Friday the 13th of August

Paralysis at the Fed. Paul Krugman, NYT.

Ten years ago, one of America’s leading economists delivered a stinging critique of the Bank of Japan, Japan’s equivalent of the Federal Reserve, titled “Japanese Monetary Policy: A Case of Self-Induced Paralysis?” With only a few changes in wording, the critique applies to the Fed today.

The real reason banks aren't lending. Marshall Auerback, via Credit Writedowns.

credit growth follows creditworthiness, which can only be achieved through sustaining job growth and incomes. That means embracing stimulatory fiscal policy, not “credit-enhancing” measures per se, such as quantitative easing, which will not work. QE is based on the erroneous belief that the banks need reserves before they can lend and that this process provides those reserves... that is a major misrepresentation of the way the banking system actually operates:

In the U. S., when a bank makes a loan, this loan creates a deposit for the borrower. If the bank then ends up with a reserve requirement that it cannot meet by borrowing from other banks, it receives an overdraft at the Fed automatically (at the Fed’s stated penalty rate), which the bank then clears by borrowing from other banks or by posting collateral for an overnight loan from the Fed. Similarly, if the borrower withdraws the deposit to make a purchase and the bank does not have sufficient reserve balances to cover the withdrawal, the Fed provides an overdraft automatically, which again the bank then clears either by borrowing from other banks or by posting collateral for an overnight loan from the Fed.

The point of all this is that the bank clearly does not have to be holding prior reserve balances before it creates a loan. In fact, the bank’s ability to create a new loan and along with it a new deposit has NOTHING to do with how many or how few reserve balances it is holding.

What is required to drive lending is a creditworthy borrower on the other side of the bank lending officer’s desk, which means an employed borrower, whose income allows him to sustain regular repayments. Absent that, there will be no lending activity. It is pointless to blame the evil bankers for this of state affairs, since they don’t control fiscal policy, which is the remit of the Treasury. For all the talk from policy makers about not repeating the mistakes of Great Depression, we seem to be perilously close to doing precisely that. This is largely based on a poor understanding of the economic dynamics of that period, even by that noted scholar of the Great Depression, Ben Bernanke.

The pause that doesn't refresh. Comstock Partners.

The market has suddenly awakened to the fact that the economy is tanking and that the Fed has used all of its conventional ammunition. Interest rates are near zero, the budget deficit is 10% of GDP and the Fed’s balance sheet has tripled to $2.3 trillion. After some $700 billion of TARP funds, $1.7 trillion of Fed purchases of mortgages and Treasuries, untold billions of dollars of guarantees, the auto industry bailout, cash for clunkers, home purchase credits and mortgage workout programs, the economy still cannot stand on its own....

most economists have reduced their second quarter GDP growth estimate to a range of 1%-1.5%, compared to the previously reported 2.7%. Taken together with a sharp rise in unemployment claims, the disappointing payroll employment number, a continually declining housing market, tepid consumer spending and yet another gloomy report from the small business survey, the economic outlook going into the third quarter does not look promising.

The Only Things That Matter… And No One Talks About. Graham Summers, Phoenix Capital Research.

the stooges are out again in full force proclaiming that the US economy is in trouble again (duh), that the Stimulus high is wearing off (duh again) and that the only solution is to issue more Stimulus and money printing to stop another economic contraction (WHAT!?!). Let’s be honest here. The money printing and Stimulus DIDN’T work last time. All it did was buy time.

so, what does matter? jobs and income

Are you ready for how bad it will get? Phoenix Capital.

yes you could claim we had an economic recovery in the sense that things got less bad for a while, however this recovery took place within the context of a larger economic contraction or Depression. A decent analogy would be to throw a rubber ball off the edge of the Grand Canyon. If the ball hit a ledge on the way down, it might bounce upwards temporarily, but unless it somehow cleared the edge from which you threw it, the ball’s trajectory remains “down.”

Can the Nation Stimulate Its Way to Prosperity? Economic Letter, Federal Reserve Bank of Dallas.

Compared with no stimulus, the stimulus plan in 2009 alone was expected to increase GDP by 1 to 3 percentage points, raise payroll employment by 500,000 to 1 million jobs and lower the unemployment rate by half a percentage point. At first glance, it doesn’t appear the stimulus achieved these objectives.

In the year after the plan’s passage, the labor market continued to hemorrhage jobs and unemployment climbed above 10 percent. Indeed, the unemployment rate is now higher than it was expected to be without the stimulus plan—and has been every month since the plan’s passage

What Made America Great Is Now Killing Her! Gordon Long via zero hedge.

Our political leaders are presently addressing what they perceive as an intractable cyclical recovery problem when in fact it is a structural problem that is secular in nature. Like generals fighting the last war with outdated perceptions, we face a new and daunting challenge. A challenge that needs to be addressed with the urgency and scope of a Marshall plan that saved Europe from the ravages of a different type of destruction. We need a modern US centric Marshall plan focused on growth, but orders of magnitude larger than the one in the 1940’s. A plan even more brash than Kennedy’s plan in the 60’s to put a man of the moon by the end of the decade. America needs to again think and act boldly. First however, we need to see the enemy. As the great philosopher Pogo said: “I saw the enemy and it was I”.....

.... As I said in the beginning the US needs a bold new “Marshall” plan to fight the new destruction of creative destruction. Here is a starting point for public debate:

1 – If we can spend $165B bailing out AIG, then we can spend $100B (4 years of college @ 50K/year X 500,000 students) and guarantee everyone in America a college education to compete in the 21st century. Parents will start to spend immediately instead of presently being almost financially paralyzed with skyrocketing education costs.

2- Obama says we need to be leaders in Energy. OK. Where are the programs? Where are the 50,000 new university teaching and research positions ( 50,000 X 75K = $3.8B)? At $3.8B this is a rounding error compared to the banks TARP program.

3- 99% of all jobs in America are created by small business with less than 500 employees. Stop treating them like they are last on the ‘to help’ list after the banks, financial institutions and S&P 500 but first on the taxation list. S&P 500 paid almost net zero taxes, reduced US hiring, yet received the bulk of the governments bailouts. Small business is the golden goose that every administration seems determine to cook....

5- Make Social Security and Medicare financially sound so Americas can believe and budget that it will be there for them....

6- When did the American people decide to fund military operations in over 130 countries around the world?...

8- Washington and the lobbyists that control it have taken control of our government.

Consensus plays catch-up to the fall in interest rates. BondSquawk.

Gary Shilling is one of those guys that I always try to listen to; the unfortunate part is that his analysis isn't as accessible as is Rosie's or the bloggers I read, or even the likes of Jeremy Grantham and van Hoisington, who at least have quarterly updates that are available to the public; he's more like Meredith Whitney: you catch them when you can, when they're interviewed; in any case, he's been right for a long time, and he's worth paying attention to:
Deflation's Coming, Says Gary Shilling, And It's Going To Clobber The Stock Market. and The Long Workout: Gary Shilling Sees 10 Years of Low Growth + Rising. Yahoo tech ticker video interviews.

Another man's opinion. Bruce Krasting.

We’re digging an ever deeper hole here, the EU problems have not gone away by any means. And after I saw the amount of sov debt the European banks own, I have conviction the EURUSD rally is a headfake. Those banks will go down as they are forced to take the haircuts on the sov debt… unlike in the US, where the gov’t could borrow to bail out the losses on private securitized debt, the Euro banks’ ‘toxic problem’ is the gov’t debt itself… it’s a tight closed loop… or spiral, as it were…

Stocks are nearly out of accounting tricks, imo…. The final demand is not there and won’t be. Trading on fwd P/E when the ‘E’ is pure fantasy will not end well. Everyone seems to say “stocks have gone nowhere in 10 years” as the ultimate sign of how poor stocks have done…. actually S&P is down over 25% in the last 10yrs. And it continues as we de-lever.

If we think fund flows into bonds / out of stocks are significant now, just wait til we get another big leg down in stocks this fall… I think we see banks (and individuals to a lesser, but significant degree) go all in UST… every day there’s less and less hi-quality, non-UST bonds – eventually, if it has not already happened, the
yield premium for taking incremental risk in high-grade f/i over USTs withers to a level that is not meaningful, and the UST bid from banks and mom/pop begins, and then feeds itself… the proverbial towel will be thrown in.

If Deflation Wins, What Will Gold Stocks Do? Jeff Clark via zerohedge.

Feds rethink policies that encourage home ownership. USA Today.

Hidden income in China boosts income of top 10%, fueling speculation, social strains. Yves Smith, naked capitalism.

other fare:

New evidence that matter and antimatter may behave differently. MIT News.

The intelligent universe. maisonneuve.

August 12

NYT asks: Should We Brace for Deflation Now?
debate/responses from Brad DeLong, Tyler Cowen, Mark Thoma, Simon Johnson, Heather Boushey.

U.S. using "really stupid strategy" to hide bank losses. interview with Bill Black, Yahoo! tech ticker.

in our current situation, “we’re following a Japanese type strategy of hiding the losses,” he says. “This is a really stupid strategy, and it’s ours."

QE: “the greatest monetary non-event”. The Pragmatic Capitalist.

They’re not “printing money” or dropping money from helicopters as many economists and pundits would have you believe. It is merely an asset swap

quotes the BIS:

In fact, the level of reserves hardly figures in banks’ lending decisions. The amount of credit outstanding is determined by banks’ willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans... an expansion of reserves in excess of any requirement does not give banks more resources to expand lending. It only changes the composition of liquid assets of the banking system. Given the very high substitutability between bank reserves and other government assets held for liquidity purposes, the impact can be marginal at best. This is true in both normal and also in stress conditions. Importantly, excess reserves do not represent idle resources nor should they be viewed as somehow undesired by banks (again, recall that our notion of excess refers to holdings above minimum requirements). When the opportunity cost of excess reserves is zero, either because they are remunerated at the policy rate or the latter reaches the zero lower bound, they simply represent a form of liquid asset for banks

also includes quote from Richard Koo:

Even though QE failed to produce the expected results, the belief that monetary policy is always effective persists among economists in Japan and elsewhere. To these economists, QE did not fail: it simply was not tried hard enough... At the risk of belabouring the obvious, imagine a patient in the hospital who takes a drug prescribed by her doctor, but does not react as the doctor expected and, more importantly, does not get better. When she reports back to the doctor, he tells her to double the dosage. But this does not help either. So he orders her to take four times, eight times, and finally a hundred times the original dosage. All to no avail. Under these circumstances, any normal human being would come to the conclusion that the doctor’s original diagnosis was wrong, and that the patient suffered from a different disease. But today’s macroeconomics assumes that private sector firms are maximizing profits at all times, meaning that given a low enough interest rate, they should be willing to borrow money to invest.. In reality, however, borrowers – not lenders, as argued by academic economists – were the primary bottleneck in Japan’s Great Recession.

Time to rethink Milton Friedman? Rick Ackerman.

so those writers don't think the Fed's policies are effective; does even the Fed think its policies will work???
Money, Reserves and the Transmission of Monetary Policy: Does the Money Multiplier Exist? Federal Reserve Board Divisions of Research & Statistics and Monetary Affairs.

textbook treatments of the money multiplier give the quantity of bank reserves a causal role in determining the quantity of money and bank lending and thus the transmission mechanism of monetary policy. This role results from the assumptions that reserve requirements generate a direct and tight linkage between money and reserves and that the central bank controls the money supply by adjusting the quantity of reserves through open market operations.

Using data from recent decades, we have demonstrated that this simple textbook link is implausible in the United States for a number of reasons.... Changes in reserves are unrelated to changes in lending, and open market operations do not have a direct impact on lending.

Why US final demand is weak, and why Fed interventions are pointless. TrimTabs, via zerohedge.

TrimTabs does a simple yet elegant analysis that seeks to explain why US final demand is not only sluggish but declining, and is ultimately the reason why the US government needs to consistently pump more and more capital in the economy to keep GDP at best flat.

TrimTabs focuses on the "consumer spendables" indicator - It consists of the sum of three components: 1. After-tax income from wages and salaries; 2. After-tax income from non-wage sources, such as capital gains, dividends, and interest; 3. Cash harvested from home equity when mortgages are refinanced. As TrimTabs shows, and this should come as a surprise to nobody, "much of the economic growth in the middle of the previous decade was fueled by an explosion of consumer debt. Consumers treated their homes like automatic teller machines—cash-out refinancings topped out at $804 billion in the four quarters ended in Q2 2006—and they borrowed freely on low-rate auto loans and credit cards given to almost anyone who could fog a mirror. Now that the era of easy consumer credit is over, the economy is resetting to a lower level of activity. We believe the interventions of the Fed and the government to try to head off this adjustment will do more harm in the long run than the adjustment itself."

U.S. Selected Issues Paper. IMF.

The U.S. fiscal gap associated with today’s federal fiscal policy is huge for plausible discount rates.... closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP

to put that in perspective, to raise 14% of GDP would require a doubling of all federal taxes


data:
I've referred to the Consumer Metrics Growth Index and the ECRI WLI to flag growth relapse (i.e. double-dip) concerns; on the other hand:

All signs continue to point to an economy in recovery with the latest release of the Ceridian-UCLA Pulse of Commerce Index™ (PCI) by UCLA Anderson School of Management

PCI Climbs in July, Confirming Economy’s Slow but Steady Recovery. Ceridian-UCLA Pulse of Commerce Index.


BP link of the day:
Will BP skip the relief well, declare mission accomplished, and abandon ship without permanently killing the oil leak? Washington's Blog.


other fare:
Robert Gibbs attacks the fringe losers of the left. Glenn Greenwald, Salon.

You may think that the reason you're dissatisfied with the Obama administration is because of substantive objections to their policies: that they've done so little about crisis-level unemployment, foreclosures and widespread economic misery. Or because of the White House's apparently endless devotion to Wall Street. Or because the President has escalated a miserable, pointless and unwinnable war that is entering its ninth year. Or because he has claimed the power to imprison people for life with no charges and to assassinate American citizens without due process, intensified the secrecy weapons and immunity instruments abused by his predecessor, and found all new ways of denying habeas corpus. Or because he granted full-scale legal immunity to those who committed serious crimes in the last administration. Or because he's failed to fulfill -- or affirmatively broken -- promises ranging from transparency to gay rights.

But [White House press secretary] Robert Gibbs -- in one of the most petulant, self-pitying outbursts seen from a top political official in recent memory, half derived from a paranoid Richard Nixon rant and the other half from a Sean Hannity/Sarah Palin caricature of The Far Left -- is here to tell you that the real reason you're dissatisfied with the President is because you're a fringe, ideological, Leftist extremist ingrate who needs drug counseling.

Kill Hugo? Mike Whitney, CounterPunch.

It's hard to believe that a two-year senator from Chicago with a background in 'community organizing' presides over this elaborate and opaque system of imperial rule. He doesn't, of course. The real leaders remain hidden behind the cloak of democratic government and all of Washington's phony institutions. Obama is merely a public relations hologram, a friendly face that conceals the machinations of a global Mafia. Other people--whoever they may be--control the levers of power moving the pieces as needed to assure the best outcome for themselves and their constituents.

August 11, part 2 - Quote of the day

quote of the day in bold:

Economy Lost Momentum While I Was Pulling Weeds. Caroline Baum, Bloomberg.

In order to lose momentum, the U.S. economy has to have momentum to begin with. If it had any, I missed it.

What we had was a government-prescribed course of amphetamines (to keep it up), antibiotics (to prevent infection) and antidepressants (to make it feel better). It endured regular steroid injections from both monetary and fiscal authorities. And it still has no real muscle.

Inventory restocking isn't a strategy for long-term growth... Inventory accumulation accounted for more than half of gross domestic product growth in the fourth quarter, three- fourths in the first quarter and a little less than half in the second quarter.

The Federal Reserve’s near-zero percent interest rates and $2.3 trillion balance sheet, almost three times its pre-crisis level, haven’t translated into growth in broad money and credit. Banks are holding $1 trillion in excess reserves in their accounts at the Fed....

On the fiscal front, the government threw huge sums of money at the economy. It paid people to buy cars and homes. It paid them to weatherize their houses, maybe the same ones the government paid them to buy. It paid them to buy appliances for the houses the government paid them to buy. And it paid banks to modify mortgages....

There is no quick fix, no painless solution, for what ails the U.S. economy. It took a long time to accumulate enough leverage and bad debts to sink the economy. It should take at least as long to recover.

August 11

after yesterday's successful Treasury auction and the FOMC announcement, today we have the Canada 10yr yield under 3.00%, and UST10 at 2.70%, both at lowest they've been since April 2009


speaking of the FOMC, which announced it would keep the size of its balance sheet static by reinvesting principal pre-payments and maturities of its existing assets into Treasuries, Paul Krugman asks:

"Presumably there’s some optimal size of the Fed’s balance sheet, given the state and prospects of the economy. What are the odds that the optimal size of that balance sheet is precisely the size it’s currently at?"

in any case, what, if any impact, should this QE-lite or QE-neutrality (or whatever we should refer to it as) have on interest rates?

In a research paper earlier this year, Joseph Gagnon and other Fed staffers at the FRBNY estimated that a purchase of long-term assets in an amount equivalent to 1% of GDP would lower the yield on 10-year Treasuries by 4.4 basis points (see Table 5a on page 35) (hat tip James Hamilton).

So for each $150 billion (about 1% of GDP) in assets that the Fed has rolling off its balance sheet over the next year, the yield on 10-years might be expected to rise about 4.4bps; and by rolling the proceeds of those maturies into Treasuries, the Fed might be expected to prevent that 4.4bp rise in yields from happening. So, say, rather than the 10-year going from 2.70 to 2.75, ceteris paribus, it will now stay at 2.70. WOW, thats some stimulus!

by the by, is Hoenig being instructed to dissent, for some obscure political or P.R. purpose, as MK thinks, or is he simply smoking something?

he claims he dissented because he "judges that the economy is recovering modestly, as projected"

REALLY? as projected? as of April, the Fed was projecting 2010 growth of 3.2% to 3.7%; but Q2 GDP growth was estimated at 2.4% (and is likely to be revised down), while the median forecast of economists for Q3 & Q4 are 2.5% and 2.6% respectively

so, this is the same guy who dissented in April when he opined that the fed funds rate should be hiked to 1% this summer --- and who dissented in October 2007, on the eve of the recession, preferring to leave the fed funds rate unchanged at 4.75%, with no need for monetary stimulus (hat tip, Barry Ritholtz)

so, frankly, I think Hoenig's on drugs; whatever he says, go the other way

China Seen Robbing Consumers With Low Interest Rates. Bloomberg.

discusses reasons to be very skeptical of a consumer boom in China

consumption as a share of GDP has plummeted from 46% in 2000, already a very low share relative to most economies, to just 35%

though the economy has grown remarkably over the last decade, only a small proportion of this has flowed through to consumers in the form of income growth

MIT professor Huang Yasheng:

“Even in the best-case scenario I do not see household consumption replacing investment as a driver of growth in the foreseeable future.”

“I never believed the hype that China was turning the corner on rebalancing growth toward consumption. The main political agenda is not to let GDP growth slip and that means continued investment growth.”

Vice Premier Li Keqiang, widely believed to be the anointed premier when leadership changes in 2012:

China’s past development has created an “irrational economic structure” and "uncoordinated and unsustainable development is increasingly apparent.” Long-term dependence on investment and exports for growth “will grow the instability of the economy,” he said.

Glen Maguire, economist at SocGen:

“Until consumption grows faster than fixed-asset investment for a sustained period, the economy will remain unbalanced.”

Chinese consumption and the Japanese "sorpasso". Michael Pettis.

most analysts viewed the surge in auto sales and in durable goods-driven retail sales was immensely good news and they argued that this increased demand signaled a major shift in the consuming and saving behavior of Chinese households

[but skeptics like me] claimed that the surge in demand for automobiles was caused mainly by government subsidies, and that these were not sustainable. The same thing happened, by the way, to durable goods, which were also subsidized and which also saw a surge in retail sales. More importantly, we argued, any current increase in automobiles sales and durable goods would be reversed in the future as households absorbed the cost of the subsidies.

Remember that subsidies are not manna from heaven. They must be paid for, and ultimately it is the household sector that pays for them, usually in the form of higher taxes but sometimes, and certainly in the case of China, in the form of financial repression. The government, in other words, borrows from the household sector (via the banks) at artificially low interest rates, which implies continual government debt forgiveness paid for by the household sector. Either way, whether it is through taxes or debt forgiveness, as households pay for today’s subsidies out of tomorrow’s income, consumption will rise today and decline tomorrow....

Contrary to conventional thinking, the Chinese have no aversion to consuming. They are eager consumers, as even the most cursory visit to a Chinese shopping mall will indicate.

So why do they consume such a low share of national GDP – perhaps the lowest share ever recorded? The answer has to do with the level of household income as a share of GDP, also one of the lowest ever recorded.

Chinese households are happy to consume, but they own such a small share of total national income that their consumption is necessarily also a small share of national income. And just as the household share of national income has declined dramatically in the past decade, so has household consumption. This isn’t to say households are getting poorer. On the contrary, they are getting richer, but they are getting richer at a much slower speed than the country overall, which means their share of total income is declining.

some observers are getting excited about the fact that China's GDP will soon overtake that of Japan, thus becoming the 2nd-largest economy in the world; Pettis has reservations:

before we get too excited about China’s overtaking Japan, we should remember that this has as much to do with Japan’s astonishing decline as with China’s astonishing rise, and that there is at least some small chance that the policies responsible both for Japan’s breakneck rise and equally breakneck decline may be being replicated in China

other fare:

Frozen jet stream links Pakistan floods, Russian fires. Michael Marshall, New Scientist.

First They Came For The Climate Scientists. Paul Krugman, NYT.

August 10

Economic outlook: slip-sliding away. Anthony Hall, UPI.

It is open to question what the Fed might do about a recovery that is slipping away, but the first task at hand is to name the problem. Is deflation an imminent threat? Some on the Fed's Open Market Committee say it is, including Boston Fed President Eric Rosengren and St. Louis bank President James Bullard, who recently warned a potential "Japanese-style deflationary trend" could be developing.... Entrenched in its "first, do no harm" mentality, the Fed has not whispered any official consensus on deflation.

What will happen if the Fed stops paying interest on reserves? Andy Harless.
lots of things; but at the end of the day, says Harless,

All in all, we get a mild economic stimulus at the price of some substantial disruptions to the financial system.

More from Harless:
Inflation targeting when the natural interest rate is negative.

When the natural interest rate is negative, since it’s impossible to cut nominal interest rates much below zero, the only way to get back to normal is to create an expectation of inflation. If the nominal interest rate is zero and the inflation rate is positive, then the real interest rate is negative; thus it is possible, with a sufficient amount of expected inflation, to set the real interest rate down to the negative natural rate. But how can that inflation be achieved? Wicksell argues that prices rise when the actual interest rate falls below the natural rate, but in order for that to happen, prices must already be expected to rise. Can a central bank pull itself up by its own bootstraps?

The answer is almost certainly yes, since nearly everyone agrees that a sufficiently reckless central bank will always be able to produce a high inflation rate. (Imagine the Fed buying up the entire national debt, along with all the private sector’s offerings of commercial paper, mortgages, corporate bonds, and so on. Eventually, there will be inflation.) The problem is that it is hard to estimate in advance how aggressive monetary policy needs to be in order to produce the needed expectation of inflation. Not only doesn’t the central bank know what actions would produce a given “happy medium” target between too-low and too-high inflation expectations; it never really even knows what the natural interest rate is, so it doesn’t know how much inflation would be enough to get the real rate down to the natural rate.

If the central bank estimates wrong and overshoots, it risks a period of very high, and unnecessarily high, inflation. If (as seems infinitely more likely to me) it estimates wrong and undershoots, it risks reducing its credibility, so that it becomes more difficult, subsequently, to achieve the necessary inflation rate. (Note BTW that if you take the Mankiw Rule as an estimate of the natural interest rate, then the Fed’s current 2% inflation target is not high enough: the Fed is on a course to fail and thereby reduce its subsequent credibility.)

Economic pessimists gain cachet. NYT.
Not a lot of meat on this bond, but a few snippets:
Albert Edwards of SocGen forecasts a "bloody, deep recession", stocks down at least 60%, then money printing leading to very high inflation; Edwards says that even he gets depressed reading stuff from Bob Janjuah, soon to be at Nomura after leaving RBoS; Raoul Pal is betting that "the United States economy is not just about to enter a double-dip recession but that it will be far worse than anything experienced in the lifetime of anyone younger than 70."

For more meat, at least from Edwards, see:
Albert Edwards Explains How The Leading Indicator Is Already Back Into Recession Territory And Why The Japan "Ice Age" Is Coming. ZeroHedge.

T2 Partners Monthly Letter. Whitney Tilson.

In general, we believe that in the aftermath of the bursting of the biggest asset bubble in history, we are in uncharted waters and there is a very wide range of possible outcomes over the next 2-7 years. Broadly speaking, they fall into three scenarios:

1) A V-shaped economic recovery with strong GDP growth (3-5%), a falling unemployment rate, and reduced government deficits. Under this scenario, the stock market would likely compound at 7-10%.

2) A “muddle-through” economy with weak GDP growth (1-2%), unemployment remaining high (7-9%), and continued government deficits. Under this scenario, the stock market would likely compound at 2-5%.

3) A double- (and triple-, and quadruple-) dip recession where periods of growth are followed by periods of contraction, with no overall GDP growth, unemployment around 10% (with the actual level higher due to people giving up looking for work), and large deficits as the government tries to stimulate the economy (but with little impact). Under this scenario, which looks like what Japan has gone through for more than two decades, the stock market would be flat to down.

Both as investors and as Americans, we’re of course hoping for 1), but fear that this is the least likely of these scenarios. A few months ago, we would have guessed (and it’s no more than an educated guess) that the odds were 25%, 50% and 25%, respectively, but in light of recent weak economic indicators, the odds have shifted unfavorably. Hence, we are positioning our portfolio more conservatively

a couple of points: he doesn't give revised probabilities, other than to say (1) is now least likely; well, duh; question is, what's more likely? 2 or 3? I believe 3; and the odds I'd give are 65-35. But I do not buy his version of 3. In the 3 I envision, the stock market would have no chance of just being flat.

Four defamations of the apocalypse. David Stockman (was a director of the OMB under Reagan), NYT.

QE take II: uncharted territory. Mish.

The Known
1. Structural problems (tide of debt, demographics, etc) are numerous.
2. Stocks are not cheap if you factor in quality of earnings, dividends, historical PEs, etc. Stocks only "appear" cheap if you believe forward earnings estimates in the face of those structural problems.
3. Buying stocks in the face of such structural issues, at a time when they are not cheap is highly likely to yield poor results.
4. It is difficult if not impossible to time the effect (if any) of quantitative easing. In fact, we may have already seen it in advance.
5. Gold is in a long-term bull market with its monthly trendlines intact. Other than treasuries, not much if anything else is.

Stoneleigh takes on John Williams: deflation it is. Automatic Earth.
very good summary of the deflation argument, one I concur with wholeheartedly

China visit: economic report. Simon Hunt, via Credit Writedowns.

In all likelihood, China has entered the most critical and taxing period since the country was reopened to the outside world in the 1970s. Domestically, there are a slew of issues, any one of which could create instability. These issues include:

Home affordability
Leadership instability
A potential if not actual housing bubble
The rising income and wealth differential between those who have made it and those who have not
The country’s continued dependence on exports as its principal driver of growth
Cheap credit, which punishes savings and encourages investment/speculation
The misallocation of capital that springs from the previous factor
Local/provincial government indebtedness
A new assertiveness and arrogance at all levels
Policy making that focuses on short-termism without addressing structural and longer-term issues, etc.
Impact of rising wages
Energy intensity
Role of foreign companies
Resource dependability – water, raw materials, etc.

The list could go on, but these issues are evolving at a time when the global environment is fraught with difficulties and uncertainty, making policy making within China that much more complex.

The mother of all bubbles. Bud Conrad, Casey Research.

Fear empty flats in China's property bubble. Andy Xie, Caixin Online.

on the other hand, Clay Fisher takes exception to some of Xie's assumptions in:
Behind Andy Xie's China Housing Numbers.


I havent't done a BP link in a while, because BP's coverup policy has been successfully fooling the mainstream media recently, but in case you thought all was well now, read this:

BP's Insidious Coverup and Propaganda Campaign: Out of Sight, Out of Mind. Dahr Jamail, Global Research.ca

In late April, after the Deepwater Horizon rig exploded and sank into the depths and the Macondo well began gushing oil, BP and the complicit Coast Guard announced no oil was being released. The Gulf Restoration Network flew out to the scene and saw massive amounts of oil and sounded the alarm, which forced BP and the US government to admit there was, indeed, oil. Such has the trend of BP/US Government lying, countered by (sometimes) forced accountability, then to more lying, been set.

Thus has the BP spill been handled in a P.R. sense no different than the Soviets handled Chernobyl.

When the disaster at Chernobyl occurred, it was only after radiation levels triggered alarms at the Forsmark Nuclear Power Plant in Sweden that the Soviet Union admitted an accident had even occurred. Even then, government authorities immediately began to attempt to conceal the scale of the disaster. Sound familiar?

for instance, carcasses of whales and other sea creatures are being sent to secret locations for disposal:

the numbers of birds, fish, turtles, and mammals killed by the use of Corexit will never be known as the evidence strongly suggests that BP worked with the Coast Guard, the Department of Homeland Security, the FAA, private security contractors, and local law enforcement, all of which cooperated to conceal the operations disposing of the animals from the media and the public

also, though BP claims/insists that it is doing all it can to clean up the oil; problem is, cleaning the mess is a lot harder and more expensive than hiding it, so when they do hear of oil slicks, rather than sending in the clean-up operations "BP is using night flights to drop dispersant on oiled bays"

much more at Washington's Blog

also at Mother Jones, in The BP Cover-Up. Julia Whitty.

Deepwater Horizon is different from any other spill in human history. The extreme technology used to drill at unprecedented depths lacks the extreme safety equipment and protocols needed to stave off disaster. BP, gambling at the border of controllable engineering, has lost spectacularly in its bid to be the deepest and cheapest driller of them all....

BP and its partners have transformed themselves into modern-day pirates, operating beyond law or conscience. Their reckless quest has endangered and perhaps condemned not just the Gulf Coast, but the largest, richest, most pristine, most biologically important, and last completely unprotected ecosystem left on Earth: the deep ocean.... The relatively small amounts of oil washing ashore, and the relief felt when the surface oil began to dissipate, hardly account for the devastation being wrought in the dark world beyond our sight.

Sadly, one of the other most vocal truth-telling critics of BP, Matt Simmons, passed away recently.


and here's a more positive energy-related one:
It can be done, and quickly. Sudden Debt.


other fare:
Why socialism? Albert Einstein.
interesting how something written so long ago can strike such a chord today

August 9

Flexible Forecasting: Looking for the Next Economic Model. Bill Watkins, newgeography.

The world changed in September 2008. We call it a regime shift. It's a move from one (good) equilibrium to another (bad) equilibrium. Statistical models that worked well in the old regime don’t work in the new regime...

Some economists didn’t recognize the regime shift. They went about their business using the same old models in a new world. Comments about the length of a typical recession or about how sharp declines are followed by rapid recoveries were clear signals that the speaker didn’t understand the situation.

Some economists were fooled by the stimulus. The rules of accounting cause government spending to be reflected as an increase in economic activity. Stimulus plans such as Cash for Clunkers and tax credits for home purchases moved the timing of transactions, artificially reinforcing the direct spending impacts. Similarly, bailouts and foreclosure prevention programs postponed the recognition of losses.

Many interpreted the resulting increase in last winter’s reported activity as permanent, but that could not be. We were not building anything or laying the groundwork for sustained prosperity. Instead, we were just continuing the previous decade’s consumption binge. The banks had failed, but the government had stepped in. It became the mother of all banks, borrowing from future citizens and other countries to fuel today’s consumption.

I happen to think the world changed earlier than September 2008: perhaps the summer of 2007, when the music stopped playing and the credit crunch began; perhaps earlier, when U.S. housing prices began declining; in any case, it certainly pre-dated LEH.

I'd also say that rather than "some economists didn't recognize the regime shift" it would be more accurate to say: the vast majority did not --- in fact, most still do not.

To follow up on Watkins' point that:

"The stimulus’s omissions are glaring. We didn’t significantly invest in infrastructure that would improve our future growth. We failed to address the weaknesses in our education sector that fuel increasing inequality, sentence many to a life of hopelessness, and permanently constrain our economic growth. We did nothing to encourage small business’s growth"

Paul Krugman, in America goes dark (NYT), says that not only was the opportunity lost to use fiscal stimulus to improve infrastructure and education, but the country is now moving backwards on those fronts:

And what about the economy’s future? Everything we know about economic growth says that a well-educated population and high-quality infrastructure are crucial. Emerging nations are making huge efforts to upgrade their roads, their ports and their schools. Yet in America we’re going backward.

Waiting for nothing? Tim Duy, Fed Watch.

Word on the street is that Fed staff are increasingly frustrated with the lack of action from leadership. Why exactly is Bernanke showing such deference to the more hawkish elements such as Kansas City Federal Reserve President Thomas Hoenig, Dallas Federal Reserve President Richard Fischer, and Philadelphia Fed President Charles Plosser? If you seek more easing, you are not alone. Board staff are increasingly your allies.