replace it. No fundamental reform can be passed when the proponents are pretending that there really is no crisis or need for change.

• Harvard professor of government Jeffry A. Frieden says:

  Regulatory agencies are often sympathetic to the industries they regulate. This pattern is so well known among scholars that it has a name: “regulatory capture.” This effect can be due to the political influence of the industry on its regulators; or to the fact that the regulators spend so much time with their charges that they come to accept their world view; or to the prospect of lucrative private-sector jobs when regulators retire or resign.

• Economic consultant Edward Harrison agrees:Regulating Wall Street has become difficult in large part because of regulatory capture.

But there is an even more interesting reason . . .

The number one reason the TBTF's aren't being broken up is [drumroll] . . . the 'ole 80's playbook is being used.

As the New York Times wrote in February:

In the 1980s, during the height of the Latin American debt crisis, the total risk to the nine money-center banks in New York was estimated at more than three times the capital of those banks. The regulators, analysts say, did not force the banks to value those loans at the fire-sale prices of the moment, helping to avert a disaster in the banking system.

In other words, the nine biggest banks were all insolvent in the 1980s.

Indeed, Richard C. Koo - former economist at the Federal Reserve Bank of New York and doctoral fellow with the Fed's Board of Governors, and now chief economist for Nomura - confirmed this fact last year in a speech to the Center for Strategic & International Studies. Specifically, Koo said that -after the Latin American crisis hit in 1982 - the New York Fed concluded that 7 out of 8 money center banks were actually "underwater" and "bankrupt", but that the Fed hid that fact from the American people.

So the government's failure to break up the insolvent giants - even though virtually all independent experts say that is the only way to save the economy, and even though there is no good reason not to break them up - is nothing new.

William K. Black's statement that the government's entire strategy now - as in the S&L crisis - is to cover up how bad things are ("the entire strategy is to keep people from getting the facts") makes a lot more sense.

by Bruce Webb

Key Senate committee passes health care plan

The Senate Finance Committee passed a long-awaited $829 billion health care bill Tuesday by a 14-9 vote. Sen. Olympia Snowe, R-Maine, was the lone committee member to cross party lines, breaking with other Republicans to vote for the measure. All the committee's Democrats supported the bill.

The MSM will lead with Snowe, but the real story to follow is that last sentence. Neither Conrad nor Lincoln left the fold. Meaning that at first glance there is no chance they would vote to keep the merged bill from at least coming to the floor for debate (which was a possibility if they had defected on the SFC bill itself) and I would think little chance they would back a filibuster on final passage.

TPM liveblogged the vote here: LIVEBLOG: Senate Finance Committee Votes On Health Care Reform Bill

I'll be following this story all day and night but mostly not be able to comment. So consider this an open Health Care thread. I would throw one question out for discussion: Did AHIP overplay its hand by releasing the PWC Report? Because I certainly would not have predicted the Conservadems falling into line the way they did, something got them off the fence.

From an article by Jody Shenn and Dawn Kopecki on Bloomberg: JPMorgan Pitches Interest-Only Mortgages to Boost Obama Plan

Banks will push the Obama administration to expand its mortgage-modification program to allow interest-only periods on reworked loans ... while recognizing concern that it may only postpone defaults, according to JPMorgan Chase & Co.

“We’re working with our peers to develop a proposal to present,” Douglas Potolsky, a senior vice president at JPMorgan’s Chase home-loan unit, said yesterday at a Mortgage Bankers Association conference in San Diego.

This is simply more extend and pretend, and only postpones defaults.

The article also has some comments from Laurie Anne Maggiano, director of the Treasury’s policy office for homeownership preservation. Maggiano acknowleges that only "a couple thousand" modification are now permanent, and she notes that the trial period has been extended an extra two months (I guess a disappointing number of trial modifications are becoming permanent).

The key numbers to track going forward will be the number of permanent modificatons, and the redefault rate for permanent modifications. So far it is "a couple thousand" and too early to say.

The article also quotes Maggiano on the short sale initiative that should be announced next week. Housing Wire has more: Treasury to Announce New Program to Avoid Foreclosure

The Chief of the Homeowner Preservation Office at the Treasury, Laurie Maggiano, released information on the Home Affordable Foreclosure Alternatives (HAFA) while speaking at the MBA’s 96th Annual Convention going on in San Diego. The official launch is expected in the next week or so.
...
Maggiano adds that HAFA will offer financial incentives to both servicers and borrowers, and associated secondary investors, in order to facilitate a short sale or deed in lieu of the property.

I am spending a lot of time researching a really amazing new technology, so I've gone relatively quiet (e.g. no blog posts for almost an hour!) In the meantime, a bit of music to throw your way. An English translation of the Latin is beneath.

When the damned are confounded

and consigned to keen flames,

call me with the blessed.

I pray, suppliant and kneeling,

a heart as contrite as ashes;

take Thou my ending into Thy care.

Just looking at the earnings per share estimate for a company heading prior to its quarterly report doesn't tell you much. A more informative analysis is to look at how the estimates have changed throughout the quarter to see if analysts have gotten more positive or negative on earnings. Below we highlight the trend in earnings estimates for five major...

If you click the top screen, you'll see how the 40 stocks in my basket are trading relative to their opening price. Note the mix of green and red--one nice tell of a range market. A click on the bottom "spectrum" screen from the excellent FinViz site shows how each major S&P 500 sector is trading, with weakness (red) in Financial shares and strength in consumer services. When we see a good deal of black in the spectrum and a relatively even level of red and green, that's another nice tell of a range market.
.

The Fed’s Vice Chairman Kohn speaking on the economic outlook is not saying anything new. He discusses the signs of improvement that will lead to growth in Q3, “dissipation of some of the forces that had been exerting downward pressure on the economy during the preceding several quarters,” inventories, stabilized housing, business spending on equipment and software and some signs of stabilization with final demand. But he also has the obvious caveats. Net-net, “US economic activity will proceed at a moderate pace in the 2nd half of this year before strengthening some in 2010.” He remains dovish on inflation as he has little concern due to “substantial slack” in labor and product markets and sees “stable longer term inflation expectations.” He repeats the FOMC view that rates will stay low for a while as they cling to the belief that it’s the cure to what ails us.

Die Bundesregierung hat gerade ihre Prognosen fuer die Wirtschaftsentwicklung aufgehuebscht. Das verspricht weniger Steuerverluste und erlaubt rechnerisch etwas mehr Steuersenkungen. Doch im Hintergrund stehen die Zeichen erneut auf Sturm. Vieles sind harte Fakten der amtlichen Statistik. Anderes sind Eindruecke, die sich dem Betrachter erschliessen, wenn er durch die aktuellen Meldungen blaettert.

John Mauldin has proposed some interesting solutions for fixing the economy in his weekly E-Letter Killing The Goose. Let's take a look, first at the problem, then at various solutions.

Long-time readers know that I think the Fed has been able to get away with its rather large monetization program because of the massive deflationary forces let loose in the world by the credit crisis, which is forcing a monster deleveraging regime all over the world.

And this brings us to our conundrum. You cannot continue to run deficits significantly larger than nominal GDP for too long without risking the demise of the economic system. But we are in a deflationary environment, so the Fed can monetize the debt far more than any of us suppose without risking immediate and spiraling inflation. How long can we go before there is an upheaval? I don't know. The markets can remain irrational or complacent for a lot longer than most of us think. It could be years. Or not. Some of my most knowledgeable friends argue for the inflation side, and others take the deflation side. I tend to think the Fed will fight deflation until we get inflation, but the consequences will not be pleasant. There is no benign path. How can we avoid such an upheaval? The only way is to make some very difficult choices. There have to be some adults making the choices, as the teenagers now in control clearly cannot make them. It is not a matter of pain or no pain, it is just deciding when and how bad it will be. The longer we wait, the worse the consequences. First, we must acknowledge the deficit is out of control, and spending must be cut. If we raise taxes by as much as the Obama administration now wants to, we will most assuredly put the country back into a deep recession in 2011. Think what raising taxes in 1937 did to a nascent recovery. A $3-trillion-dollar budget is 20% of the US economy. That is just simply too much. The most credible studies show that government expenditures exert no multiplier effect on the economy. Actually, they show them to be very slightly negative. This is not just in the US. However, the tax effect has a multiplier of 3! If we raise taxes by $300 billion in 2011, that will slam the economy in the face. Further, we will collect less taxes than projected, as economic activity will fall. You cannot cure a too much debt problem with more debt. We cannot borrow our way into prosperity. Every crisis of the past decades has been a result of too much debt and leverage and we seem to want to repeat the past mistakes, hoping that this time it will be different. It won't. Mauldin summarizes the problem very well. What cannot last forever by definition won't. Unfortunately the only options are to pay the piper sometime soon, or have a major global monetary collapse later. There is no realistic middle ground. Let's now take a look at his suggestions one by one. I will comment on each one individually and add some things that he missed. Mauldin: We should start with a 5% across-the-board cut in spending in all programs. Federal employees, except for military personnel, should see a 5% cut in pay as part of that program. The average federal worker makes $75,419 a year, while the average in the private sector is $39,751. The rest of us are taking pay cuts in the form of higher taxes. No cost of living increases, etc. We are on an austerity program and need to do what it takes. If a program is deemed too important to be cut, then another program has to be cut more. Then the next year another 2.5% cut across the board. And then an absolute freeze on the overall budget size until the deficit is 2% or less of GDP. Mish: The goal must be a balance budget, not deficits of 2% of GDP. Public sector wages are indeed way out of line. In addition, there are entire departments that are redundant or unneeded. We can start by getting rid of HUD, the FHA, the department of Education, the Department of Energy, Homeland Security and numerous other unnecessary departments. Should someone think there are critical functions in those departments, then just cut the budgets by 60-80%. After cutting the waste, we might not need to cut wages, but should do so anyway to keep government jobs inline with pay in the private sector. Mauldin: Social Security must be fixed now. We all know that it is going to have to be done, so why not just do it? Means testing should be a part of the mix. As an idea, for every $10,000 in income a retiree has, he gets $1,000 less in SS payments. And increase the retirement age down the road. When SS was launched, retirement age was 65. But the average life span was 65. There are other things we can do, but whatever our poison of choice is, we need to take it. Mish: Ideally we should find a way to phase out social security completely. Politically that will never fly. As a practical matter, raising the retirement age and placing means tests are about the best we can hope for. Given that the Maximum Social Security Benefit is around $25,400 (an amount that does not go all that far), penalizing people immediately for every $10,000 in income is excessive. For the sake of argument, I propose a starting point at $50,000 then a $1,000 reduction in SS benefits for every $10,000 in income between $50,000 and $100,000, with a $2,000 reduction in SS benefits for every $10,000 in income above $100,000. Mauldin: Medicare must be revised, with real health-care reform. The national debt is $56 trillion if we count unfunded liabilities, much of which is Medicare. It will become a nightmare around the middle of the next decade. Adding more expenses now without cutting elsewhere makes no sense. If we kill the goose, no one will get anything except very empty promises. There actually is a lot of waste in the system. Software should be written that analyzes every patient and procedure and produces an outcomes-based analysis of what is reasonable, rather than throwing every test at every patient. And the government should make sure, even if it has to spend the money, that the updated system is in place in every hospital and clinic in the country. And doctors should be given access to it so they can decide what type of care is appropriate to prescribe. And health-care reform means tort reform. Mish: The key problem is there is an unlimited demand for free services. Nearly everyone is concerned about rationing. I am concerned there will not be rationing. Beyond a certain age or likelihood of success of a procedure, services should be denied unless one has private insurance on top of Medicare. A huge percentage of health care money is spent in the last two years' of someone's life, typically only prolonging the agony. This needs to stop. Mauldin: Each year we allow almost 1 million immigrants into the US, mostly family of people already here. I suggest that for the next two years we stop that. Instead, let anyone who can buy a home, passes basic screening, and can demonstrate the ability to pay for health insurance immigrate to the US and get a temporary green card. If they behave, then the card becomes permanent after four years. We almost immediately put a floor on the housing market, absorb the excess homes, and within a year the housing-construction market, along with the jobs that are now gone, will be back. That is stimulus that costs the taxpayers nothing. Mish: Mauldin is optimistic here. How many immigrants have enough income to pay for a home, healthcare, insurance, etc? Enough to matter? Besides, where will that income come from? Where are the jobs? This may not cost much, but it may not gain much either. Moreover, should the goal be to put a floor on home prices? Calculated Risk offers his opinion in A Policy: Supporting House Prices. I side 100% with calculated risk. However, if someone does have enough money to support themselves, pay for healthcare, etc, by all means let them buy homes, as many as they want. In the meantime $8,000 tax credits for homes, 3% FHA down payments, and borrowed down payments are all making matters worse. These ill-advised housing programs are making matters worse. Mauldin: While I can't believe I am writing this, taxes are going to have to rise, if for no other reason than this Congress is hell bent on raising taxes. But rescinding the entire Bush tax cuts, plus adding a 10% surcharge as Congress wants to do in one fell swoop, is an absolute guarantee of a recession. So do it gradually over (say) 4 years, and then reinstitute the cuts when the deficit is under 2% of GDP. Remember the negative tax-multiplier effect of raising taxes. And the definitive work on that was done by Obama's chairman of the Council of Economic Advisors, Christina Romer. We should consider a VAT tax and a major cut/reorganization of the corporate tax. We need to encourage corporations to hire more, and you do that by taxing less. Let's make our corporations more competitive, not less. Our taxes are much higher than those of any of our major competitors. And please forget that insane carbon tax. If you want to cut emissions, do it straightforwardly by raising taxes significantly on gasoline. Don't back-door it on consumers. (And I am NOT advocating such a policy.) Mish: I am in favor of elimination of corporate income taxes. Right now we have a peculiar situation whereby corporate profits held outside the US are tax deferred but inside the US they are not. Talk about a perverse policy of encouraging capital flight. Why not turn that around and require corporate taxes on money held outside the US and no taxes on profits held in the US? Mauldin is correct that the carbon tax is ridiculous. As for the VAT, my big fear would be that in practice, it would become a monster unleashed. In theory, however, some combination of a flat income tax with no deductions and a small VAT to encourage saving vs. spending is reasonable. The VAT should not apply to medical expenses and food (explicitly food purchased at grocery stores). The flat income tax should truly be flat, with no deductions, even for housing. If we cut enough military and other spending (easily doable as noted below), we need not raise taxes at all, and in fact can probably lower them. Mauldin: An aggressive tax benefit for new venture-capital money that is invested in new technologies will result in new industries. The only way we can grow our way out of this mess is to create whole new industries, like we did in the late '70s and '80s. (Think computers and the internet and telecom.) Mish: Our tax code is perverted enough. We do not need tax incentives if we eliminate corporate taxes as suggested. We should get rid of all tax incentives. They are part of the problem. Government has no business picking winners and losers. It needs to get out of the way. Mauldin: Unemployment is likely to continue to rise and last longer than ever before. We have to take care of the basic needs of those who want work but can't find it. Unemployment insurance should be extended to those who are still looking for work past the time for benefits to expire, and some program of local volunteer service should be instituted as the price for getting continued benefits after the primary benefits time period runs out. Not only will this help the community, but it will get the person out into the world where he is more likely to meet someone who can give him a job. But the costs of this program should be revenue-neutral. Something else has to be cut. Mish: Can we deal with 15 million volunteers? Somehow I doubt it. Mauldin: We have to re-think our military costs (I can't believe I am writing this!). We now spend almost 50% of the world's total military budget. Maybe we need to understand that we can't fight two wars and support hundreds of bases around the world. If we kill the goose, our ability to fight even one medium-sized war will be diminished. The harsh reality is that everything has to be re-evaluated. As an example, do we really need to be in Korea? If so, why can't Korea pay for much of the cost? They are now a rich nation. There are budgetary fiscal limits to being the policeman for the world. Mish: Bingo. We can easily slash our military budget by 70% and still be the most powerful nation in the world. Moreover, it is time to declare the war in Iraq and Afghanistan over, pack our bags and leave. Gradually, over the next 5-8 years we should bring home all our troops from literally every county they are stationed. This chart shows the absurdity of our spending. Chart courtesy of Global Issues - World Military Spending. By the way that chart does not include the latest increase in the US military budget. Please consider US lawmakers pass 680-billion-dollar defense budget bill

The US House of Representatives passed a 680-billion-dollar defense authorization bill on Thursday that includes funds to train Afghan security forces and more mine-resistant troop carriers.

Lawmakers defied President Barack Obama's veto threat and approved 560 million dollars to continue work on an alternative engine for the F-35 fighter jet built by General Electric and British manufacturer Rolls-Royce. The compromise legislation would also raise military pay by 3.4 percent -- half a percentage point higher than Pentagon recommendations -- and assign 6.7 billion dollars for mine-resistant armored vehicles known as MRAPs, which is 1.2 billion dollars more than the administration had proposed. Nearly $700 billion dollars of "defense" spending. The amount needed for actual defense is 20% of that at most, and more likely 5%. Balancing the budget is easy if you start here. Mauldin: Glass-Steagall, or some form of it, should be brought back. Banks, which are subject to taxpayer bailouts, should not be in the investment banking and derivatives-creating business. Derivatives, especially credit default swaps, should be on an exchange, and too big to fail must go. Banks have enough risk just making loans. Leverage should be dialed down, and hedge funds selling what amounts to naked call options in any form, derivative or otherwise, should be regulated. Mish: What we need to do is get rid of the Fed, FDIC, and fractional reserve lending. Regulation has failed every step of the way. Regulation created Fannie Mae, Freddie Mac, and the Fed. Regulation by the SEC anointed Moodys, Fitch, and the S&P as debt rating companies. We do not need more regulation, we need less regulation, a sound currency, and no Fed. Regulation is clearly the problem, yet the cries for still more regulation come from nearly every corner save the Austrian economists. Mauldin: Let me see, is there any group I have not offended yet? But something like I am suggesting is going to have to be done at some point. There is no way we can continue forever on the current path. At some point, we will hit the wall. The fight between the bug and the windshield always ends in favor of the windshield. The bond market is going to have to see a credible effort to get back to a reasonable deficit, or we risk a very difficult economic environment. The longer we wait, the worse it will be. Mish: "Is there any group I have not offended yet?" Yes. You failed to offend those on public pension plans. Not to fear, I did that myself in Five Major Pension Problems - One Simple Solution. Unsolvable Problems

• Expecting 8% returns in a 4% world. When 30 year treasury bonds are yielding 4%, the dividend yield of the S&P 500 is 2%, and the S&P 500 PE is 140 (26 if you use operating earnings), 8% returns are from Fantasyland.
• Pension benefits start too early. People are living longer.
• Private employees do not receive these kind of benefits. Public employees should not either, especially at taxpayer expense.
• Indeed, continuing to chase high-yield in a low-yield world is a guarantee those plans will blow up again down the road.
• Pension plans are so underfunded that it is virtually impossible to catch up, no matter what risks the plan managers undertake. When asked how long it would now take for its investments to put the fund back on track, Ohio officials simply said: "Infinity."

There is a solution of course, it's just not one that anyone wants to hear: The correct plan is to kill all unnecessary services, fire all the government workers and privatize everything remaining. That is a choice the Washington Post failed to mention. Moreover, it's the only thing that reasonably works. Mauldin: It is not going to be easy to persuade a majority of Americans that we need to do something now. More realistically, we are going to probably have to begin to experience a crisis of some type to get politicians motivated to do something. We are not going back to normal, although it is likely we will see some form of Statistical Recovery. But we cannot get complacent. Somewhere out there is the real potential for another crisis, which will dwarf the last one. You will not want to be long much of anything when it happens, except hedged or liquid investments. Though admittedly, this could go on for a long time. Mish: Obama, Geithner, Congress, Bernanke, the Fed, central bankers in general, and foreign governments are all in the process of rearranging the chairs on the deck of the Titanic right now. Their solution is printing money. Don't Mistake Printing For A Sustainable Recovery The plan to date is called Competitive Currency Debasement with the US, China, and Japan as the key players. As noted in Gold And The Watched Pot Theory, "Every country wants to grow by ramping up exports in a world of decreasing consumer demand. To achieve that end, every country wants its currency to be weaker against every other currency. Of course that is logically impossible. Besides, the US consumer is tapped out. European consumers are tapped out as well. And tapped out or not, the Japanese consumer just does not want to buy." Neither the G-20 nor G-7 did anything to address the massive global imbalances. Something critical is going to blow sky high, when and what remains to be seen. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List

This is just for fun (well, it's kind of serious too, since I have a huge long position in TWM).

Below is the ultra-bear ETF on the Russell 2000, symbol TWM, flipped upside-down. I've taken a stab at labeling its explosive rise "higher" (that is, lower). Any opinions?

From DataQuick: Southern California home sales inch up; median price steady

Last month 21,539 new and resale houses and condos sold in Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties. That was up 0.2 percent from 21,502 in August and up 5.1 percent from 20,497 a year earlier, according to MDA DataQuick of San Diego.

September marked the 15th month in a row with a year-over-year sales gain, although last month’s was the smallest of those increases. ... The small uptick in September sales from August was atypical. On average, sales have fallen 9.5 percent between those two months.
...
“There were more than just normal, seasonal forces at work in these September sales numbers. More attempts at short sales, which typically take longer, and new appraisal rules no doubt delayed some deals this summer, causing them to close in September rather than August. September probably also got a boost from people opting to buy sooner rather than later to take advantage of the federal tax credit for first-time buyers, which is set to expire next month,” said John Walsh, MDA DataQuick president.
...
Foreclosure resales – houses and condos sold in September that had been foreclosed on at some point in the prior 12 months – made up 40.4 percent of all Southland homes resold last month. That was down slightly from a revised 41.7 percent foreclosure resales in August and down from a high of 56.7 percent in February this year.
...
A common form of financing used by first-time buyers in more affordable neighborhoods remained near record levels. Government-insured FHA mortgages made up 36.4 percent of all home purchase loans last month ...

Foreclosure activity remains high by historical standards.
emphasis added

Although DataQuick doesn't track short sales, we can estimate from the Sacramento data that another 15% or so of sales in SoCal were short sales - so probably over half the sales are distressed.

This report suggests sales were strong in September - similar to other regional reports.

We will probably see a decrease in year-over-year sales soon, as the first-time homebuyer tax credit buying frenzy subsides later this year.

This essay rounds up arguments for looking at gold as a reasonable investment: 1) The dollar; 2) China; 3) declining production; 4) inflation; 5) deflation; 6) global short-term interest rates; 7) uncertainty and distrust in government; and 8) flight to safety.

The Dollar

As everyone knows, gold is linked to the dollar.

As MarketWatch notes:

Gold's performance in the euro, British pound and other currencies has been lackluster compared to its rise in U.S. dollars, a trend suggesting investors are more interested in bullion as a hedge against the greenback than global inflation.

That sensitivity also means the gold rally could quickly reverse if the U.S. dollar gains ground, one analyst warned.

"The lion's share of the gold-price increase is due to the weak dollar," said Carsten Fritsch, a commodities analyst for Commerzbank in Frankfurt. "Once things make a turn there, you could see a quite rapid correction in gold prices"...

In British pounds, gold has sunk about 6% from February highs and is up just 6% for the year, based on pricing of the most active contracts at the time.

In Australian dollars, the metal has tumbled about 25% from its February highs and has actually lost ground for the year.

The disparity reveals just how crucial a role the falling U.S. dollar has played in driving up gold and other commodities prices.

Gold is usually seen as the ultimate currency - a liquid investment that holds fast when paper currencies depreciate, potentially because inflation is rising. But in recent months, investors seem to be treating the metal specifically as a hedge against the dollar's drop than a deterioration in currencies in general.

As I have recently argued, the dollar will likely strengthen during the next big decline in the stock market. But the long-term trend is strongly downward, favoring gold.

China

Commentators such as Ambrose Evans-Pritchard and Byron King argue that China's hunger for gold will put a floor on gold prices.

Specifically, they argue that China will "buy the dips" in gold prices, effectively putting a minimum on how low gold prices can go.

Declining Production

King also claims that another reason that gold will hold its value is declining production.

In an interview Tuesday, King argued:

Because we're in a world that appears to have encountered peak gold as well as peak oil. If you look at historical production, worldwide gold output reached a top right around the year 2000–2001. Overall output has declined and we're not replacing output from the big mines of the past. Despite discoveries here and there, miners have to dig deeper and deeper into the reserves. In a big mining country such as South Africa, for example, some of the deepest mines now are at 4,000 meters. That's 13,000 feet.

Is King right?

It turns out he might be.

Mining-Technology.com stated in March 2008:

Global gold production has been in steady decline since 2002. Production in 2007 was around 2,444t, down 1% on the previous year.

Analysts note that virtually all of the low-lying fruit has now been picked with respect to gold, meaning that companies will have to take on more challenging and more expensive projects to meet supply. The extent to which the current high price of gold can translate into profits remains to be seen...

According to Bhavesh Morar, national leader of the mining, energy and infrastructure group with Deloitte Australia, frenzied exploration activity over the last few years has seen virtually all of the easy harvest been picked with respect to gold...

The high price of gold is however encouraging more adventurous projects, be they more challenging financially, geologically, geopolitically or all three. New projects for gold and other resources are mushrooming throughout Africa, China, the Middle East and the former Soviet Union; all areas where sovereign risk is potentially very high.

Zeal Speculation and Investment wrote in July of this year:

Miners have the same geological landscape to work with today as those miners thousands of years ago. The only difference is the low-hanging fruit has already been picked. Gold producers must now search for and mine their gold in locations that may not be very amenable to mining. Many of today’s gold mines are located in parts of the world that would not have even been considered in the past based on geography, geology, and/or geopolitics.

And these factors among many are attributable to an alarming trend we are seeing in global mined production volume. According to data provided by the US Geological Survey, global gold production is at a 12-year low. And provocatively this downward trend has accelerated during a period where the price of gold is skyrocketing.

You would think that with the price of gold rising at such a torrid pace gold miners would ramp up production in order to profit from this trend. But as you can see in this chart this has not been the case, at all. Not only has gold production not responded, but it has dropped at an unsightly pace that has sent shockwaves throughout the gold trade.

As the red line illustrates gold’s secular bull began in 2001, finally changing direction after a long and brutal bear market drove down prices to ridiculous lows in the $200s. To match this bull the blue-shaded area provides a picture of the corresponding global production trend. And you’ll notice that in the first 3 years of gold’s bull production was steady. This is not a surprise as you figure it would take the producers a few years to ramp up supply. But instead of supply increasing in response to growing demand and rising prices, it took a turn to the downside. And what’s even more amazing is the persistence of this downtrend. Since 2001 gold production is down a staggering 9.3%! In 2008 there were 7.7m fewer ounces of gold produced than in 2001.

Also in July, Whiskey and Gunpowder posted a chart on historical gold production, and argued for decreasing production:

Take a look at the chart below from Macquarie Research, depicting world gold production 1850-2008...



[Click here for full chart]

For example, look at the very steep rise in gold output during the 1930s. That was during the depths of the worldwide Great Depression.

In both the US/Canada (blue area), and the rest of the world (gray area), people were digging more and more gold. The Soviets (purple area) increased their gold output too, courtesy of Joseph Stalin and his Gulag. Desperate times call for desperate measures, I suppose. Will that sort of history repeat this time around?

Or look at that massive run-up in gold output from South Africa (green area) in the 1950s and 1960s. That was during a time when South Africa was instituting its post-World War II system of apartheid. Labor was cheap (sorrowfully cheap), and quite a lot of international investment poured into South Africa without moral qualm. The South Africans dug deep and just plain tore into those gold-bearing reef structures of the Witwatersrand Basin.

But notice how quickly the South African gold output declined in the 1970s, as the mines got REALLY deep and the rest of the world began to institute sanctions against South Africa over its apartheid system.

And then look at the Gold Price run-up that followed in the late 1970s. It was a time of inflation, mainly coming from the US Dollar. Yet world gold mine output was dropping as well. Falling output, plus monetary inflation? The Gold Price skyrocketed. Another bit of useful history, right?

Now let's focus on more recent history, since about 1990. There were large increases in gold output from the US/Canada (blue), Australia (gold) and Asia (China orange, non-China open bar). By 2000 or so – the world production peak – Gold Prices were down toward $300 per ounce and below.

But as the chart shows, in the past 10 years, gold output has shown a marked DECLINE in the major historic Gold Mining regions. The prolific gold output from the US/Canada, Australia and South Africa has followed downward trends. Sure, these regions still lift a lot of ore and pour a lot of melt. But the production trend is DOWN.

The US/Canada, Australia and South Africa all have well-established and (more or less) workable mining laws – despite the best efforts of many current politicians and regulators to screw it all up. These historically producing areas are politically stable. Overall, there's good mining infrastructure, with road and rail networks, power systems, refining plants, a vendor base, mining personnel and access to capital.

But that's not the case in many areas of the developing parts of the world. Political stability? Security? Infrastructure? Transport? Power? Refining? Vendors? Personnel? Capital? Everywhere is different, of course. But overall, the entire process is much more problematic. So there's a lot more risk. When you move away from the traditional mining jurisdictions, the whole process of exploration, development and mining is more expensive.

Thus, the new gold discoveries of the future are going to lack some (if not most, or perhaps all) of the advantages of the developed mining world. That means that the ore deposits of the future will have to offer much higher profit margins, based on size and ore grade, to compensate for the increased risks. Too bad Mother Nature (or Saint Barbara, who looks after miners) doesn't work that way.

It also means the timeline to develop the mines of the future will likely be stretched over many years while political, legal, bureaucratic, logistical and social issues are ironed out.

The key driver for the future of worldwide gold supply will be DECLINING output overall over time.

Of course, if the price of gold warrant ramping up then production will increase. Just as with discussions about peak oil, the issue is not that the resource is totally running out, it is that it will be more and more expensive to extract.

Inflation

It is conventional wisdom that gold is a hedge against inflation.

For example, noted inflationist John Williams advises buying gold.

Axel Merk argues that gold is a better buy than TIPS as an inflation bet.

And Taleb advised buying gold in May, since currencies including the dollar and euro face pressures.

As of this writing, gold has had a good run, and might face a correction. But as hedge fund luminary John Paulson argues, its something you buy-and-hold for at least the medium term:

Paulson is convinced that gold will be a very good way to protect himself from the eventuality of currency debasement (i.e., inflation). He observed that if one thinks about gold in a three- or five-year time horizon (instead of hour to hour, day to day or week to week), the probability increases of gold being higher over time...

Deflation

If gold does well during times of inflation, it makes sense that it would perform poorly during deflationary periods.

But Examiner.com points out that such an assumption is probably untrue.

Specifically, as Examiner.com writes:

Eric Sprott - who manages $4.5 billion in assets, and correctly predicted in March of 2008 a "systemic financial meltdown” - says:

“I believe no matter what environment you’re in - deflation or inflation - people will run to gold,” Sprott said. “Gold is proving exactly what we all would have expected, that in almost any environment, it’s a go-to asset.”

And investment analyst and financial writer Yves Smith argues that gold does well during both periods of deflation and high inflation. She argues:

Historically, gold does well [in] hyperinflation and deflationary [periods]. Gold does poorly under more normal conditions, and gets hammered in disinflationary conditions, a falling but positive rate of inflation.

Analyst Adrian Ash argues that gold's value actually increases during periods of deflation even if its price drops:

Does the price of gold rise or fall in a deflation?

Hint: It’s a trick question, already tripping up plenty of would-be advisors...

Absent the money-supply limits which the gold standard imposed on the world, people rightly guess that double-digit inflation would prove rocket-fuel for the bull market in gold. Yet the purchasing power of gold nearly doubled during the Great Depression, and it’s risen four-fold during this decade’s low consumer-price inflation as well.

Why? Because both those periods of low price-inflation saw the money-issuing authorities devalue the currency, first with explicit reference to gold but now without daring to name it. Roosevelt in the mid-30s slashed the dollar’s gold content by 40%; the Greenspan/Bernanke Fed devalued the Dollar again to sidestep a DotCom Depression, keeping real interest rates at less than zero, between 2002-2005.

The maestro’s apprentice applied the same trick in the back-half of 2008, but so far to no avail. And now even the European Central Bank is pumping out money – a near half-trillion euros today alone – in a bid to revive bank lending, swamp the currency markets, and pull Germany out of its first flirt with deflation since the 1930s.

Just such a devaluation – and again, absent any stated reference to gold – was attempted by the Bank of Japan a little less than a decade ago.

Indeed, Japan is the only developed nation since the end of the gold standard to have suffered an extended deflation in prices. So far, at least. Germany and Switzerland look set to try for a re-wind, and unless the dollar can outpace the euro’s descent, we might yet see truly sub-zero inflation in the United States, too.

But whatever that should mean for gold prices, all other things being equal, just doesn’t matter. Because the gold price will not get a chance. All other things are not equal, and the policy solution – rank devaluation – can only make gold more appealing to investors and savers, whether the “monetarist experiment” of TARP, quantitative easing or a half-trillion euros proves successful or not.

Japan’s slump into deflation coincided with the Bank of Japan’s “zero interest rate policy” (ZIRP) at the start of this decade. It also saw the gold price worldwide hit rock-bottom and turn higher, a move that analysts (including us) have typically linked to US monetary moves and investment cash looking for safety as the Dotcom Bubble exploded.

But zero-rate money from the world’s second-largest economy shouldn’t be ignored. And today, zero-rate money is all the developed world has to offer – a trick that might not beat deflation, but might just spur a whole new rush into gold.

In other words, Ash argues that you can't take inflation or deflation in a vacuum. During deflationary periods - like we have now - governments always increase the money supply with a flood of new dollars, which is bullish for gold.

And PhD economist Marc Faber wrote in October 2007 that gold will do well even in a deflation:

How would gold perform in a deflationary global recession? Initially gold could come under some pressure as well but once the realization sinks in how messy deflation would be for over-indebted countries and households, its price would likely soar.

Therefore, under both scenarios - stagflation or deflationary recession - gold, gold equities and other precious metals should continue to perform better than financial assets.

Looking At the Charts

Is Faber right?

Well, take a look at the following charts showing gold's performance as compared to the yen during Japan's "lost decade" of deflation:

Japan's deflation didn't definitively end until 2007 or 2008.

This provides some evidence that gold may tend to hold or increase its value at least in the later part of the deflationary period as compared with the relevant national currency.

Moreover - approximately half the time - gold has risen during recessions in the United States:

(The grey vertical bars show periods of recession; the chart gives gold prices in monthly averages; click here for larger image).

If you study the above chart, you will see that gold seems to often fall during the beginning stages of a recession, then rise in the later stages of the recession (before 1971, the dollar was still backed by gold at a fixed price, and so gold did not fluctuate).

But what about Ash's theory?

The American Enterprises Institute notes:

After five years in a deflationary economic wilderness, the Bank of Japan switched during the spring of 2001 to a policy of quantitative easing--targeting the growth of the money supply instead of nominal interest rates--in order to engineer a rebound in demand growth.

Look again at the first gold chart for Japan, above. Gold appears to start increasing against the Yen in 2001.

This may provide some evidence for Ash's thesis that it is an expansion of the money supply which pushes the price of gold up in the later stages of deflationary periods.

Uncertainty

Finally, Chris Martenson argues that - in prolonged periods of deflation - we usually see failures of large and significant banks, institutions, and perhaps even states and countries. Because gold traditionally does well during periods of uncertainty, Martenson likes gold during periods of deflation.

Examiner.com notes in a subsequent article:

Merrill Lynch agrees.

Specifically, PhD economist Nouriel Roubini paraphrases a report from Merill Lynch (not available online) as follows:

Short-term rates of 0% are bullish for gold, which serves as a store of value but is a useful hedge against deflation as well, since deflation is inherently destabilizing for financial assets. In the 2001-03 deflationary period, gold rose more than 30%, not to mention the prospect of a return to a dollar bear market. "Gold is inversely correlated to global short-term interest rates and there is a race right now towards 0%. Production is down 4.0% y/y while fiat currencies globally are being created at a double digit rate by the world's central banks....As for all the talk of a 'gold bubble,' it would take a nearly 625% surge in gold to over US$6,000/oz and a flat stock market to actually get the ratio of the two asset classes back to where it was three decades ago when bullion was in an unsustainable bubble phase."

Gold tends to be less sensitive to global economic slowdown than industrial metals or energy and works better as a hedge against crisis than inflation.

See also Fred Sheehan's summary of Roy Jastram's study of the performance of gold during deflationary periods throughout history.

Global Short Term Interest Rates Are Low

The above-quoted Merrill article states:

Gold is inversely correlated to global short-term interest rates and there is a race right now towards 0%.

This argues for gold.

Distrust in Government

Time Magazine writes:

Traditionally, gold has been a store of value when citizens do not trust their government politically or economically.

Given the enormous levels of distrust in the government politically and/or economically (and the fact that some have warned of recession-induced violence), gold might do well.

Also, as mentioned above, gold tends to do well during periods of uncertainty. Given that the fundamental problems with the economy have not been fixed, things will likely become less certain.

Greenspan and Exeter

Professor Emeritus of Mathematics Antal Fekete has argued for years that gold is the ultimate - and only - safe haven when things really hit the fan.

For example, in 2007 Fekete wrote:

The grand old man of the New York Federal Reserve bank’s gold department, the last Mohican, John Exter explained the devolution of money (not his term) using the model of an inverted pyramid, delicately balanced on its apex at the bottom consisting of pure gold. The pyramid has many other layers of asset classes graded according to safety, from the safest and least prolific at bottom to the least safe and most prolific asset layer, electronic dollar credits on top. (When Exter developed his model, electronic dollars had not yet existed; he talked about FR deposits.) In between you find, in decreasing order of safety, as you pass from the lower to the higher layer: silver, FR notes, T-bills, T-bonds, agency paper, other loans and liabilities denominated in dollars. In times of financial crisis people scramble downwards in the pyramid trying to get to the next and nearest safer and less prolific layer underneath. But down there the pyramid gets narrower. There is not enough of the safer and less prolific kind of assets to accommodate all who want to "devolve”. Devolution is also called "flight to
safety”.

Darryl Schoon makes the same argument.

Here's a visual depiction Exeter's inverted pyramid, courtesy of Wikimedia:

(Click here for full image; I can't vouch for the accuracy of the rankings for all of the levels . . . for example, muni bonds versus corporate bonds)

Alan Greenspan has just lent some support to the theory. Specifically:

Gold prices that jumped above $1,000 an ounce this week are signaling that investors are buying metals to hedge against declines in currencies, former Federal Reserve Chairman Alan Greenspan said.

The gains are “strictly a monetary phenomenon,” Greenspan said today at an investment conference in New York. Rising prices of precious metals and other commodities are “an indication of a very early stage of an endeavor to move away from paper currencies,” he said...

“What is fascinating is the extent to which gold still holds reign over the financial system as the ultimate source of payment,” Greenspan said.

In other words, Greenspan is saying that investors are moving out of the second-to-lowest step on the pyramid (currencies and government bonds) and into the lowest step (gold).

Greenspan is also verifying what goldbugs like Exeter, Fekete and Schoon have been claiming: that "the barbarous relic" still holds an important place in the modern investor's psyche.

Are Exeter, Fekete and Schoon right? I don't know. And Greenspan might be wrong, or trying to excuse weakness in the dollar (as opposed to all paper currencies).

Note 1: Some of the best recent arguments I've heard against investing in gold are written by Vitaliy Katsenelson. Read this, this, this and this.

Note 2: As Zero Hedge has shown, newly-declassified federal documents prove that gold prices have been manipulated, at least in the past. If the strategy of artificial price suppression is continuing to the present, if this is widely publicized, if such publicity causes someone like Congressmen Alan Grayson, Brad Sherman, Ron Paul, or Dennis Kucinich (hello - congressional aides?) to raise a ruckus in Congress, and if Congress as a whole votes to ban such a practice, then the price of gold would presumably rise - as it would no longer be suppressed. That's a lot of ifs.

However, Schoon argues that gold manipulation will end because the world's central banks (and their primary dealers) will no longer be able to afford it. Specifically, he argues that they will simply run out of money to keep playing the game.

Note 3: I am not an investment advisor and this should not be taken as investment advice.

October 9, 2009

A client asked the following question above ….

Jim, yes, same page, “inflection” point = March rally over. I missed the conf call so you may have touched upon it. Will have time to review this weekend. I think you believe rally is over when Fed “pulls” liquidity, i.e, rate high, etc. Rate hike = $ positive = correlation w/equity still holds. I am wondering if we’ll see $ down, equity down before the rate hike thus breaking the $ down, equity up correlation. Catalyst ? Something similar to yesterday’s 30-year result or another Independent-like article. The catalyst causes Dixie to move lower and equities head for the exit. Is that scenario probable ? Thanks.

First as we noted above,

<Click on chart for larger image>

<Click on chart for larger image>

We took out yesterday's lows in ES, but not NQ; the morning trade brought weakness to energy shares (XLE), but not homebuilders (XHB). Such mixed signals are helpful in identifying when market moves may reverse, rather than extend into trends. We reversed back into the overnight range, but advancing shares still trailed decliners. At this juncture I'm watching the volume-weighted average price around 1068, to see if that serves as a fulcrum for a range trade bound between the morning lows and the overnight highs.
.

Die PKW-Verkäufe sind nach Angaben der chinesischen Automobilvereinigung (China Association of Automobile Manufacturers) im September 2009 regelrecht explodiert, um +18,3% zum Vormonat und um gewaltige +83,62% zum Vorjahresmonat auf 1,0151 Millionen verkaufter Fahrzeugeinheiten! Zum ersten Mal in der Geschichte Chinas, werden im September 2009, während eines Monat mehr als 1 Million PKW-Einheiten verkauft! Von Januar bis September 2009 wurden 7,2 Millionen PKWs verkauft, ein Anstieg von +42% im Vergleich zum Vorjahreszeitraum.

Inklusive der Verkäufe von Bussen und Lastwagen stiegen die Verkaufszahlen um +78%, im Vergleich zum Vorjahresmonat, auf 1,33 Millionen Einheiten.

> Der rasante Anstieg der PKW-Verkäufe in den letzten 13 Monaten. <

Die chinesische Regierung hatte im Rahmen ihres Konjunkturprogramms in Höhe von 4 Billionen Yuan bzw. 585 Mrd. Dollar u.a. auch den Automarkt angekurbelt! So wurde die Mehrwertsteuer für PKWs mit Motoren von weniger als 1,6 Liter Hubraum gesenkt und Subventionen für die Anschaffung von Fahrzeugen in den ländlichen Gebieten eingeführt. Nicht zu unterschätzen ist auch die Wirkung der brachialen Kreditversorgung durch die Banken, in den ersten 8 Monaten 2009 kumulierten sich die neu vergebenen Kredite in China auf fulminante 8,133 Billionen Yuan (1,196 Billionen Dollar)! Dies ist das 2,6-fache der Kreditvergabe der ebenfalls nicht bescheidenen Kreditvergabe aus dem Vorjahreszeitraum mit 3,0985 Billionen Yuan (455 Mrd. Dollar)!

Nachdem im Jahr 2008 der gesamte Automarkt, um die niedrigste Rate seit 10 Jahren von "nur" +6,7%, auf 9,38 Millionen verkaufter Einheiten gewachsen ist (2007: +21,8%), wird für das Gesamtjahr 2009 ein Gesamtabsatz von 12,6 Millionen Fahrzeugen erwartet. Die Schätzzung der Steigerung für 2009 zum Vorjahr ist wohl eher konservativ, mit prognostizierten +35%, angesichts der rasanten Wachstumsraten aus dem August und September 2009. Von Januar bis September 2009 sind mit 9,66 Millionen Einheiten bereits mehr Fahrzeugen verkauft worden als im gesamten Jahr 2008 (9,38 Mio.)!

Nicht nur im September haben die Chinesen die USA als weltgrößten Absatzmarkt deutlich abgehängt, auch im breit gefassten Zeitraum von Januar bis September 2009 zeigten die Chinesen deutlich wo der Wachstumsmarkt liegt. Die gesamten Autoverkäufe inkl. Busse und LKWs stiegen in den ersten neun Monaten 2009 um +34% auf 9,66 Millionen verkauften Einheiten! In den USA ging es im gleichen Zeitraum um -27% abwärts auf 7,8 Millionen an verkauften Fahrzeugeinheiten!

Sogar General Motors, US-Autohersteller und Dauerkomapatient - am Tropf der US-Steuerzahler - profitiert vom Boom in China, der Umsatz GMs in China hat sich im September im Vergleich zum Vorjahresmonat mehr als verdoppelt auf 181'148 verkaufter Fahrzeugeinheiten. In den ersten neun Monaten 2009 verkaufte GM in China bereits 1,29 Millionen Fahrzeuge und übertraf damit schon die gesamten Verkaufszahlen aus dem Jahr 2008!

Der Boom auf dem chinesischen Automarkt dürfte nicht nur Teile der Einbrüche bei den Verkäufen in den USA und Westeuropa kompensieren, er wirft auch seinen Schatten auf das momentan sträflich vernachlässigte Problem der Endlichkeit der fossilen Rohstoffe, insbesondere des Rohöls voraus!

Auch in Indien steigen die Verkaufszahlen den 8. Monat in Folge, um +17,1% im Vergleich zum Vorjahresmonat an, auf 212'975 verkaufter Fahrzeugeinheiten im September. Noch ist traditionell die Hauptnachfrage in Indien vor allem auf Zweiräder fixiert. Die Verkäufe von Motorrädern und Mopeds zogen im September um +6,5% auf gewaltige 838'150 Einheiten an!

Quelle Daten: Caam.org.cn

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