Wednesday, August 31, 2011

Today's links

Today's Quote: "The rapid and marked deterioration in economic and financial conditions means that the risk of a serious disruption is now significant." Satyajit Das, "From Green to Red – Is Credit Crunch 2.0 Imminent?", The Big Picture

1--A Reprieve from Misguided Recklessness, John P. Hussman, Ph.D, Hussman Funds

Excerpt: It is now urgent for investors to recognize that the set of economic evidence we observe reflects a unique signature of recessions comprising deterioration in financial and economic measures that is always and only observed during or immediately prior to U.S. recessions. These include a widening of credit spreads on corporate debt versus 6 months prior, the S&P 500 below its level of 6 months prior, the Treasury yield curve flatter than 2.5% (10-year minus 3-month), year-over-year GDP growth below 2%, ISM Purchasing Managers Index below 54, year-over-year growth in total nonfarm payrolls below 1%, as well as important corroborating indicators such as plunging consumer confidence. There are certainly a great number of opinions about the prospect of recession, but the evidence we observe at present has 100% sensitivity (these conditions have always been observed during or just prior to each U.S. recession) and 100% specificity (the only time we observe the full set of these conditions is during or just prior to U.S. recessions). This doesn't mean that the U.S. economy cannot possibly avoid a recession, but to expect that outcome relies on the hope that "this time is different."
While the reduced set of options for monetary policy action may seem unfortunate, it is important to observe that each time the Fed has attempted to "backstop" the financial markets by distorting the set of investment opportunities that are available, the Fed has bought a temporary reprieve only at the cost of amplifying the later fallout....

The way to get out of this is to abandon the misguided belief that economic prosperity can be obtained by encouraging speculation and distorting the set of investment opportunities. Rather, we will eventually find, as was eventually also discovered in the post-Depression stagnation of the 1930's, that the way to get the economy moving again is to restructure hopelessly burdensome debt obligations.

Bernanke offered some of the only sound words of his tenure, stressing that "U.S. fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable, or, preferably, declining over time," and warning against excessive austerity by observing "Although the issue of fiscal sustainability must urgently be addressed, fiscal policymakers should not, as a consequence, disregard the fragility of the current economic recovery."

2--President Obama's job creation mirage, Dean Baker, Guardian

Excerpt: At the top of the list of job-creating measures is extending the 2 percentage-point reduction in the social security payroll tax. This provides no boost to the economy, since it just keeps in place a tax cut that was already there, but if the cut is allowed to end at the start of 2012, it will be a drag on growth....

A second item frequently mentioned is an infrastructure bank. This would allow the government to treat long-lived infrastructure investment as capital expenditures depreciated over their expected lifetimes, rather than expenditures to be paid for in full in the years the construction takes place. This is good policy and accounting (it is the same approach used by both private businesses and state governments), but it is not going to create many jobs and certainly not in the next couple of years.

The other items on the list are less clear. On bad days, we hear that President Obama is going to tout the trade agreements with Panama, South Korea and Colombia. These deals are all problematic at best, but even their supporters can't claim with a straight face that they will generate any noticeable number of jobs.

There are also reports that President Obama may propose some sort of tax subsidy for job creation. Such a subsidy can be bad or not so bad. One of the proposals, temporarily eliminating the employer side of the payroll tax, is a great plan – if your intention is to give still more money to business and undermine social security.

3--Mind the ($5.1 Trillion) Gap, VOX

Excerpt: The need for additional fiscal stimulus is based on the assumption that we are not in a normal year. If unemployment was at a normal level, if the output gap was zero (output was equal to potential), then there is no reason to postpone the necessary adjustment. But there is a dimension of economic policy (both monetary and fiscal) that works towards the stabilization of the business cycle. We do not expect monetary policy or fiscal policy to be the same in a recession than in an expansion. And while fiscal policy might require to show discipline over the coming decades, the amount of discipline should be different depending on the phase of the business cycle. Letting the economy be producing below potential for a long number of years is not only socially costly but it leads to a permanent loss in output which is a potential source of tax revenues. And the most recent projections from the CBO (Congressional Budget Office) in the US show that GDP will be significantly below potential output for about 8 years, from 2008 to 2015...

If we accumulate the output gap for all these years we are talking about a $5.1 Trillion gap that represents a permanent loss in output (and income, and tax revenues). Some might see this as a natural and unavoidable adjustment which almost amounts to claim that GDP and potential output are identical, the output gap is zero, unemployment is all structural. But given that the US economy has a strong tendency to return to its trend regardless of economic shocks, it is difficult to argue that there is no output gap to be filled in 2011 (or any other year before we get to 2015).

4--Arguments for Expansionary Fiscal Policy Watch, Grasping Reality with Both Hands

Excerpt: Poor Richard Koo talks sense. But his adversary in the pages of the Economist is… Allan Meltzer.

When the U.S. government can borrow at a real interest rate of -0.65%/year for five years, the case for larger deficits now--for pulling spending forward from the future into the present and pushing taxes back from the present into the future--is unanswerable: of course the government should borrow more on such terms: households value the taxes they will pay in the future if taxes are pushed back as much less painful than the taxes they would otherwise pay today, and a huge number of government spending programs offer at least a zero percent real rate of return via their effect on the productive capacity of the economy. Even if expansionary fiscal policy had no effect on capacity utilization and unemployment bigger deficits now while the government can borrow on such terms would be a no-brainer. And since expansionary fiscal policy does have such effects, it is something that you should advocate even if you have less than no brain at all--even if you have a negative brain.

5--A Former Clinton Official on How Obama Isn't Doing Enough for the Economy, Robert Schapiro, The New Republic

Excerpt: The results are now clear in the data. Financial institutions amassed trillions of dollars without expanding business lending, mainly because the financial-market distortions that brought on the crisis are still with us. These institutions are still holding trillions of dollars in wobbly asset-based securities, whose risks even now they cannot reasonably price. So they sit on most of their new capital (after paying out their bonuses) in hopes of avoiding another bout of bankruptcy from those assets, should another crisis erupt. Yet, the prospect of new legislation to sustainably resolve those weak assets by pulling them off the books—as Sweden did in its early-1990s banking crisis, and we did in the S&L crisis of 1989-1990—is nonexistent.

The prospect of another imminent crisis on the horizon ought to put the necessary policies into relief. One initiative that cannot wait: President Obama should call an emergency G-8 meeting to help head off a new financial meltdown in Europe. The sobering fact is that many of Europe’s largest banks are nearly insolvent. It’s a legacy from not only the 2008-2009 meltdown, but also the EU’s decision in 2007 to reduce bank capital requirements under the level set by the “Basel 2” accords. Americans benefited from the fact that our own banking regulators dawdled in making similar changes desired by the Bush administration, by which time even the Bush Treasury had doubts about cutting capital requirements. The result today is that the German and French banking systems in particular are in much worse shape than Wall Street.

Now these weak banks face additional, large-scale losses from the falling values of Italian and Spanish government bonds, a contagion from the now-anticipated defaults of Greek and Portuguese public sovereign debt. If this turmoil intensifies, it will probably pull down some of Europe’s largest banks. And if institutions such as BNP Paribas and Deutsche Bank (the world’s two largest banks) fail, the U.S. and global economies would probably follow.

Moreover, this time, the consequences would be even more dire than in 2008-2009, since governments have already exhausted their fiscal and monetary policy options.

We can still head off a 1931 scenario if Germany and France will accept the inevitable and obvious: A common Euro currency requires that every member pledge its full faith and credit for Eurobonds to support the full faith and credit of everybody else. Otherwise, the failure of a small member (today, Greece and/or Portugal) can destroy confidence in the economic sustainability of much larger members (Italy and Spain). And then, everybody’s goose is cooked....

The broad reach of these effects reflects how wealth is now distributed in the United States: According to Fed data for 2007, the bottom 80 percent of American households held 40 percent of the value of all real estate assets, compared to a miserable seven percent of the total value of all financial assets (and yes, that includes pensions). Home equity, in short, is very nearly the only real asset for more than half of all Americans. The decision to allow housing values to fall for four straight years—in contrast to the equity and bonds of large financial institutions—leaves the majority of American consumers growing poorer month after month. Just as people who grow richer spend more, people who find themselves poorer spend less. So, consumer demand and with it business investment will not recover until housing values stabilize....

Waiting for the markets to begin acting rationally again is a fool’s errand. The economy will only right itself when housing values stabilize and distortions in Wall Street’s and Europe’s financial systems have been addressed.

6--Have the Double-Dippers Been Dipping Too Much? Dean Baker, CEPR

Excerpt: The Commerce Department just released data showing that real consumption spending rose by 0.5 percent in July. This makes it highly unlikely that growth will turn negative in the current quarter. Consumption is 70 percent of GDP and this figure implies a 6.0 percent annual growth rate.
Of course consumption is not really growing that fast, more likely it is increasing at near a 2.0 percent annual rate, but maybe this number will shut up the arithmetic challenged economists who keep talking about a double-dip recession.

The economy's problem is pathetically slow growth. We should be seeing growth of 5-7 percent as the economy rebounds from the worst downturn of the post-war period. Instead, we will be lucky if growth just keep pace with the growth of the labor force, preventing unemployment rate from rising further.

The implication is that tens of millions of people will remain unemployed or underemployed because of the Wall Street sleazes and the incompetent economists who could not see an $8 trillion housing bubble and still don't know a damn thing about the economy. It's a crime that they still have their jobs.

7--From S&P: Nationally, Home Prices Went Up in the Second Quarter of 2011 According to the S&P/Case-Shiller Home Price Indices, Calculated Risk

Excerpt: Data through June 2011, released today by S&P Indices for its S&P/Case-Shiller Home Price Indices ... show that the U.S. National Home Price Index increased by 3.6% in the second quarter of 2011, after having fallen 4.1% in the first quarter of 2011. With the second quarter’s data, the National Index recovered from its first quarter low, but still posted an annual decline of 5.9% versus the second quarter of 2010. Nationally, home prices are back to their early 2003 levels.

As of June 2011, 19 of the 20 MSAs covered by S&P/Case-Shiller Home Price Indices and both monthly composites were up versus May – Portland was flat. However, they were all down compared to June 2010....
There could be some confusion between the SA and NSA numbers, but this increase was mostly seasonal. I'll have more later ...

8--Ben Bernanke’s Dream World, J. Bradford DeLong, Project Syndicate

Excerpt: ...Bernanke claimed that “the growth fundamentals of the United States do not appear to have been permanently altered by the shocks of the past four years.”...

But let me focus on Bernanke’s fourth statement. Even if we project a relatively rapid economic recovery, by the time this lesser depression is over, the US will have experienced an investment shortfall of at least $4 trillion. Until that investment shortfall is made up, the missing capital will serve to depress the level of real GDP in the US by two full percentage points. America’s growth trajectory will be 2% below what it would have been had the financial crisis been successfully finessed and the lesser depression avoided.

There is more: state and local budget-cutting has slowed America’s pace of investment in human capital and infrastructure, adding a third percentage point to the downward shift in the country’s long-term growth trajectory....

Moreover, there is an additional source of drag. A powerful factor that diminished perceived risk and encouraged investment and enterprise in the post-WWII era was the so-called “Roosevelt put.” Industrial-country governments all around the world now took fighting depression to be their first and highest economic priority, so that savers and businesses had no reason to worry that the hard times that followed 1873, 1884, or 1929 would return.

That is no longer true. The world in the future will be a riskier place than we thought it was – not because government will no longer offer guarantees that it should never have offered in the first place, but rather because the real risk that one’s customers might vanish in a prolonged depression is back.

9--Vital Signs: Disposable Income Dips, Sudeep Reddy, WSJ

Excerpt: Consumers’ spending power failed to keep up with inflation and taxes in July. While overall personal income rose during the month, inflation-adjusted personal income after taxes fell 0.1%. It was the first drop since last September. Stronger incomes will be key to support continued gains in consumer spending. (See chart)

10--US economic indicators, Dr. Ed's blog

Excerpt: Hooray, we are still in the soft patch! That seemed to be the stock market’s reaction to yesterday’s personal income and consumption report for July. The 0.8% increase in personal consumption expenditures (PCE), which beat expectations, was led by a 10.0% increase in spending on new cars and a 5.2% increase in spending on household utilities. Excluding these two categories, spending rose 0.5%. It’s also up 0.5% excluding gasoline sales....

At the start of this month, real GDP growth reports for the US, the UK, Germany, and France during Q2 all were disappointingly close to zero. The plunge in stock prices during the first four weeks of the month suggested that investors no longer believed that the soft patch would be followed by better growth, but rather by a recession. We also gave up on better growth during Q4, but we remain in the soft patch camp. ...

There has been no soft patch in capital spending. That’s because capital spending is driven by corporate profits, which have been very strong, as discussed in yesterday’s Morning Briefing. Indeed, while Q2 real GDP growth was revised downwards slightly from 1.3% to 1.0% (saar), nonresidential fixed investment was revised upwards from 6.3% to 9.9%. Spending on equipment and software was revised higher from 5.7% to 7.9%, and structures rose 15.7% rather than the preliminary estimate of 8.1%. During July, nondefense capital goods shipments rose for the third straight month, up 0.2% and 12.9% over the past three months, at an annual rate. That’s the best pace in a year....

11--US. Consumer Confidence Falls to Two-Year Low, Bloomberg

Excerpt: Confidence among U.S. consumers plunged in August to the lowest in more than two years as Americans’ outlooks for employment, incomes and business conditions soured.

The Conference Board’s index slumped to 44.5, the weakest since April 2009, from a revised 59.2 reading in July, figures from the New York-based private research group showed today. It was the biggest point drop since October 2008. Economists predicted the August gauge would fall to 52, according to the median forecast in a Bloomberg News survey.
An unemployment rate above 9 percent, a downgrade of the country’s top credit rating, partisan squabbling over the budget deficit and a volatile stock market weighed on sentiment. Increased pessimism may make households less apt to open their wallets, a hurdle for the economy and retailers such as Gap Inc. (GPS)

“This paints a picture of underlying demand weakening,” said Bricklin Dwyer, an economist at BNP Paribas in New York, whose forecast of 45 was most accurate in the Bloomberg survey. “Consumers are seeing their wealth deteriorate. We’ve seen a huge decline continuing in the housing market. They’ve also been hit on the chin by the equity markets.”

Tuesday, August 30, 2011

Today's links

Today's Quote: “The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses.” Karl Marx, Kapital

1--Matt Stoller: Power Politics – What Eric Schneiderman Reveals About Obama, Naked Capitalism

Excerpt: When you look closely at most significant areas of government, it becomes clear that the President and his administration are enormously powerful actors who get a lot done. Handing over our national wealth to the banks and to China is not nothing. These people are reorganizing the economy and the political system so that there are no constraints on the oligarchical interests that fund and pay them. That is their goal, it has been their goal from day one (or even before that), and anyone who says otherwise is just wrong or deluding him or herself. Obama spoke at the founding of Robert Rubin’s Hamilton Institute, and his first, and most important by far policy initiative, was his whipping for TARP, a policy that was signed by Bush but could not have passed without Obama getting his party in line. That was his goal, and he’s still pursuing it. The numerous “what happened to Obama” wailing editorials overlook the consistency of his policy agenda, which stretches back years at this point.

If someone worked or works for the Obama administration, or the Department of Justice, or any other executive branch agency, they need to remember their service as a mark of shame for the rest of their lives. Remembering how they participated in this example of how to govern is literally the least they could do for the damage they have caused. I would leave out the small number of people who are there to overtly prevent as much damage as possible, and those who resign or are fired in protest.

For the rest of the Democratic Party, well, reality is just beginning to intrude into the fantasy-land of partisans, even though the 2010 loss should have delivered a searing wake-up call to the failure Obama’s policy agenda. From 2006-2008, the Bush administration’s failures crashed down upon conservatives, and they in many ways could not cope. But their intellectual collapse was bailed out by Obama. Faux liberals are seeing their grand experiment in tatters, though right now they can only admit to feeling disappointed because the recognition that they have been swindled is far too painful. And the recognition for many of the professionals is even more difficult, because they must recognize that they have helped swindle many others and acknowledge the debt they have incurred to their victims. The signs of coming betrayal were there, but in the end it all comes down to judging people based on what they do and who they choose as opponents. And this Democratic partisans did not do, choosing instead a comfortable delusional fantasy-land where foreclosures don’t matter and theft enabled by Obama (and Clinton before him) doesn’t matter.

2--From Green to Red – Is Credit Crunch 2.0 Imminent?, Satyajit Das, The Big Picture

Excerpt: The rapid and marked deterioration in economic and financial conditions means that the risk of a serious disruption is now significant.
If markets seize up again, then “this time it will be different“. There might just not be enough money to bail out everyone and every country that may need rescuing.

Government policy options are severely restricted. Government support is restricted because of excessive debt levels and the reluctance of investors to finance indebted sovereigns. Interest rates in most developed countries are low or zero, restricting the ability to stimulate the economy by cutting borrowing cost. Unconventional monetary strategies – namely printing money or quantitative easing – have been tried with limited success. Further doses, while eagerly anticipated by market participants, may not be effective.

The global economy may muddle through, but a second credit crash is now distinctly possible. But the trigger and timing is unknown. As John Maynard Keynes remarked: “The expected never happens; it is the unexpected always.”

3--Trichet Gives Master Class in Saying Nothing, CNBC

Excerpt: On Sunday, the Sunday Times in the UK reported that policy makers in Brussels are drawing up radical plans to offer central guarantees over certain types of debt issued by banks. The move is reported to be a direct response to the sharp fall in U.S. funding for Europe’s banks. If true, this is clearly something the boss of the ECB can't be discussing in public....

The head of the International Monetary Fund, Christine Lagarde, summed up the mood in her own speech to the meeting in Jackson Hole perfectly. “Developments this summer have indicated we are in dangerous new phase. The stakes are clear, we risk seeing a fragile recovery derailed, so we should act now.”

The former French Finance Minister said Europe’s banking industry needs to be recapitalized whilst warning fiscal policy must aim boost growth and monetary policy remain highly accommodative."

4--Europe May Offer to Guarantee Banks’ Bonds, Sunday Times Says, Bloomberg

Excerpt: European policy makers are considering providing central guarantees over some types of debt sold by banks to prevent a new credit crunch in the region, Sunday Times reported.

The debt guarantee will allow cash from the 440 billion- euro ($635 billion) European Financial Stability Fund to be used temporarily to insure banks’ bonds, according to the newspaper.

5-Number of the Week: Slow Growth Adds to Deficit, Mark Whitehouse, WSJ

Excerpt: 32%: The increase in U.S. government debt over the next five years if US economic growth stays as slow as it is now.

It can be tough to get excited when economists warn that the U.S. could face a long period of substandard growth. Slow growth, after all, sounds a lot better than no growth at all.

A mere percentage point a year, though, can make a big difference. In an annex to its latest Global Financial Stability Report, the International Monetary Fund drives the point home as it applies to government finances.
The IMF forecasts how much various governments’ debts would rise if annual economic growth proved one percentage point slower than expected over the next five years. If, for example, the U.S. economy grows at an inflation-adjusted annual rate of 1.7% — about the rate it’s currently growing — government debt will reach 122% of annual economic output as of 2015, up from 93% now. Annual growth of 2.7% would cut that estimate to 110%. The difference equates to about $2.2 trillion, or close to $7,000 a person.

The IMF’s estimate provides a glimpse at the stakes involved in deciding whether to pump more government money into the economy. If $2.2 trillion in stimulus could provide an added percentage point of economic growth over the next five years, then the government could effectively achieve higher growth with no damage to its finances. If, by contrast, the accompanying massive budget deficits would scare people and businesses into cutting back on spending, then we could end up with slow growth and even more parlous finances.

6--(From the archives) Number of the Week: Default, Not Thrift, Pares U.S. Debt, Mark Whitehouse, WSJ

Excerpt: 122%: U.S. household debt as a share of annual disposable income
U.S. consumers are paring down their debts faster than many economists had expected. To understand what that means, though, it helps to know how they’re doing it....

The falling debt burden conjures up images of a nation seeking to repent after a decade of profligacy, conscientiously paying down mortgages and credit-card balances. That may be true in some cases, but it’s not the norm. In fact, people are making much more progress in shedding their debts by defaulting on mortgages and reneging on credit cards.

Since household debt hit its peak in early 2008, banks have charged off a total of about $210 billion in mortgage and consumer loans, including credit cards. If one assumes that investors suffered at least that much in losses on similar loans that banks packaged and sold as securities (a very conservative assumption), then the total — that is, the amount of debt consumers shed through defaults — comes to much more than $400 billion.

Problem is, that’s more than the concurrent decrease in household debts, which amounts to only $372 billion, according to the Federal Reserve. That means consumers, on average, aren’t paying down their debts at all. Rather, the defaulters account for the whole decline, while the rest have actually been building up more debt straight through the worst financial crisis and recession in decades.

7--Some predictions for the rest of the decade, Michael Pettis, China Financial Markets

Excerpt:   For much of the past decade there has been a growing recognition that Chinese growth has been seriously unbalanced, as Premier Wen put it, and that at the heart of the imbalance has been the very low consumption share of GDP. In 2005, when consumption hit the then-astonishing level of 40% of GDP, there was a widespread conviction in policy-making circles that this was an unacceptably low level and that it left Chinese growth much too dependent on the trade surplus and on increases in domestic investment.....

Low consumption levels are not an accidental coincidence. They are fundamental to the growth model, and the suppression of consumption is a consequence of the very policies – low wage growth relative to productivity growth, an undervalued currency and, above all, artificially low interest rates – that have generated the furious GDP growth. You cannot change the former without giving up the latter. Until Beijing acknowledges that it must dramatically transform the growth model, which it doesn’t yet seemed to have acknowledged, consumption will continue to be suppressed....

Why do I say we will be talking about 3% growth soon? Two reasons. First, I am impressed by the bleakness of historical precedents. Every single case in history that I have been able to find of countries undergoing a decade or more of “miracle” levels of growth driven by investment (and there are many) has ended with long periods of extremely low or even negative growth – often referred to as “lost decades” – which turned out to be far worse than even the most pessimistic forecasts of the few skeptics that existed during the boom period. I see no reason why China, having pursued the most extreme version of this growth model, would somehow find itself immune from the consequences that have afflicted every other case....

That is why Japan is a useful reminder of what can happen. After 1990 GDP growth collapsed from two decades of around 9% on average to two decades of less than 1% on average, but there was no social discontent, and unemployment didn’t surge. Some analysts credited Japanese lifetime employment or invoked the natural docility of Japanese people (a bizarre argument at best) to explain the lack of social upheaval, but for me it was because Japan genuinely rebalanced in the past two decades....

Because of its rapidly rising debt burden, the only way for China to manage a smooth social transition will be through wealth transfers from the state sector to the household sector. In the past, Chinese households received a diminishing share of a rapidly growing pie. In the future they must receive a growing share. This will probably be accomplished through formal or informal privatization.

The right way to engineer the transition to a system in which household wealth isn’t used to subsidize growth is to raise wages, raise the value of the currency, eliminate SOE monopoly pricing, and raise interest rates. The problem is that all of these have to adjust so far that to do so quickly would lead to massive financial distress....

What’s more, the only strategies by which Spain can regain competitiveness are either to deflate and force down wages, which will hurt workers and small businesses, or to leave the euro and devalue. Given the large share of vote workers have, the former strategy will not last long. But of course once Spain leaves the euro and devalues, its external debt will soar. Debt restructuring and forgiveness is almost inevitable.

Unless Germany moves quickly to reverse its current account surplus – which is very unlikely – the European crisis will force a sharp balance-of-trade adjustment onto Germany, which will cause its economy to slow sharply and even to contract. By 2015-16 German economic performance will be much worse than that of France and the UK.

If Germany does not take radical steps to push its current account surplus into deficit, the brunt of the European adjustment will fall on the deficit countries with a sharp decrease in domestic demand. This is what the world means when it insists that these countries “tighten their belts”.

If the deficit countries of Europe do not intervene in trade, they will bear the full employment impact of that drop in demand – i.e. unemployment will continue to rise. If they do intervene, they will force the brunt of the adjustment onto Germany and Germany will suffer the employment consequences.

For one or two years the deficit countries will try to bear the full brunt of the adjustment while Germany scolds and cajoles from the side. Eventually they will be unable politically to accept the necessary high unemployment and they will intervene in trade – almost certainly by abandoning the euro and devaluing. In that case they automatically push the brunt of the adjustment onto the surplus countries, i.e. Germany, and German unemployment will rise. I don’t know how soon this will happen, but remember that in global demand contractions it is the surplus countries who always suffer the most. I don’t see why this time will be any different....

As unemployment persists, and as the political pressure to address unemployment rises, the US will, like Britain in 1930-31, lose its ideological commitment to free trade and become increasingly protectionist. Also like Britain in 1930-31, once it does so the US economy will begin growing more rapidly – thus putting the burden of adjustment on China, Germany (which will already be suffering from the European adjustment) and Japan.

Trade policy in the next few years will be about deciding who will bear the brunt of the global contraction in demand growth. The surplus countries, because they are so reliant on surpluses, will be very reluctant to eliminate their trade intervention policies. Because they are making the same mistake the US made in the late 1920s and Japan in the late 1980s – thinking they are in a strong enough position to dictate terms – they will refuse to take the necessary steps to adjust.

But in fact in this fight over global demand it is the deficit countries that have all the best cards. They control demand, which is the world’s scarcest and most valuable commodity. Once they begin intervening in trade and regaining the full use of their domestic demand, they will push the adjustment onto the surplus countries. Unemployment in deficit countries will drop, while it will rise in surplus countries.

8--Profits Falling, Banks Confront a Leaner Future, New York Times

Excerpt: Battered by a weak economy, the nation’s biggest banks are cutting jobs, consolidating businesses and scrambling for new sources of income in anticipation of a fundamentally altered financial landscape requiring leaner operations.

Bank executives and analysts had expected a temporary drop in profits in the aftermath of the 2008 financial crisis. But a deeper jolt did not materialize as trillions of dollars in federal aid helped prop up the banks and revive the industry.

Now, however, as government lifelines fade and a second recession seems increasingly possible, banks are finding growth constrained. They are bracing for a slowdown in lending and trading, with higher fees for consumers as well as lower investment returns amid tighter regulations. Profits and revenues are slipping to the levels of 2004 and 2005, before the housing bubble.

“People heard all these things before, but the reality of seeing the numbers is finally sinking in,” said John Chrin, a former JPMorgan Chase investment banker and executive in residence at Lehigh University’s business school. “It’s hard to imagine big institutions achieving their precrisis profitability levels, and even the community and regional banks are faced with the same problems.”....

A new wave of layoffs is emblematic of this shift as nearly every major bank undertakes a cost-cutting initiative, some with names like Project Compass. UBS has announced 3,500 layoffs, 5 percent of its staff, and Citigroup is quietly cutting dozens of traders. Bank of America could cut as many as 10,000 jobs, or 3.5 percent of its work force. ABN Amro, Barclays, Bank of New York Mellon, Credit Suisse, Goldman Sachs, HSBC, Lloyds, State Street and Wells Fargo have in recent months all announced plans to cut jobs — tens of thousands all told. ..

Banks have been through plenty of boom and bust cycles before. But executives and analysts say this time is different.

Lending, the prime driver of revenue, has been depressed for several years and is not expected to pick up anytime soon, even with historically low interest rates favorable to borrowers. Consumers are spurning debt after a 20-year binge, while businesses are so uncertain about the economy that they are hunkering down, rather than financing expansion plans.

Making matters worse, the Federal Reserve’s pledge to keep rates near zero into 2013 is eating into profit margins earned on mortgages and other loans, as well depressing investment yields that usually offset fallow periods for lending.

Trading profits have also been waning amid a slowdown in volumes, and Wall Street’s once-lucrative mortgage packaging business is unlikely to bring in the blockbuster fees it earned during the housing boom....

All of this looms over the industry. To be sure, profits have rebounded from the depths of the financial crisis. All told, the nation’s banks earned $28.8 billion in the second quarter, nearly 38 percent more than a year ago and about what they earned in 2004, according to Trepp, a financial research firm. But more than one-third of those profits came as banks shifted capital to their bottom line that had been set aside to cover losses.

That helped obscure a 4.4 percent drop in revenue, which fell to $188 billion, the industry’s level in 2005. Trepp analysts project it could fall an additional 4 to 5 percent over the next year.

9--Personal Saving Rate Plunges From 5.5% To 5.0% As July Energy Expenditures Soar, zero hedge

Excerpt: July personal income and expenditures were quite surprising in that while many were expecting the drop in the market to force consumer saving to upshift (lower spending than income), not only was this not true, but expenditures spiked by 1 whole percent from -0.2% to 0.8%, on expectations of 0.5%, even as Personal Income came in line with expectations of 0.3%, up from a revised 0.2% (concurrent with extensive prior data revisions). This was the biggest difference between a monthly change in income and spending since October 209. The net result was a plunge in the savings rate from 5.5% to 5.0%. And while on the surface this would be good news, as in Americans are spending again, a quick look at the PCE components indicates that virtually the entire surge is due to a spike in Energy goods and services. In other words, the entire spike in spending was to... pay for gas and associated energy expenses. Which makes sense: in June this was a drop of -4.5%, it is only logical that the subsequent jump in Brent and WTI forced American savings to drop. All in all: in July Americans continued to max out their credit cards to pay for gas. As for the income side, transfer payments as a % of spending refuse to budge: thank you Uncle Sam.

10--Personal Consumption and the Housing Bubble, Dean Baker, CEPR

Excerpt: ...Unless another asset bubble again propels consumption by pusing the savings rate to extraordinarily low levels, the factor that will eventually have to lift the economy is an improving trade balance. This is not a matter of speculation, it is an accounting identity. That means it has to be true....

consumption depends in part on housing wealth. The size of the effect is usually estimated at between 5 to 7 percent, meaning that for every additional dollar of housing wealth annual consumption will increase by between 5-7 cents.

This effect was very important during the years of the housing bubble. The $8 trillion of housing bubble wealth led to a consumption boom that pushed the savings rate to near zero. With the loss of most of this wealth, it was 100 percent predictable that consumption would fall....

Savings have fallen first and foremost because most of the $8 trillion in housing bubble wealth that was driving consumption has disappeared since the collapse of the bubble. Consumer sentiment, especially about future conditions, is a very poor predictor of consumption. The most obvious explanation for the weakening of consumption in the second quarter was the surge in oil prices which reduced real incomes. With oil prices falling again in the last two months, most economists expect somewhat of an upturn in consumption in the second half of 2011.

Monday, August 29, 2011

Today's links

Today's Quote:

  "We cannot allow our economic life to be controlled by that small group of men whose chief outlook upon the social welfare is tinctured by the fact that they can make huge profits from the lending of money and the marketing of securities--an outlook which deserves the adjectives ‘selfish’ and ‘opportunist.’" Franklin Delano Roosevelt, "FDR Explains the Crisis: Why it feels like 1932", Pam Martens, Counterpunch

1--One Number Says it All, Stephen S. Roach, Projet Syndicate

Excerpt: The number is 0.2%. It is the average annualized growth of US consumer spending over the past 14 quarters – calculated in inflation-adjusted terms from the first quarter of 2008 to the second quarter of 2011. Never before in the post-World War II era have American consumers been so weak for so long. This one number encapsulates much of what is wrong today in the US – and in the global economy.

There are two distinct phases to this period of unprecedented US consumer weakness. From the first quarter of 2008 through the second period of 2009, consumer demand fell for six consecutive quarters at a 2.2% annual rate. Not surprisingly, the contraction was most acute during the depths of the Great Crisis, when consumption plunged at a 4.5% rate in the third and fourth quarters of 2008.

As the US economy bottomed out in mid-2009, consumers entered a second phase – a very subdued recovery. Annualized real consumption growth over the subsequent eight-quarter period from the third quarter of 2009 through the second quarter of 2011 averaged 2.1%. That is the most anemic consumer recovery on record – fully 1.5 percentage points slower than the 12-year pre-crisis trend of 3.6% that prevailed between 1996 and 2007.

These figures are a good deal weaker than originally stated. As part of the annual reworking of the US National Income and Product Accounts that was released in July 2011, Commerce Department statisticians slashed their earlier estimates of consumer spending. The 14-quarter growth trend from early 2008 to mid-2011 was cut from 0.5% to 0.2%; the bulk of the downward revision was concentrated in the first six quarters of this period – for which the estimate of the annualized consumption decline was doubled, from 1.1% to 2.2%.

I have been tracking these so-called benchmark revisions for about 40 years. This is, by far, one of the most significant I have ever seen. We all knew it was tough for the American consumer – but this revision portrays the crisis-induced cutbacks and subsequent anemic recovery in a much dimmer light.

The reasons behind this are not hard to fathom. By exploiting a record credit bubble to borrow against an unprecedented property bubble, American consumers spent well beyond their means for many years. When both bubbles burst, over-extended US households had no choice but to cut back and rebuild their damaged balance sheets by paying down outsize debt burdens and rebuilding depleted savings.

Yet, on both counts, balance-sheet repair has only just begun. While household-sector debt was pruned to 115% of disposable personal income in early 2011 from the peak of 130% hit in 2007, it remains well in excess of the 75% average of the 1970-2000 period. And, while the personal saving rate rose to 5% of disposable income in the first half of 2011 from the rock-bottom 1.2% low hit in mid-2005, this is far short of the nearly 8% norm that prevailed during the last 30 years of the twentieth century.

With retrenchment and balance-sheet repair only in its early stages, the zombie-like behavior of American consumers should persist. The 2.1% consumption growth trend realized during the anemic recovery of the past two years could well be indicative of what lies ahead for years to come.... other economy is capable of filling the void left by a protracted shortfall of US consumption. Europe and Japan are in no position to take up the slack, and consumer sectors in the world’s major developing economies – especially China – lack the scale and dynamism to take over. So enduring weakness in US consumption implies pressure on the growth of export-led developing economies. The good news is that will force them to embrace long-overdue rebalancing strategies aimed at stimulating domestic consumer demand.

What can be done? While measures adapted in the depths of the crisis – massive fiscal and monetary stimuli – were effective in placing a bottom under the free-fall, they have been ineffective in sparking meaningful recovery. That should hardly be surprising in an era of balance-sheet repair.

Instead, the US needs a menu of policies tailored to the needs and pressures bearing down on American consumers. Some possibilities: debt forgiveness to speed up the deleveraging process; creative saving policies that restore financial security to crisis-battered Americans; and, of course, jobs and the income they generate.

The US economy – as well as the global economy – cannot get back on its feet without the American consumer. It is time to look beyond ideology – on the left as well as on the right – and frame the policy debate with that key consideration in mind.

2--Recovering From a Balance-Sheet Recession, LAURA D'ANDREA TYSON, New York Times

Excerpt: To develop cures to ease the jobs crisis, its causes must be diagnosed correctly. The fundamental cause is the drastic breakdown in private-sector demand brought on by the 2008 financial crisis that burst the debt-financed housing and spending boom preceding it.

This boom displayed all of the features of a major financial crisis in the making — asset price inflation, rising leverage, a large current account deficit and slowing growth. And the recession that followed had all of the features of what Richard Koo called a “balance-sheet” recession — a sharp decline in output and employment caused by a collapse of demand resulting from vast wealth destruction and painful de-leveraging by the private sector.

The economy is now mired in an anemic balance-sheet recovery in which many consumers and businesses continue to curtail their spending relative to their income, increase their saving and reduce their debt even though interest rates are near zero. And the process of de-leveraging is only beginning....

Household debt has come down to about 115 percent of disposable income, largely as a result of foreclosures, 15 percentage points below its peak of 130 percent in 2007 but significantly higher than its 1970-2000 average of 75 percent. Household saving has risen to about 5 percent of disposable income, far above the 2005 low of 1.2 percent but far short of the 1970-2000 average of 8 percent

Consumption is the major driver of aggregate demand in the United States economy, and since early 2008 it has grown at an average rate of 0.5 percent in real terms. Not since before World War II has consumption growth been this weak for such an extended period.

Despite misleading claims by Republican members of Congress and by Republican candidates on the presidential campaign trail that the size of government, regulation and excessive taxation have caused the jobs problem, business surveys repeatedly have identified weak demand as the primary constraint on job creation.

As one small-business owner told The Los Angeles Times, “If you don’t have the demand, you don’t hire the people.” ...

In other recoveries during the last 50 years, public-sector employment increased. This time it is falling: during the last year the private sector added 1.8 million jobs while the public sector cut 550,000.

What should policy makers do to combat the large and lingering job losses that result from a financial crisis and balance-sheet recession? Mr. Koo, whose book on Japan’s experience should be required reading for members of Congress, showed that when the private sector is curtailing spending, fiscal stimulus to increase growth and reduce unemployment is the most effective way to reduce the private-sector debt overhang choking private spending.

When the Japanese government tried fiscal consolidation to slow the growth of government debt in response to International Monetary Fund advice in 1997, the results were economic contraction and an increase in the government deficit. In contrast, when the Japanese government increased government spending, the pace of recovery strengthened and the deficit as a share of gross domestic product declined....

The market understands that the most important driver of the fiscal deficit in the short to medium run is weak tax revenues, reflecting slow growth and high unemployment, and that additional fiscal measures to put people back to work are the most effective way to reduce the deficit.

Every one percentage point of growth adds about $2.5 trillion in government revenue. An extra percentage point of growth over the next five years would do more to reduce the deficit during that period than any of the spending cuts currently under discussion. And faster growth would make it easier for the private sector to reduce its debt burden....

Under these conditions, slow growth leads to a higher debt ratio, not vice versa...

In the United States, where mortgages account for most of the private debt overhang, the federal government should enact stronger measures to reduce principal balances on troubled mortgages and to make refinancing easier. These measures would help stabilize the housing market, would prevent future defaults and would free money for borrowers to use to pay down their debt or increase their spending.

This would translate into stronger private-sector demand and more jobs. Many economists, including me, warned in 2008 that the economy would not recover until the housing market recovered, and the housing market won’t recover until the debt overhang from the housing bubble is reduced through programs that shift some of the burden to creditors from debtors.

Increases in public spending along with housing relief and expansionary monetary policy helped the economy recover from the Great Depression in the 1930s. The same combination of policies can help the United States recover from the Great Recession now.

3--Household Debt Restructuring in U.S. Would Stimulate Growth, Reinhart Says, Bloomberg

Excerpt: A restructuring of U.S. household debt, including debt forgiveness for low-income Americans, would be most effective in speeding economic growth, said Carmen Reinhart, a senior fellow at the Peterson Institute for International Economics in Washington.

“Until we deal head-on with the fact that some of those debts are not ever going to be repaid, we will continue to have this shadow” over growth, Reinhart said today in an interview on Bloomberg Television’s “Political Capital with Al Hunt,” airing this weekend.

The U.S. recovery faltered in the first half of 2011, with gross domestic product rising at a 1.3 percent annual rate in the second quarter and 0.4 percent in the first three months. Reinhart co-wrote a book entitled “This Time is Different: Eight Centuries of Financial Folly” with Harvard University professor Kenneth Rogoff focusing on the “deep and lasting effect” of financial crises on output, employment, and asset prices.

U.S. home prices will probably continue to decline, she said. Recent data indicate that the pipeline of foreclosures in the market is still weighing on the housing recovery.

4--Merkel: Markets Won’t ‘Blackmail’ Euro Leaders, Bloomberg

Excerpt: German Chancellor Angela Merkel said investors are trying to “blackmail” governments into helping debt-strapped European countries, underscoring the need for all euro-area governments to reduce debt.

“After the states bailed out the banks, the financial markets are again trying to blackmail states and tell them, ‘You’ve made so much debt,’” Merkel said today at a rally of her Christian Democratic Union in the eastern city of Brandenburg, about 50 kilometers (30 miles) from Berlin.

The solution is to press “countries that are highly indebted to really do their homework and get their debt down,” she said. “A Europe with a common currency requires common duties.”

Merkel is underlining her stand on the euro region’s debt crisis in local election rallies in August before national lawmakers vote next month on a second aid package for Greece and an expansion of the powers of the European Union’s crisis fund.

She stood firm in rejecting euro bonds, joint debt issuance by euro countries, which is supported by Germany’s two main opposition parties, the Social Democrats and Greens.

5--Keynes/Bernanke, Paul Krugman, New York Times

Excerpt: John Maynard Keynes:

But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.

Ben Bernanke:

These are tempestuous times, but when the storm is long past the ocean will be flat again.

OK, not a literal quote, but pretty much what he said.

6--The Unrecovery, Acknowledged, Paul Krugman, New York Times

Excerpt: One positive thing in Bernanke’s speech — I’m trying to look on the bright side — is that for what seems to me the first time he has more or less acknowledged that we are not, in any real sense, experiencing a recovery:

Notwithstanding these more positive developments, however, it is clear that the recovery from the crisis has been much less robust than we had hoped.

From the latest comprehensive revisions to the national accounts as well as the most recent estimates of growth in the first half of this year, we have learned that the recession was even deeper and the recovery even weaker than we had thought; indeed, aggregate output in the United States still has not returned to the level that it attained before the crisis. Importantly, economic growth has for the most part been at rates insufficient to achieve sustained reductions in unemployment, which has recently been fluctuating a bit above 9 percent.

(see chart)

Does that look like a solid if slow recovery? Of course not.

Ideally, the realization that the economy is not healing would spur the Fed to take the kind of action Bernanke recommended a decade ago when Japan was similarly in a long-term trap.

7--The Heart of the Matter, The Big Picture

Excerpt:...We’ve gone, 14 quarters from the start of the recession, from an index value of 100 to a current index value of 100.7, which is an average annualized growth rate of 0.2 percent. Anemic. Given that consumer spending represents some 70 percent of GDP, a wobbly consumer — note the flatline over the past two quarters — is problematic. And at the risk of turning blue in the face, I’d point out yet again that we know small businesses cite “Poor Sales” as their number one single biggest problem. So, to the extent very little (anything?) has been done to help the consumer, the mess in which we find ourselves should come as absolutely no surprise.

Corporations, which are flush with cash, are spending that cash on such things as mergers, acquisitions, share buybacks, and dividend hikes. While that’s all well and good for the investor class, it does virtually nothing for Joe Six Pack on Main St....

...As the MLR points out:

Labor share averaged 64.3 percent from 1947 to 2000. Labor share has declined over the past decade, falling to its lowest point in the third quarter of 2010, 57.8 percent. The change in labor share from one period to the next has become a major factor contributing to the compensation–productivity gap in the nonfarm business sector....

While Labor Share has recently plummeted to all-time lows since record keeping began, Median Household Income has stagnated for the past 12 years. In the last recession (2001), incomes had only begun to decline. I’m sure back then no one contemplated the possibility that the decline would last (certainly not for a decade), credit was still widely available and, as we know now, being freely tapped (see the PCE chart above for evidence of how normal consumer spending remained during that period). One decade later, Labor Share has collapsed, incomes have gone nowhere, and credit availability — to say nothing of consumers’ attitudes toward it — has all but vanished except for the most creditworthy...

To add insult to injury, Output — or Productivity — has far outstripped Compensation since ’70s, no doubt due in very large part to advances in technology. The gap is even wider in the manufacturing sector of the economy (see Chart 6 in the MLR study). Producing more for less and with less has become a hallmark of good corporate management at the expense, of course, of the American worker. It is a lynchpin of the great American mantra of “maximizing shareholder value.”...

Have a look at U.S. May Back Refinance Plan For Mortgages on the front page of the NY Times. Now this is a proposal that may work — allowing the millions of homeowners who currently do not qualify for a mortgage refinancing the opportunity to do so. There is an estimated $2.4 trillion in mortgages that are currently yielding over 4.5% (and rates are at 4%). This plan would potentially free up $85 billion in cash flow for mortgage households, and that is equivalent to a 1% pay hike. [...]

The bottom line is the lack of refinancing response to lower rates has been a huge transfer of wealth from homeowners and government (they have credit risk) to holders of agency MBS. An effective refinancing program would level the playing field and would be a very effective policy tool and accentuate the impact of the Fed’s ultra low rate policy in terms of the transmission mechanism for the mortgage market. This could end up being big in terms of releasing vital cash flow to the household sector at a time of still-soft labour market conditions. Who ends up getting hurt? In all likelihood, MBS holders (holders of higher coupon MBS) would be the victims, but for a good social cause, don’t you think?

8--More Liquidity Only Douses Growth Sparks, Wall Street Journal

Excerpt: Today's ultralow interest rates have helped boost profits, but not economic growth.

This is plainly evident in recent figures. Since the recession ended in mid-2009, U.S. corporate profits have jumped by about 43% to a record $1.45 trillion as of the first quarter, after taxes, inventory and accounting adjustments, according to the Commerce Department.

What hasn't recovered, however, is economic growth. Indeed, in real terms, gross domestic product hasn't even returned to its prerecession peak.

On Friday, Commerce data is likely to show GDP losing further ground. Second-quarter growth, originally reported at a measly 1.3%, is expected to be revised down to 1% in part because exports proved weaker than first thought. That follows GDP growth of just 0.4% in the first quarter, on a seasonally adjusted annualized basis.

In other words, in real terms the economy barely expanded in the first half of the year. Profits, too, now look set to weaken, as Friday's second-quarter figures are expected to show.

This has occurred even as the Federal Reserve has pushed its target lending rate to zero and embarked on unprecedented "quantitative easing" measures meant to stimulate the economy.

And, on Friday, Fed Chairman Ben Bernanke in a speech from Jackson Hole, Wyo. might outline even further steps to be taken.

Unfortunately, the U.S. is suffering from a lack of demand, not liquidity. As a result, ultraloose Fed policy has exacerbated the dichotomy between profit and growth.

By and large, companies aren't holding back on hiring and investment because of a lack of funds. Cash piles are at all-time highs and corporate balance sheets are in much better shape now than after the last recession in 2001.

So, as BofA Merrill Lynch notes, super-low interest rates have mainly spurred companies to refinance existing debt at lower rates, which boosts their bottom line. Roughly two-thirds of "junk"-bond issuance since 2009, for example, has been put to this use, according to Barclays Capital.

Trouble is, companies aren't exactly putting these freed-up funds to productive use. Their cash levels continue to rise while hiring remains anemic and investment is showing signs of slowing. In short, it isn't a lack of fuel that is holding back the recovery—it is a lack of willing drivers.

9--(From the archives) "Will U.S. Consumer Debt Reduction Cripple the Recovery?", McKinsey Global Institute

Excerpt: "Between 2000 and 2007 US households led a national borrowing binge nearly doubling their outstanding debt to $13.8 trillion. The amount of US household debt amassed by 2007 was unprecedented whether measured in nominal terms, as a share of GDP (98 per cent) or as a ratio of liabilities to personal disposable income (138 per cent) But as the global financial and economic crisis worsened at the end of last year, a shift occurred; US households for the first time since WW2 reduced their debt outstanding.... We show that the hit to consumption from household debt reduction, or "deleveraging" will depend on whether it is accompanied by personal income growth.

“Over the past decade US household spending has served as the main engine of US economic growth. From 2000 to 2007 US annual personal consumption grew by 44 per cent, from $6.9 trillion to $9.9 trillion — faster than either GDP or household income. Consumption accounted for 77 per cent of real US GDP growth during this period — high by comparison with both US and international experience. The US spendthrift ways have fueled global economic growth as well. The US has accounted for one-third of the total growth in global private consumption since 1990.... Powering the US spending spree through 2007 were three strong stimulants; a surge in household borrowing, a decline in saving, and a rapid appreciation of assets." (Martin N. Baily, Susan Lund and Charles Atkins, "Will U.S. Consumer Debt Reduction Cripple the Recovery?" McKinsey Global Institute.)

10--The Wages of Destroying Labor Bargaining Power: Nearly 30% of Job Losses Due to Management Cutting Pie in Favor of Capital, Robert Gordon, Naked Capitalism

Excerpt: ....The first hangover was the excess supply of housing....

This led to a glut of unsold houses and condos that put continuous downward pressure on home prices. Foreclosures added to the glut; each foreclosure raises the supply of vacant housing units by one unit while increasing the demand for housing units by zero, because the foreclosed family has by definition defaulted on its mortgage and cannot obtain credit for several years into the future. Many homeowners avoided foreclosure but were “underwater,” with houses now worth less than the face value of the mortgage and thus faced the hapless choice of draining resources to pay the mortgages or defaulting, with the consequence of a ruined credit rating.

The second hangover was the impact of excessive indebtedness.

Just as consumption could exceed income as debts were being run up, so the second hangover required consumption to be below income while debts were paid off. The ratio of total household indebtedness to personal disposable income rose from 90% in 1995 to 133% in 2007 and has since fallen just to 120%. Year after year of saving and underconsumption will continue as households continue to pay off debts....

In contrast to the overall consumption shortfall – which continues to be as negative as in early 2009 – the total investment shortfall is somewhat smaller now....

Total government spending’s contribution to the output gap was positive in 2008, neutral in 2009, and has become increasingly negative (i.e., contributing to the overall shortfall in total GDP) since early 2010. The small positive contribution of the two federal government components has been more than cancelled by declining state and local spending.


A change in labour market dynamics accounts for about 3 million of the over 10 million missing jobs in mid-2011. This shift can be traced to weakness of labour and growing assertiveness of management. But even with the labour-market institutions of 1955 through 1985, the weakness of aggregate demand in the recession and recovery would have cost roughly 7 million jobs instead of the 10 million jobs that are actually missing compared to normal economic conditions such as occurred in 2007.

The recession itself is usually and correctly traced to the collapse of the housing bubble and the post-Lehman financial panic. But the recovery has been unusually weak, completely unlike the economy’s rapid bounce-back in 1983-84, and this requires an explanation as well. The best place to start is the double hangover approach, which explains not just the collapse of residential structures investment but also the continued and growing weakness in consumer spending. Perhaps the most surprising result of this essay is that the spending component responsible for the largest share of the missing jobs is not residential investment but consumer spending on services.

This is not the place to talk about remedies.

The spending decomposition shows that fiscal policy has failed in that the government spending sector has made the output gap shortfall worse, not better.

The double hangover theory helps to explain why monetary policy is impotent, no matter how much “Quantitative Easing” is attempted.

Authors including Hall (2011) focus on the zero lower bound as the crux of the Fed’s problem and ignore the complementary problem of low interest-insensitivity of consumers who are trying to pay off old debt instead of taking on new debt.

Friday, August 26, 2011

Today's links

1--Thinking about the liquidity trap, Paul Krugman, (from the archive)

Excerpt: Expectations: Finally, we return to the issue of inflation targeting. The basic point, once again, is that a credible commitment to expand the future money supply, perhaps via an inflation target, will be expansionary even in a liquidity trap. There are two problems, however, with this view. One is that it is not enough to get central bankers to change their spots; one must also convince the market that the spots have changed, that is, actually change expectations. The truth is that economic theory does not offer a clear answer to how to make this happen. One might well argue, however, that one way to help make a commitment to do something unusual credible is to do a lot of other unusual things, demonstrating unambiguously that the central bank does understand that it is living in a different world. Market participants are pretty much unanimous in their belief that unsterilized intervention would have a much bigger effect than sterilized, essentially because it would convey news about future BOJ policy; the same could be said of other actions, including quantitative easing. My personal view is that a country deep in a liquidity trap should try everything, even if careful analysis says that some of the actions should not matter; if, in the precise if annoying phrase I used in my first paper on the liquidity trap, a central bank must "credibly promise to be irresponsible", it should waste no opportunity to demonstrate its new spirit.

The other problem is that the policy shift must not only be credible but sufficiently large. A too-modest inflation target will turn into a self-defeating prophecy. Suppose that the central bank successfully convinces everyone that there will henceforth be 1 percent inflation – but that a real interest rate of minus 1 percent is not low enough to restore full employment. Then despite the expectational change, the economy will remain subject to deflationary pressure, and the policy will fail. Half a loaf, in other words, can be worse than none.

2--Fallout from the Fed’s secret $1.2 trillion bank bailout, Marketwatch

Excerpt: Did you know the Federal Reserve secretly loaned up to as much as $1.2 trillion to U.S. and foreign banks? This information has now been released and we even know the institutions that got the bulk of the funds. Can you say, Morgan Stanley (MS), Citigroup (C), Bank of America (BAC). Due to the inflammatory nature of this information, the Fed has been reluctant to share it with Americans, but now it has now come out due to a lengthy Freedom of Information Act (FOIA) investigation by Bloomberg.

This blog post by Barry Ritholtz gives details about a secretive $1.2 trillion bailout program by the Federal Reserve [emphasis added]:

...We knew that Citigroup (C), who borrowed $99.5 billion, and Bank of America (BAC), who took loans of $91.4 billion, were in trouble. I’ve been saying for the better part of 3 years now that they were, and likely still are mostly insolvent. But the surprise data point was Morgan Stanley (MS), got as much as $107.3 billion in loans, with no strings attached.

...Imagine if the government and the Federal Reserve were run not by knaves and fools and Wall Street sycophants, but instead, were run honestly for the benefit of the taxpaying voter. Imagine the goal was saving the banking system (not the banks), and the financial rescue was for the benefit of the taxpayers, not the bondholders…

3--4th UPDATE: Banks Borrow More Euros From ECB, Dollar Supply Seen Tighter, Wall Street Journal

Excerpt: Euro-zone commercial banks Tuesday borrowed a far larger amount of euros from the European Central Bank than the day before, which isn't helping to allay worries that the region's banking system could be heading for a liquidity shortage.

Banks didn't tap the ECB for dollars Wednesday, which came as a relief after one bank borrowed $500 million from the ECB last week, for the first time in 23 weeks. But comments from Bundesbank executive board member Andreas Dombret made it clear that market tensions could be just around the corner as U.S. banks have become more selective with their lending policies to euro-zone banks.

"Without doubt, unsecured dollar funding markets have tightened somewhat recently...But let me emphasize that we are very far away from the situation we witnessed in 2008," Dombret said in a speech in New York Wednesday.

Many market watchers worry that conditions on money markets are worsening to levels not seen since the second half of 2008, when the global credit crisis first hit.

Banks borrowed Tuesday EUR2.822 billion from the ECB's overnight lending facility--which charges a punitive interest rate of 2.25%--up from EUR555 million in the previous trading session, the ECB data showed Wednesday.

Liquidity fears grew when Rabobank Group, one of Europe's best-capitalized lenders, said it has become more careful in providing loans to banks in fiscally-troubled euro-zone countries, another sign that the sovereign debt crisis threatens to disrupt the bank funding market.

4--Europe's Banks in Lending Squeeze, Wall Street Journal

Excerpt: Commercial banks boosted their reliance on the European Central Bank, borrowing €2.82 billion ($4.07 billion) from an emergency lending facility on Tuesday, while other banks continue to park unusually large amounts with the central bank, according to data released Wednesday.

While the amount of borrowing is tiny relative to the multitrillion-euro European banking system, it, and the increase from €555 million a day earlier, nonetheless suggest that some lenders are struggling to borrow from traditional funding sources, such as the capital markets or other banks.

The ECB charges a punitive 2.25% interest rate to borrow from its facility, well above what a healthy bank typically would pay to borrow via other channels and Tuesday's total is well above normal....

All told, the evidence points to an environment when even strong European banks are finding it harder to obtain affordable long-term funding. Banks are being forced to pay more to borrow for shorter periods of time.

The troubles come against the backdrop of Europe's broad and intensifying financial crisis. Already, three euro-zone countries have needed international bailouts, and investors and others fear that larger countries like Spain and Italy could get sucked into the vortex. That is bad news for Europe's banks, which hold large sums of those governments' bonds that could then lose value.

As a result, a growing number of investors are balking at lending money to banks for any longer than just overnight.

"We are not seeing a lack of funding, but we are seeing a shortening of maturities," said a senior executive at a U.K. bank that is generally a borrower in the interbank market....

The ECB doesn't specify why its emergency facility is being used or by whom, but analysts say it is usually tapped for unexpected funding shortfalls that can occur for technical reasons such as insufficient borrowing at the ECB's regular one-week loan offerings. Banks can borrow an unlimited amount at those regular facilities at a lower rate that at the emergency window, which is why spikes in the emergency facility are usually temporary.

Although Tuesday's use of the ECB's emergency facility is much higher than usual, it has been exceeded several other times this year, most recently on Aug. 10, when banks borrowed more than €4 billion.

At the same time, European banks, wary of lending to one another, have been stashing above-average amounts of deposits at an ECB overnight facility. The facility pays a paltry interest rate, and banks could earn more by lending out the funds on the interbank market.

5--Money Markets: Dollar funding costs on the rise, Reuters

Excerpt: European bank funding pressures remained high on Tuesday as the cost of short-term interbank dollars continued to rise, while U.S. banks' debt costs also came under pressure in the unsecured bond markets.

European banks are facing higher dollar funding costs as U.S. money fund investors, nervous over bank exposure to peripheral euro zone countries, reduce the length and amount of loans to the companies.

U.S. banks have largely, thus far, been spared short-term funding stress, though a dramatic share price drop at Bank of America (BAC.N) in the past two days has raised concern that the firm will need to raise new capital at the same time as big investors are increasingly risk averse. For details, see [ID:nN1E77M0FC]

"There are definitely issues in funding affecting banks across the board," said Abdullah Karatash, head of U.S. fixed-income credit trading at Natixis in New York.

6--The Cost Of Insuring European Bank Debt Has Doubled Since April, Business Insider

Excerpt: The cost of insuring junior and senior bonds at 25 European banks has doubled since April, according to a Bloomberg report.

Such numbers appear to confirm fears that funding problems are threatening to cripple European banks.
The report also cited the highest Euribor-OIS spread since 2009 as indicative of banks' reluctance to lend to one another.

"The banks seem to prefer to deposit cash with the ECB rather than lend it out to others that need it," John Raymond, an analyst at CreditSights, Inc., in London told reporters. "In itself, that's a sign of stress in the interbank market."

A retreat in the availability of bank funding could further slow growth in Europe, particularly in the south where bank problems are most severe. Poor economic conditions could aggravate the already unsteady political positions of governments in the PIIGS and erase hopes that austerity measures will fix their sovereign debt problems.

7--Weekly Initial Unemployment Claims increased to 417,000, Calculated Risk

Excerpt: The DOL reports:

In the week ending August 20, the advance figure for seasonally adjusted initial claims was 417,000, an increase of 5,000 from the previous week's revised figure of 412,000. The 4-week moving average was 407,500, an increase of 4,000 from the previous week's revised average of 403,500.
The following graph shows the 4-week moving average of weekly claims since January 2000

The four-week average of weekly unemployment claims increased this week to 407,500.

Weekly claims have increased for two consecutive weeks and the 4-week average is still elevated.

8--How Much More Can the Fed Help the economy, New York Times

Excerpt: Interest rates are already at zero, though (and have been for a while), so the Fed cannot lower them any further. That’s why the Fed has engaged in more unusual — in some cases, unprecedented — measures....

After two rounds of quantitative easing, long-term interest rates are already quite low. It is not clear that lowering them further with a third round of quantitative easing (QE3) would do a whole lot more to encourage investment in riskier assets, or to increase lending. Many companies are choosing not to borrow primarily because demand is so weak, and not because credit is expensive.

Additionally, if investors do start increasing their investments in assets with higher returns, they may pour more money into commodities like oil. And commodity prices are already higher today than they were a year ago; pushing energy and food prices further up could actually discourage consumers from spending.

And many economists are still debating whether the last round of quantitative easing was terribly useful.

“It’s hard to make the argument that QE2 was a rousing success or we wouldn’t be on the verge of seeing QE3,” the economists at RBC Capital Markets wrote in a client note. “The market may very well get what it seems to desire, but we believe there is no magic bullet here.”...

Many economists have suggested that the most powerful tool the Fed might employ would be an announcement that it is raising its medium-term target for inflation.

If prices are expected to rise, banks, businesses and consumers will be more eager to spend their money before it loses value. That could have positive effects throughout the economy, since spending means more demand for goods and services, which means companies need to hire more employees, which means more spending, and so on. That is the much-sought-after virtuous cycle.

Additionally, inflation would lower the value of many people’s debt burdens and so help with the painful process of deleveraging.

The problem, though, is that inflation has some major downsides too — especially if coupled with sluggish growth, as seen during the “stagflation” of the 1970s. Not having a good sense of how much your next gallon of milk or gas will cost is stressful, particularly if your wages aren’t rising to match the higher prices.

9--Fiscalization Watch, Paul Krugman, New York Times

Excerpt: A correspondent informs me that Wolfgang Schaeuble, the German finance minister, has just given a speech asserting that excessive public debt caused the 2008 crisis. In fact, I’m told, he said that

It’s actually undisputed among economists worldwide that one of the main causes – if not the main cause – of the turbulence – not just now, but already in 2008 – was excessive public debt everywhere in the world.

OK, we can prove that wrong immediately: I dispute it, Brad DeLong disputes it, Christy Romer disputes it, and I think we fall into the category of “economists worldwide”.

But more seriously, let’s look at the full list of countries that got into trouble because of high debts accumulated before the crisis, as opposed to those that have developed large deficits as a consequence of the crisis. Here’s the full list:


Spain and Ireland had low debts and budget surpluses on the eve of the crisis. The US financial crisis represented a collapse of confidence in private debt, not public debt. So Schaeuble is just making stuff up, inventing a crisis that didn’t happen rather than dealing with the crisis that did happen.

Unfortunately, he’s not alone. The fiscalization of the crisis story — the insistence, in the teeth of the evidence, that it was about excessive public borrowing — has become an article of faith on both sides of the Atlantic. And that faith has done and will do untold damage.

10--Five Trillion Dollars, Paul Krugman, New York Times

Excerpt: A couple of notes on the most recent Congressional Budget Office Projections:

1. They offer a portrait of an economic catastrophe. Here’s the CBO estimates of potential real GDP — the amount the economy could produce without causing inflationary pressure — and actual GDP, in trillions of 2005 dollars per year:

No, I don’t know where that recovery in 2015 is supposed to come from; my guess is that it’s basically the CBO unwilling to project a depressed economy more or less forever. But even with that bounceback assumed, the projection says that we’ll have a cumulative output gap of $5.1 trillion, with $2.8 trillion of that having already happened.

Surely it would have been worth making an extraordinary effort to avoid this outcome. In particular, an $800 billion stimulus, a significant fraction of which was stuff that would have happened anyway (like extending the patch on the alternative minimum tax) looks ludicrously underpowered. Yet policy has been timid and conventional.

2. The CBO also projects unemployment staying above 8 percent until late 2014 — again, with no clear explanation of why it should fall sharply in 2015. This translates into a human catastrophe for the long-term unemployed. It also says that there will be no good reason to raise interest rates for the foreseeable future.

I think if you had told people back in, say, 2007 that this would happen, they would have asserted with confidence that generating a faster recovery would be at the top of the political agenda. The fact that it isn’t — that deficits are still dominating the conversation, even as interest rates plumb record lows — is truly remarkable.

Thursday, August 25, 2011

Today's links

1--What Should We Have Known About Fiscal Stimulus?, Paul Krugman, New York Times

Excerpt: I’ve noticed a number of people arguing that the original Obama stimulus was underpowered because at the time nobody realized how deep a hole the economy was in. And it’s true that revised GDP numbers have shown that the 2007-2009 recession was even deeper than we thought. But the basic line of thought here is wrong: there was plenty of information in January 2009 indicating that the economy needed a lot more help than it was about to get.

First, even in January 2009 the CBO was forecasting an “output gap” — a shortfall of the economy’s actual production over what it could and should be producing — of more than $2 trillion over 2009-2010. That told you right there that an $800 billion stimulus, much of it consisting of tax cuts of dubious effectiveness, was likely to fall short.

There were also good reasons to believe that the slump would be prolonged, that the economy would need help over a protracted period. After all, the two previous recessions had been followed by long periods of jobless recovery, and there was every reason to expect a repeat. Moreover, we had international evidence showing that the aftermath of financial crises is a long period of high unemployment.

The point is that even in January 2009 it should have been obvious that the economy probably needed a really major push. Maybe that wasn’t possible politically; but it’s clear that there was a complacency in the White House that remains very hard to understand.

2--Home Prices Decline 5.9% in Second Quarter, Bloomberg

Excerpt: Home prices in the U.S. fell 5.9 percent in the second quarter from a year earlier, the biggest decline since 2009, as foreclosures added to the inventory of properties for sale.

Prices dropped 0.6 percent from the prior three months, the Federal Housing Finance Agency said today in a report from Washington. In June, prices retreated 4.3 percent from a year earlier, while increasing 0.9 percent from the previous month.

Foreclosures are boosting the supply of properties on the market and undercutting the confidence of homebuyers, sapping demand even as mortgage rates tumble to the lowest in more than half a century. The U.S. inventory of homes for sale averaged 3.7 million during the second quarter, the highest since the third quarter of 2010, data from the National Association of Realtors show. The mortgages on 6.5 million U.S. homes had late payments or were in foreclosure in June, according to Lender Processing Services Inc. in Jacksonville, Florida.

“Foreclosures water down home prices because banks want to get rid of properties as fast as they can,” said Patrick Newport, an economist at IHS Global Insight in Lexington, Massachusetts. “The key number driving foreclosures is the unemployment rate, and we saw that worsen in the second quarter.”

3--CBO: No Recession, But Growth So Slow Jobless Rate To Top 8% Until 2014, David Wessel, Wall Street Journal

Excerpt: The Congressional Budget Office, in its midyear update of its budget and economic forecast, says it “expects that the recovery will continue,” meaning it doesn’t foresee a recession, but it says that slow growth will keep GDP well below the economy’s potential for several years. On the basis of economic data available through early July – which means it doesn’t reflect more recent gloomy date – CBO projects that inflation-adjusted GDP will increase by only 2.3% this year and by 2.7% next year.

Under current law, it says, federal tax and spending policies will impose substantial restraint on the economy in 2013, so CBO projects that economic growth will slow that year before picking up later to average 3.6% per year from 2013 through 2016. The U.S. economy won’t be operating at potential – meaning that labor and capital are fully employed – until 2017, CBO projects.

That means a lousy job market for years to come. CBO expects the unemployment rate to fall from today’s 9.1 to 8.5 percent in the fourth quarter of 2012—and then to remain above 8% until 2014. “Weakness in the demand for goods and services is the principal restraint on hiring, but structural impediments in the labor market—such as a mismatch between the requirements of existing job openings and the characteristics of job seekers (including their skills and geographic location)—appear to be hindering hiring as well,” CBO said.

Although inflation increased in the first half of 2011, spurred largely by a sharp rise in oil prices, CBO projects that it will diminish in the second half of the year and then stay below 2.0% over the next several years.

4--The household-debt crisis, Washington Post

Excerpt: That means that in this crisis, indebted households can’t spend, which means businesses can’t spend, which means that unless government steps into the breach in a massive way or until households work through their debt burden, we can’t recover. In the 1982 recession, households could spend, and so when the Federal Reserve lowered interest rates and made spending attractive, we accelerated out of the recession.

The utility of calling this downturn a “household-debt crisis” is it tells you where to put your focus: you either need to make consumers better able to pay their debts, which you can do through conventional stimulus policy like tax cuts and jobs programs, or you need to make their debts smaller so they’re better able to pay them, which you can do by forgiving some of their debt through policies like cramdown or eroding the value of their debt by increasing inflation. I’ve heard various economist make various smart points about why we should prefer one approach or the other, and it also happens to be the case that the two policies support each other and so we don’t actually need to choose between them.

All of these solutions, of course, have drawbacks: if you put the government deeper into debt in order to help households now, you increase the risk of a public-debt crisis later. That’s why it’s wise to pair further short-term stimulus with a large amount of long-term deficit reduction. If you force banks to swallow losses or face inflation now, you need to worry about whether they’ll be able to keep lending at a pace that will support recovery over the next few years. But as we’re seeing, not doing enough isn’t a safe strategy, either.

5--MONEY MARKETS-Bank borrowing costs hit highest in a year, Reuters

Excerpt: Three-month dollar Libor reaches highest rate in a year...

The cost for banks to borrow short-term dollar funds from other banks rose to the highest level in a year on Wednesday as large U.S. money funds continued to pull back on making loans to Europe and as fears over bank counterparty risk increased.

London interbank offered rates for three-month dollars LIBOR increased to 0.31428 percent, the highest rate since last August and up from 0.31178 percent on Tuesday.

The rate has been steadily rising as investors have become increasingly reluctant to make dollar-based loans to European banks on longer than an overnight basis.

"Term funding markets have significantly less liquidity than they had, a lot of investors are getting very short. They don't want to take a lot of term risk," said Ira Jersey, interest rate strategist at Credit Suisse in New York.

U.S. money funds, which have traditionally been among the largest lenders of short-term dollar loans to European banks, have been reducing exposures to the region on concern over bank exposure to the debt of peripheral European nations....


The Libor panel continued to reflect tiering of banks, with European banks including Barclays (BARC.L), Credit Agricole (CAGR.PA), Credit Suisse (CSGN.VX), Royal Bank of Scotland (RBS.L), Societe Generale (SOGN.PA) and UBS (UBSN.VX) all reported having to pay slightly above the daily fixing.

6--QE2---The unintended consequences, FT.Alphaville

Excerpt: By 2010, the Fed became aware the US could be approaching a deflationary trap — where top line revenue for companies and individuals begins to decline, meaning the ability to pay off debt declines, extending the recession indefinitely. The weight of past debt simply keeps getting heavier.

Negative inflation thus had to be avoided at all costs.

But with traditional monetary clearly not working any more, how was the Fed to prevent the floor instituted by QE1 and Tarp from caving in?

At Jackson Hole, says Spellman, the Fed decided to do something quite extraordinary. Something they’d never done before — they put their hope in the shadow banking system to get the money into the spending stream instead of the banks.

After all, the reasoning was, inflation is a goods market phenomenon.

Rather than putting the money out to banks to loan, they would put it out to public capital markets in a bid to try to create an asset bubble. This they hoped would a) create a wealth effect and b) raise the price of public securities and reduce the rate for borrowers. In this way some business firms would be able raise capital cheaply enough in the public capital markets to cause them to pass on the money into the wider economy through energy and infrastructure spending.

A major economics 101 fail

But here’s where the story gets funny. Initially QE2 did exactly what it was intended to do. It inflated equities. Private institutions from which the Fed had purchased Treasuries began to put their money directly into the equity market. Stocks went up. Hurrah!

But there were also some unintended and potentially more serious consequences. Firstly, many institutions had no intention of getting riskier. They wanted to allocate the cash exactly the same way they had always done — in safety. Though, idealy, in better-yielding ‘safety’ securities.

According to Spellman, that saw QE2 money flow out in many curious ways. Among them, back into shadow banks and hedge funds, via overnight collateralised repo loans (unsecured lending is dead remember). The hedgies would use these loans to invest in high yielding instruments like junk bonds, emerging market securities (usually corporate) and even distressed peripheral debt. The “prudent” institutions were happy to do this, because it was only ever on a very short-term duration and they received a better return.

On top of all this, one of the most important factors in determining how money flowed was connected to a major monetary misunderstanding due to the way economics has been taught around the world for fifty-plus years.

Due to the quantity of money theory and the overuse of the term “money printing” in economics 101 coursebooks, Spellman says QE2 became synomyous with “money printing”, a fact which radically changed inflation expectations. This suited the Fed fine, since inflation expectations are important in a debt deflation. But arguably, the inflation expectations overshot entirely. (Spellman interestingly blames Bill Gross for fueling much of the inflation hysteria.)

When “prudent” investors, due to an inflationary view, decided to allocate QE2 cash into commodities and other emerging markets, further unintended consequences began to appear.

Unintended consequences

The first unintended consequence was the degree to which inflation was exported out of the United States and into emerging markets and commodities.

The second was the volatility this passed over into the foreign exchange markets — currency wars, capital control fears, and hot money inflows fears being the primary results.

The third was the degree to which all of the above posed a quandry for emerging market countries, torn between allowing currency appreciation and lower exports or domestic asset bubbles, which ultimately ran even more serious risks.

The fourth was the double-tiering of the US economy. Whatever policy route emerging countries took, Americans ultimately ended up paying more for imports whilst prices of domestically produced goods continued to fall.

Debt debacle effect

And that’s about where we were at when the debt debacle kicked off and QE2 finished. Which, as yet, has not been covered by Professor Spellman.

But FT Alphaville’s own interpretation is that this possibly changed everything. Above all it’s probably injected a short sharp shock of realisation into the market that high inflation expectations in an over-leveraged economy are highly unrealistic. The search for safety has now taken new and radical proportions, so much so that negative real inflation rates are once again the key concern of the Fed. But you can read more about that here. And here.

What are the options left now that QE3 is clearly not a viable option? We’ll discuss those in a follow-up post. But we ultimately we see debt deflation being prominently on Ben Bernanke’s mind at Jackson Hole more than anything else.

7--Fed's fantasy options, FT.Alphaville

Excerpt: ... Fed should start targeting nominal GDP – i.e. forget about inflation targeting altogether and start targeting nominal GDP via nominal incomes and something called NGDP futures. In Sumner’s own words:

It would be something like the classical gold standard, but with the dollar defined in terms of a specific NGDP futures contract, instead of a given weight of gold. The public, not policymakers in Washington, would determine the level of the money supply and interest rates most consistent with a stable economy.

Banks would fail, but the money supply would adjust so that expected future nominal spending continued to remain on target. Creative destruction could do what it’s supposed to do, with jobs lost in declining industries being offset by jobs gained in creative new enterprises.
More on how that works here....

...Of course, there’s also Paul Krugman’s argument that in a debt deflation trap, all conventional monetary tools become redundant and all central banks end up losing credibility. (Especially if the system is intrinsically insolvent.)

8--Gold falls 3% as investors cash in gains, Economic Times

Excerpt: Gold plunged in New York, heading for the biggest drop in 18 months, on speculation that financial markets may be stabilizing, eroding the appeal of the precious metal as a haven.

Bullion has tumbled more than 5 percent in two days, erasing gains in the past two weeks that sent the metal up as much as 16 percent since Aug. 5 to a record $1,917.90 an ounce yesterday. On Aug. 16, Wells Fargo & Co. said rising speculative demand from investors had pushed the market into a “bubble that is poised to burst.”

“This is liquidation from a crowded trade,” Adam Klopfenstein, a senior market strategist at MF Global Holdings Ltd. in Chicago, said in a telephone interview. “In the short run, there’s more optimism and that doesn’t bode well for gold. Investors have been using gold more as a fear barometer than a proxy for inflation.”

Gold futures for December delivery plunged $72.30, or 3.9 percent, to $1,789 an ounce at 12:11 p.m. on the Comex in New York. A close at that level would be the biggest loss since Feb. 4, 2010.

9--Manufacturing data suggest contraction, Credit Writedowns

Excerpt: The Richmond Fed manufacturing index fell to -10 in August from -1 in July. The new orders sub index fell to -11 from -5, shipments fell to -17 from -1 and the backlog of orders fell to -25 from -18 and has not grown since March.Inventories were unchanged at +17. Looking through the various regional indices, the New York index implies an ISM of around 49, the Richmond index 48, and the Philly index about 42 whilst last month’s ISM forward index of new orders minus inventories also implies an ISM of 42

10--Nomura: U.S. Economy Lost Jobs in August, Wall Street Journal

Excerpt: Kicking off what will likely be a series of downgrades to job forecasts in the coming week, Nomura’s U.S. economists said Wednesday they now expect nonfarm payrolls to show a decline of 5,000 in August – far off from their prior estimate of a 100,000 gain – due in part to the strike by Verizon Communications Inc. workers.

They project that private payrolls will show a gain of 5,000 (following July’s 154,000 increase), suggesting that public payrolls will post a decline of 10,000 jobs this month. The economists cite three reasons for their new forecast: 1) The sharp drop in the Philadelphia Fed’s August manufacturing survey “appears to signal a sudden decline in economic activity that we expect to be reflected in a slower pace of hiring.” 2) Growth in payroll tax receipts reported by the Treasury Department slowed from July. 3) The two-week strike by Verizon workers will reduce payrolls by about 45,000 for the period in which employers are surveyed. (They note that a similar strike in August 2000 led to a drop of 77,000 workers in the telecom industry that was reversed the following month when the strike ended.)

Even though layoffs didn’t rise in early August (at least as measured by jobless claims), the economists noted, “businesses likely shut the door on hiring as the economic outlook become even more ‘unusually uncertain’ amid fears of European contagion and stock market volatility. Surveys of business confidence have also pointed to stalled hiring intentions.”

That doesn’t necessarily mean August marks the start of a new recession, particularly because the end of the telecom strike should lead to some bounce back in September’s figures. The Nomura team says concluding a new recession began this month “would seem premature, although not altogether unwarranted.”

The Labor Department is scheduled to release its August employment report on Friday, Sept. 2.

11--WSJ: Europe Banks Lean More on Emergency Funding, Calculated Risk

Excerpt: Commercial banks boosted their reliance on the European Central Bank, borrowing €2.82 billion ($4.07 billion) from an emergency lending facility on Tuesday ... While the amount of borrowing is tiny ... the increase from €555 million a day earlier, nonetheless suggest that some lenders are struggling to borrow from traditional funding sources ... The ECB charges a punitive 2.25% interest rate to borrow from its facility.

12--Not Learning from the Past, Economist's View

Excerpt: The Frum Forum notes that many economists are now assigning a high probability to a double-dip, and adds:

If a double dip does come, it will be the inaction in the face of warnings that it was on the way which future generations will be most baffled by.

One quibble, calling it a policy of inaction is too kind. There has been action, but the wrong kind:

At this point the entire advanced world is doing exactly what basic macroeconomics says it shouldn’t be doing: slashing spending in the face of high unemployment, slow growth, and a liquidity trap. It’s a global 1937. And if the result is another recession, the witch-doctors will just demand more bleeding.

It's hard to believe we're doing this again.