Economy & Market Week Ended 11/5/2010

Samuel Brittan had an excellent updated (original in May) article on "The futile attempt to save the eurozone" this week which I did not use in my post "On the Road out of Ireland" on the bubbling credit/liquidity crisis brewing in Ireland.  Using a private, subscriber available only paper published by Capital Economics and written by Christopher Smallwood, Brittan cites Germany's insistence on impossibly severe fiscal policies as reason to wonder if Germany wants the euro to continue and the fiscal tightening of Greece as an example of how to "... dampen the economy and risk creating a vicious cycle of debt and deflation."  Yet, Germany has been the prime beneficiary of the European Monetary Union's creation of exchange rate  and current account trade imbalances.

All of this has Brittan asking if the eurozone member nations might be better off with their own currencies.  While I do not believe it is necessary to abandon the euro, I find the refusal of eurozone member nations to recognize the need for monetary support of individual member nation's internal fiscal policy needs as essentially self-destructive and not salvageable by nominal adjustments alone.  Brittan is not anti-European but Ireland is on the brink of a credit/liquidity crisis.

This weekly report has become increasingly late to publication as I have been repeatedly diverted to the problem in Ireland and writing three posts this week on the subject. 


United States unemployment for October remained unchanged at 9.6% with employment up 151,000 job with a substantial decline in government layoffs/terminations.  This 151,000 job increase just barely keeps up with population growth and at this anemic rate of growth it would take until about 2030 or later to return to ful employment.  The labor participation rate was down to 64.5% from 64.7%.  The employment to population ratio was down to 58.3% from 58.5%.  Involuntary part-time workers were down 318,000 to 9.2 million.  Those unemployed more than 26 weeks  rose to 6,206,000 from 6,123,000 who "still want a job".  The U6 discouraged workers was down to 17.0% from 17.1%, but, if one used the 1994 calculation for discouraged workers, it would be closer to approximately 22%.

Retail sales were mixed, although the media emphasized growth, with soft weather related sales and significant discounting.  There is every appearance that the beginning of the Christmas shopping season is being pushed up from its traditional Friday after Thanksgiving and discounting will be a prime marketing approach.

The U.S. election brought to the forefront the failure of President Obama to clearly, consistently, and forcefully enunciate a domestic policy which focuses on reducing high unemployment.  His post election day news conference showed him at his worst as he rambled and prolonged his answers to questions, because he lacked a central focused message.  His attempts to achieve consensus at the expense of what needs to be done combined with his willingness to accept poor economic advice from discreditable economic advisers, such as Summers, who is leaving, and Geithner, has only sharpened the impression he cares more for the financial elite and little for the hardships and the imposed economic burdens of the financial bailout of the disappearing American middle class.  Austerity will not create jobs and it will dampen the economy even more with further concentration of wealth in the top 1%.  We need productive fiscal programs not pandering to delusional or self-serving politicians spewing misguided and destructive economic propaganda

The toll of unemployment continues with a job gap of 11.8 million jobs down just slightly from September at 11.9 million.  At the best average monthly rate (208,000) of job growth in the 2000's, it would take 12 years
to eliminate the job gap; at the average monthly rate (321,000) from the 1990's, it would take 5 years.  As wages decline, deflation is reinforced.  At the same time, the ratio of household debt to GDP has risen to 95% and the ratio of household liabilities to disposable personal income has risen to 135% which is creating a nation of zombie households.

Mark Thoma posted on a George Evans' paper on economic stagnation in a low interest rate environment in which the proper economic solutions are a sufficiently aggressive fiscal policy (targeted spending) of which fiscal aid to state and local governments has proven to provide quicker economic improvement and tax cuts have proven themselves ineffective unless targeted at liquidity constrained households.  Since these fiscal policies may be politically "undesirable", the Fed would maintain low interest rates in an attempt to increase consumption and start purchasing longer term government bonds, although such monetary policy may not work as it builds negative expectations.  Such approaches all have limitations in achieving timely economic impact.  While not discouraging states from balancing their budgets, the use of federal fiscal spending on productive infrastructure capital projects, which are not constrained by a balanced state budget, on the state and local level may provide a more robust approach to reviving aggregate demand future output growth.  As I have mentioned on several past occasions, China has implemented such a program in the last two years, although some of their projects, such as an empty mega mall and an entirely empty city, have been apparently wasteful.

Krugman demonstrated his position that a higher targeted inflation rate of 4% might possibly resolve unemployment and create an exit from a liquidity trap.  Since thresh holds exist in which too low or too high a rate would not be productive, the amount of inflation needs to be modeled with the level of unemployment to properly achieve full employment without credibility or inflationary problems.

The Fed announced a second quantitative easing (QE2) in which they will buy 600 billion dollars of longer tern U.S. Treasuries at a pace of $75 billion per month.  Some people saw this as slightly higher than expected although others had expected at least a trillion.  The purchases will be in the 2.5 to 10 year range.  This QE2 has already been priced into the market and now the market is speculating that a third will be needed.  This is a switch from the Fed's normal practice of buying short term bonds and reinforces its current inflation target.  There are those market analysts who believe QE2 will do nothing for the economy and, in more extreme views, may cause inflation and the destruction of the currency.  Confirming Krugman's view it reinforces the current inflation target, Bernanke asserted that QE2 will not spark unwanted inflation.  The St. Louis Fed, whose president, James Bullard, believes continued low interest rates are potentially deflationary, has published a small article on the benefits and costs of low interest rates. Yves Smith has characterized Bernanke as disengaged from reality and QE2 is nothing more than deceptive window dressing and goes on to cite El-Erian of Pimco, who says QE2 has risky adverse consequences and does nothing to resolve the need for meaningful structural reforms.  QE2 risks stoking inflation in emerging countries and putting pressure on their currencies and creating disruptive capital inflows.  In fact, emerging countries and countries preparing to attend the G20 meeting in South Korea have denounced the QE2 as a threat requiring protective responses.  On Friday, Hoenig, Kansas City Fed President, renewed his call for higher interest rates now to avoid higher future inflation from pumping liquidity into the market.

Meanwhile, the Fed continues to be viewed as raining money on financial corporations, doing nothing about unemployment, and continuing a policy which is promoting slow growth squeezing out savers and destroying retirees as middle America is left exposed and vulnerable to flap in the wind. Now, the banks have made it clear they intend to defeat the Volcker Rule inhibiting systemically risky and dangerous business activity by using the rule making process to blunt and neuter that portion of the Dodd-Frank Reform.  In the meantime, the mortgage foreclosure fraud participants continue to blow a smoke screen as they steam away from any factual discussions of the fraudulent documents, fraudulent submissions to the courts, and fraudulent process of the mortgage business and foreclosure process.  Flaws in some $50 billion of Citigroup moves of mortgages to mortgage-backed securities show it to be vulnerable to lawsuits and put-backs.  J. P. Morgan has received requests for files on $8.1 billion in mortgage loans which may be candidates for buybacks.  Six large U.S. banks are estimated to have additional exposure to $31 billion in buybacks over the already recognized $12.4 billion in losses.

Nobel Prize winning economist George Akerlof has argued that prosecution of criminal fraud is necessary for the economy to have a sustained recovery and Joseph Stiglitz agreed that a failure to enforce a equitable judicial code would result in indentured servitude.  Stiglitz is adamant in "Justice for Some" that the "rule of law" is under substantial attack in the mortgage mess with a denial of property rights, a bankruptcy process that takes rather than repairs, and a legal process that is turning justice for all into justice for those who can afford it.  As laws on campaign financing by corporations and non-profit lobbying groups, which do not have to disclose funding sources, we have seen the U. S. Chamber of Commerce become the lobbyist and conduit of campaign contributions from the international financial elite.  If you have money, you have power, while always true, is inconsistent with a free republican democracy.

The FDIC has sued executives of a failed Illinois bank to recover as much as $2 billion in losses, because they issued $11.8 million in dividends and incentive payments while masking problems in commercial real estate loans with new loans for $8.5 million of losses failing to preserve capital and provide sufficient reserves.

The attack on consumer friendly regulation in the securities and financial services business is hitting high gear with SIFMA arguing that commission based accounts are more cost effective and the "flawed" fiduciary standard would cost investors money.  These arguments all assume lumping financial salespeople with fiduciary advisers just as they are now and the objection is against disclosure and actual legal fiduciary responsibility.  Others are all upset that FINRA is contemplating an ADV like form requiring disclosure to clients from brokers of conflicts of interest and limitations of duty to the client; all of which is seen as overkill in providing information by the salespeople.  The ICI dislikes the SEC proposal to limit 12(b)1 fees, which requires a distinction between a continuing sales charge and a "marketing and service fee" and which the provider would have the choice of constructing within limits, as potentially increasing cost to the consumer.

John Hussman, in his weekly commentary on Monday the 1st, said "... greater risk does not imply greater reward if the risks investors take are overvalued and inefficient ones."  Using his forward operating earnings methodology, the ten projected return on the S&P 500 is 4.69% annually.  With the S&P 500 dividend yield at 1.96%, the ten year projection on a dividend based model would be only 2.30% annually.  On quantitative easing, Hussman believe the original QE had little effect on real GDP or inflation and what kicked the can down the road was not the QE but the guarantee of Fannie and Freddie debts and the suppression of fair and accurate financial disclosure via the FASB suspension of mark-to-market rules.  He still believes the market is overvalued, overbought, and over-bullish with a shift to neutral on not yet rising yield pressures.  He believes we have not yet cleared the recent months of economic concerns, but the economic data has been better than expected but still mixed enough to not be decisive.  The recent GDP report with 2% growth had 70% of that growth represented by inventory growth with final sales at only .6% annual gain.  The ECRI Weekly Leading Index improved to <6.5> from <11.0> in July but the same index improved from <10.8> in March 2008 to <5.9> in May 2008.  Short term activity has been reasonably quiet and modestly positive, but it is taking place over a more fragile economic structure than observers appreciate.

Market Report: 4 banks failed = 143; unofficial problem bank list = 894

                    DOW/Volume                                              NASDAQ/Volume
Mon           6.13/ down 7.3%                                            <2.57>/ down 9.9%
Tue           64.10/ down 4.8%                                           28.68/ down .1%
Wed         26.41/ up 20.6%                                                6.75/ up 4.0%
Thu          219.71/ up 23.3%                                             37.07/ up 25.5%
Fri               9.24/ down 8.6%                                            1.64/ down 15.5%

TOTAL    325.59                                                             71.57

Mon: Oil up $1.52 to $82.95; Dollar stronger but mixed against the pound; volatile price day ending flat; mixed economic reports.

Tue: Oil up 95 cents to 83.90; Dollar stronger but mixed against the euro; low volume on market hopes on election and Fed QE; Nasdaq flirted with April high again.

Wed: Oil up 79 cents to 84.69; Dollar weaker but mixed against the yen; new 2010 high for Nasdaq - best since June 2008; oil supplies were up 1.9 million barrels, gas was down 2.7 million barrels, and distillate was down 3.6 million barrels; oil was affected in part by French refinery strikes and Canadian Irving St. John  refinery maintenance.

Thu: Oil up 1.80 to 86.69; Dollar weaker; world wide stock rally on QE2 but gold and bond prices went up on inflation fears; weekly jobless claims were up 20,000 to 457,000, 4 week moving average was up 2000 to 456,000, and continuing claims were down 42,000 to 4.340,000.

Fri: Oil up 36 cents to 86.85; Dollar stronger; market turned positive at end and gold ended at $1397.40.

United States:

ECRI Weekly Leading Index was unchanged at <6.5>.

U.S. consumer spending was up .2% September (.5% in August); core PCE for 12 months was up 1.2% (lowest since September 2001); core inflation September was flat (.1 August); personal income was down .1% and disposable income was down .2%

ISM manufacturing activity was up to 56.9 October from 54.4; new orders were up to 58.9 from 51.1.

AMBAC indicated it will not pay interest on bonds as it was unable to raise capital as an alternative to Chapter 11 bankruptcy.


Pfizer Q3 missed revenue expectations by $500 million on weaker overseas sales and generic competition.

1.47 million Americans have been out of work 99 weeks or longer as of September.

Fannie Mae posted $4.1 billion Q3 loss and will be asking for $100 million more aid.

ADP private employer survey for October was up 43,000 jobs.

U.S. manufacturing new orders were up 2.1% September; ex-transportation they were up .4%; non-defense capital goods orders were down .2% (up 5.1% August).

ISM service sector was up to 54.3 from 53.2.

GM sales were up 3.5% October.

Fed plans to spend $600 billion in QE2 by the middle of next year at $75 billion per month on longer term U.S. Treasury purchases.

SEC banned brokers from allowing clients access to direct exchange trading with broker access codes without pre-trade risk controls.

In GM's IPO (seeking $13 billion), U.S. will reduce its 61% stake to 41-43% by selling at least $365 million in shares at $26-29.  Why not wait to sell?

Ford sales were up 19% October; GM sales were up 13%; Chrysler sales were up 37%; Toyota sales were down 4%.

U.S. productivity Q3 was up 1.9% (it was down 1.8% Q2); labor costs were down .1%.

Bernanke said QE low interest rates will not stoke inflation.

President Obama backtracked and indicated he may consider extension of Bush tax cuts for all income levels.

Fed may release guidelines allowing "well capitalized" banks to raise dividends.


AIG Q3 loss is $2.4 billion on asset sale losses and mixed insurance business results; operating income was up 47% to $1.07 billion.

Bank lobbyists hope to blunt the Volcker Rule during the implementation process; Representative Bacchus has warned Secretary Geithner to be careful and not be rigid.

In response to investor claims, including the New York Federal Reserve, that Bank of America should buy back mortgages improperly made, Bank of America said the lawsuit would speed up the foreclosure process and force it to evict homeowners and the losses on the mortgages sold were the result of the economic downturn and not from any underlying problem with how the mortgages were sold to investors.

Pending home sales index was down 1.8% September.

Sear will be open on Thanksgiving Day for the first time in 85 years.

Consumer credit was up $2.1 billion September in the first gain since January; August was revised down to <$4.9villion>; revolving credit (credit cards) was down $8.3 billion in the 25th straight month drop.

Berkshire Hathaway operating profit was up 28% to $1692 per share but net profit was down 8% to $2.99 billion with losses on derivatives (derivatives portfolio is about $60 billion).

REO (real estate owned) inventory for Fannie, Freddie, and FHA through Q3 is up 24% from Q2 and up 92% vs year ago.

International:

ECB has refused to release files on how the prior Greek government used derivatives to hide debt.

The Bank of Japan held interest rates at .1% and held off on further monetary policy easing, although it said it intended to buy index linked ETFs, AA or higher rated REITs, and government bonds.

The Reserve Bank of Australia raised its interest rate 25 bps to 4.75% in what some economists thought unnecessary. The Australian dollar shot up in response.  Controversy stormed up when the Commonwealth Bank of Australia, the country's largest home lender, raised its variable mortgage rate 45 bps to 7.81% in the face of profits indicating costs had risen 15%.  Analysts subsequently pointed out that nearly 50% of homeowners are suffering mortgage stress deep in the mortgage belt, but the act has cause a political firestorm. 

China PMI (Purchasing Managers Index) was up to 54.7 October from 53.8, which was more than expected, to a six month high; total new orders were up to 58.2 from 56.3; export new orders were down to 52.6 from 52.8.

China ordered banks to charge more interest to first time home buyers by halving the interest rate discount from 30% to 15%.

South Korea exports were up 29.9% October vs year ago; imports were up 22.4%; CPI was 4.1%, which is a 20 month high.


Distressed loans in Spanish banking system reached 102.5 billion euro in August at 5.6% of all loans, which is the highest proportion since 1996.  Some banks, including BBVA, are selling branches and then leasing them back in order to book short term gain and conceal mortgage losses.

Spanish unemployment statistics, in the complete survey, show unemployment did not drop to 19.79% by the end of September but rose to 20.8% from 20.5%.

India's Central Bank raised its interest rate for the 6th time --- repurchase rate to 6.25% and reverse repurchase rate to 5.25% --- in order to slow inflation and protect purchasing power of the poor.

BP profit was down 67% to $1.79 billion Q3 but Q2 had been <$17.2 billion>.

China's five year plan may create large changes, but a Central Bank governor said progress towards current account convertability and global yuan will be gradual.

French and Spanish car sales were down in October with the end of economic incentives.

Markit eurozone PMI was up to 54.6 October from 53.7 with Germany, France, and Italy up, Spain and Ireland struggling, and Greece declining.

German Economic Minister, Bruederle, expressed concern U.S. is trying to stimulate by injecting liquidity and using monetary policy to influence the dollar's exchange rate.

Asian and European markets liked the Fed QE move; both saw it as a willingness to support economic recovery.  How long will that view last?

China is considering setting up reserve of 10 metals, including rare earth; China has 95% of the global market in rare earths.

Canada block BHP's bid for Potash Corp as not in the national interest.

Portugal broke political gridlock and voted an austerity budget to reduce the deficit at 7.3% of GDP to 4.6% next year.

China auto sales were down in September to 1.27 million units but up 27% vs year ago.

Toyota Q2 profit more than quadrupled to $1.2 billion but missed views; sales were up 6%, but it revised down its annual forecast to $4.3 billion on lower U.S. sales.

CDS (credit default swaps) for Ireland, Greece, and Portugal were at their highest levels at the end of the week since September 2009; Spanish CDS were also up.



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Germany's Irish Hair Shirt

The bond market fears on Ireland's guarantees of the liabilities of three Irish banks, of which the Bank of Ireland has already essentially recapitalized with only 36% government ownership, and the nationalization of  two smaller mortgage financing  banks has spread to the stock markets as Irish bank stocks sold off yesterday.

The Wall Street Journal had a good article, which was profiled by Felix Salmon, on the development of the current concerns and how the banks loans collateralization and value had been under reported and underestimated.  A blog post by one of the article's writer makes some additional observations and then veers off into lesser, minor issues with respect to mortgages, lending practices for mortgages, property leverage, and the Irish tax code as if they were major players in the current credit/liquidity crisis.  Felix Salmon also concludes that Ireland's guarantee of the liabilities was a mistake as we have written and maintained for months.  However, this is a credit/liquidity crisis and not a banking crisis which has shifted from the banks to the government of Ireland.

Of far more interest is why Ireland made the decision, or was encouraged to make the decision, to guarantee the liabilities of the banks and protect the senior bondholders as well as the depositors.  As we have written, this decision is the very core and crux of the current credit/liquidity crisis and brings into the spotlight the necessity of the European Monetary Union and the ECB to take a proactive and consistent supportive position despite the counterproductive position of Germany which wants sovereign bondholders to share in the burden of any eurozone nation bailout by the ESFS, which has yet to be activated, with a proposal which would require a treaty change.  Merkel's statements have not only created a bond market reaction, as Merkel's statements on this subject have done in the past, but Germany refuses to back away from a concept that has a legitimate point but is being put forward at a time when it cannot be considered and effectively decided and implemented in any timely fashion while significantly aggravating the current situation.  Germany's position is particularly perplexing as we have shown in "On the Road Out of Ireland" that the BIS statistics (p. 6) show German banks have the largest exposure to Irish private debt and, consequently, should be receiving the largest protection from the Irish government's guarantees on the private Irish banks' senior bonds.  Apparently, Merkel finds the unusual protection of risky private investments by German banks acceptable but finds that German bank risk assumed by sovereign debt guarantees of a nation which is not Germany unappealing.

EU leaders have sought to reassure the bond markets that sovereign bondholders would not be affected and issued a statement from the G20 meeting that the ESFS activation does not require private sector involvement.  A proposal from Breugel as commented on by the blog The Irish Economy would create a mechanism for the resolution of a sovereign debt crisis.

EuroIntelligence has been adamant in its reporting and opinion that Ireland is going down and on the verge of seeking a bailout from the ESFS.  To me this seems premature.  If the ECB and EMU do not publicly demonstrate support for Ireland, and the ECB tends to be too secretative about its support efforts, then I would expect the IMF to publicly support Ireland and force the hands of the EMU and ECB, particularly as this has had direct negative effects on the bond and swaps cost of Portugal, Spain, Greece, and Italy.

The relevant articles on Ireland and this issue have become voluminous.  Here are some for your review without additional comment:

Investor concerns hits banks
Central Bank of Ireland Governor Honohan comments
2000 billion euro contagion
Ireland on brink as beggar for aid
Irish borrowing costs hit high
Honohan wants foreign buyers for banks
Bank of Ireland profit down
repo margin increased
Irish investors head for exits
income tax rates to rise
EU commissioner sees light at end of tunnel
no confidence 3% deficit target will be reached
corporate tax revenue
make European defaults not bailouts
revised Irish risk parameters
eurozone bond records
sovereign debt doubts grow
Berlin cast doubt and spreads contagion (Spanish)
Europe ready to split in two or recover (Spanish)
wait until mortgage defaults hit home
ECB bond purchasing
bond buyers strike
Irish debt revives concern about Europe
costs rise on financing fears
sovereign risk and budget woes


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Banking Crisis vs. Currency Crisis

It is very common for commentators, even economists, to improperly characterize a credit/liquidity crisis as a banking crisis, when a banking crisis is defined by a withdrawal of demand deposits and a credit/liquidity crisis is characterized by a withdrawal of foreign investment, lending, and deposits.  When the perception grows that the sovereign government will not undertake the necessary monetary and fiscal policy actions necessary to counteract and stabilize a credit/liquidity crisis, then, as foreign doubts increase, the risk of a currency crisis grows with the failure of the sovereign government to solve the fiscal and monetary problems behind a credit/liquidity crisis, even if it has been caused by the business activity of systemically dangerous financial institutions of whatever size.

In the case of Ireland, and any other eurozone country, it has no control over monetary policy and is reliant upon the European Monetary Union, the ECB, and the EU to provide monetary policy and backup.  Consequently, as overnight bank funding dries up and bond costs continue to escalate, the European Monetary Union and the ECB are faced with a potential currency crisis, which is a lack of faith the EMU will stand behind its member nations, which would cause a serious, roiling global credit/liquidity crisis.

The ECB, the EMU, and the European Union need to get their act together and act decisively and consistently without the counterproductive interference of member nations promoting their more immediate self-serving political and economic agendas.

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On the Road Out of Ireland

Ireland has been celebrated as the European Union poster child for eurozone austerity.  Yet, its efforts have received little respect from the bond market, which has become increasingly aware that austerity will not make Ireland again prosperous.  In attempting to be the good European Union partner, Ireland created a "bad" bad bank which gave government guarantees to all liabilities of three private banks which had engaged in risky investment policies and poor management.  In doing so, the government bailed out incompetent management and bondholders at the expense of the Irish people.  Rather than providing equity for toxic assets, the Irish government issued government bonds for the toxic debt of three Irish banks of which Anglo Irish, whose senior debt has become a serious international problem, had to be nationalized. While junior bondholders have had to accept subsequent haircuts and the three banks significant reductions in assets as toxic assets were stripped out, the depositors and senior bondholders have been untouched.  Questions on the guaranteed status of the senior bondholders has had detrimental effects on Ireland's ability to obtain and pay for credit as the position does not appear in the best interests of the Irish people while the bond market fears a haircut to senior bond holdings despite guarantees, because the austerity budget is viewed as too ambitious.  Some observers have even questioned whether it would be in the best interest of Ireland to default on these senior bonds as Iceland refused to accept responsibility for private bank debt and just as the Irish Free State, under de Valera, refused to pay the land annuities (an annual payment of 250,000 pounds for Britain's loans to finance land reform) to Britain in 1933, which led to the Anglo-Irish Trade War in which Ireland did not fare well.  In fact, these guarantees of Irish private bank debt have come to amount to 32% of Ireland's GDP.

The people of Ireland have endured centuries of oppression and economic servitude and a tumultuous transition to Irish Free State in 1922, Ireland in 1937, and Republic in 1949 with a bitter refusal to remain in the Commonwealth.  After a long period of poverty and out bound emigration, the 1990's saw the beginning of economic growth built on exports which lasted until the 2008 financial crisis.  Now, the Irish people face being prisoners of debt and indentured servants to the banks of the eurozone, who are the senior bondholders, almost 100 banks including Goldman Sachs, being protected by the Irish government.

Ireland is not Iceland, which has its own fiat currency, and it has sought to appease the European Union upon which it is dependent for monetary policy and economic support.  As NAMA, the Irish agency responsible for sorting the private bank mess out, has dug into the assets and finances, it has issued haircuts up to 47% on assets stripped from the banks and proposed 80% haircuts to junior bondholders, which has led the bond market to fear similar threats to subordinated debt in other eurozone countries.  While bondholders are the source of funds which keep banks functioning, the investment is one of acknowledged risk in a private bank.  It is even feared that an Anglo senior bond default/haircut would bring Ireland down.  To give bondholders immunity from losses is recognized by many as removing the assessment of risk from the investment process and increasing systemic risk.   Switzerland has required its large banks to issue contingent convertible bonds which can be used to write-off losses in cases of non-viability.

It is being argued that revenue will not be sufficient for deficit reduction and has increased concern that bond investors must not be discouraged and market perception is more important than fiscal or monetary policy.  Debt costs have jumped for Ireland and Portugal, Greece, Spain, and Italy.  European Union support has become all the more important if Ireland is to succeed.


Yet, this current chapter in the Pan-European Credit Crisis has been spawned by European Union leaders in the midst of debate on the ESFS, due to expire in 2013,  bailout continuation and political upheaval in the eurozone as Germany has pushed a proposal for orderly insolvency and debt restructuring, which has rattled the bond markets.  The Franco-German proposal would require a treaty change and a permanent debt resolution system with sanctions, but it has largely gained acceptance by the EU.  When Germany threatened to veto any financial crisis resolution authority unless a treaty change was approved, it painted the eurozone into a corner surrounded by bond vigilantes.  In an attempt at deficit economic ideological purity, Germany threw the peripheral eurozone countries to their fate while demanding that bond holders share the burden, which spread fear in the bond market and directly threatened German banks which have a significant exposure to private Irish debt.

Bond and swap prices escalated, despite proposed budget cuts  with a sense of impending doom settling in as to whether Ireland, as well as Greece, Portugal, and Spain, can execute their austerity budgets.  Even sovereign default swaps surged.  As credit costs ramped up, bond investors dumped bonds and the perception of risk spread.  Perhaps at the urging of one wealthy Russian bondholder, the Russian sovereign wealth fund took Ireland and Spain off their eligible investment list and a European clearing house warned that members might have to deposit more cash to trade in Irish bonds.  All of this has aggravated the bond market perception that the peripheral countries cannot control their European Union imposed austerity budgets.

In fact, Ireland's budgeting, as well as Spain's budget and economic forecasts, have been increasingly questioned as scary as Ireland has taken a three month holiday from bond auctions to avoid the current spreads as it has enough money to last into Q2 of 2011 and as it seeks European Union agreement and assistance with its 6 billion euro proposed budget cuts.  All of this has left the Irish wondering, if they knew all along that the budget cuts would be contractionary, what do the bond markets want?  Unfortunately, Ireland does not have its own currency and, therefore, is more at risk to market perception which may not always be in the best economic interests of a sovereign country.  Despite projections, Ireland cannot depend on substantial export growth in its budget.  As long as Germany and France pursue an irresponsible ideological exercise which threatens other eurozone countries, if not the monetary union, then the efforts of Ireland and the other peripheral countries risk nullification.

While the U.S. Federal Reserve plan to buy more Treasuries helped revive the bond market for Spain, Portugal, Greece, and Italy, the ensuing weaker dollar will not help the euro and its effect on bond prices.  While the ECB has stepped in and bought bonds from time to time to stabilize markets from time to time, it has not been easy to determine when and exactly how much and some reports have been mistaken.  Since Ireland was encouraged to protect senior bondholders, which includes eurozone banks which have a large exposure to Irish private debt as shown in the BIS September Quarterly report on international banking (page 6) with Germany followed by great Britain leading the way as of Q1 2010 with other European areas close behind and then France, it would be in the best interests of the European Union, eurozone, and the ECB to assist and support Ireland.  A failure to support Ireland or hesitation to act will endanger the very European banks Ireland got suckered, as a eurozone team player, into protecting.

The European Union needs to get beyond the ESFS temporary bailout to a permanent financial crisis resolution which does not acknowledge too big to fail banks and holds investors accountable for a share of the burden of restructuring systemically risky financial institutions rather than foisting the losses off onto government and the citizenry.  As long as the European Union and the eurozone members refuse to learn the lessons of deficit reduction in a monetary union in which the sovereign countries have no monetary control to combine with fiscal policy and member nations continue to engage in "smokestack chasing" as Germany is doing with its treaty change proposals which directly undermine other eurozone countries, if not the monetary union itself, the welfare of the monetary union as a whole and each of its members, including Germany, are endangered from within.

Given Ireland's continued attempts to please the ECB and the European Union, it may find, given its budget cuts already, the IMF a more practical partner in economic recovery, which does not say much about the ability of the ECB to act and of the European Monetary Union to assist members in order to strengthen the economy of the monetary union as a whole.  The Irish government's surrender to the private bank bondholders doomed them to bailout.  In as much as the ECB and European Union may have encouraged and supported that bad economic decision in order to protect other European banks makes it all the more necessary that the ECB and European Union, most especially those countries whose banks are being protected at the expense of the Irish people, support Ireland's unwinding of the three private banks and the Irish debt created by the banks and its investors.  Ireland faces insolvency and its people indentured servitude to the very European banks (with German banks heading the list) given immunity from investment risk, as the Irish people choose which bills to not pay in order to pay mortgages as mortgage losses mount, which will only increase the pressure on banks and the government's liability guarantees.

One has to ask, if Ireland found it unavoidable to offer equity or some other haircut to senior bondholders, would a currency crisis ensue?  Has the ECB and the European Union, with the help of Germany and France, boxed itself in to the point it has no choice but to help Ireland or abolish the monetary union?

The road out of Ireland is submerged.  The people of Ireland may have to do it all by themselves again, if they wish to remain free.


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The Fed, Printing Money, & Reserves

I sometimes find myself disagreeing with economics writers whom I respect, because they have made good arguments in an article and then make an inconsistent statement on debt, bank reserves, or net government savings with statements on debt and net government savings usually lacking stock flow consistency..

Alea wrote a much linked short piece on the Fed does not print money which is factually correct despite some economic textbooks and commonly accepted myth.  The Pragmatic Capitalist, which I find a very useful source of opinion and information, expanded upon the Alea piece by commenting that bank reserves constrained lending, when bank lending is actually constrained by the price of reserves (see answer for question #3) and bank capitalization.  Consequently, the leverage created by banks in lending can be good (stimulates growth) or bad (overheats the economy) just as the failure to lend can be bad (deflates the economy) or good (cools the economy).

When economically incorrect beliefs reach commonly held mythic proportions of an icon, the political debate becomes falsely conceived and subject to hidden agendas as the myths are manipulated to influence and control the citizenry.

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Everything You want to Know About Health Reform (PPACA) Law

As I have remarked in the past, occasionally Maxine Udall has a succinct post that needs no elaboration.

Here is her post presenting the Kaiser Family Foundation video explaining the 1000 page Health Care Reform Law (PPACA).  This is a must see no matter what your opinion of President Obama's health care reform.

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Economy & Market Week Ended 10/29/2010

The Q3 United States GDP was estimated this week at 2.0% of which inventory added 1.44% compared to .82% in Q2.  Without the inventory build up, Q3 would have been barely positive.  Personal consumption was 2.6% (2.2% in Q2).  This shows a slower trend growth and a generally weak (Consumer Metrics Institute October 29 commentary) and long recovery.

The unemployment rate for everyone 55-64 has more than doubled.  I have been maintaining for some time that unemployment for this age group could be a permanent condition.  At the very least it means not working at the same pay at one's full ability level.  This is a huge loss of productive talent which has nothing to do with appropriate skills for the marketplace.  It has to do with age discrimination and filling the positions with younger workers who will cost less and theoretically stay with the job longer.  At the same time the highest unemployment is among the 20-24 year old college educated who will, as a consequence of unemployment at this early stage of their careers, suffer a life long possibility of lower earnings.  This recession has the distinct possibility of creating a very negative social divide magnifying the wage inequality and wealth inequality problems which directly threaten our republican democracy and the sustainability of a market economy as opposed to a feudal corporate economy.  Every 34th wage earner in 2008 went through 2009 not earning a single dollar.   In 2009 dollars total wages have fallen $5.9 trillion.  Average wages and median wages are down and the number of idle workers grew by 6 million in 2009 with real unemployment, including discouraged workers, at 22%.  At the same time, while the number of Americans making $50 million or more fell from 131 in 2008 to 74, the average wage increased from $91.2 million in 2008 to $518.8 million in 2009 or almost $10 million per week.  Those 74 people made as much as the lowest paid 19 million workers who comprise one in every eight workers.

Econbrowser had an interesting piece on demand shocks in trade and how they manifested themselves in different countries with Japan and China showing distinct deviations from the mean, which would indicate there were alternative reasons which were not consistent with Germany and the Untied States.  It makes you wonder where all the increasing exports in the world are expected to go. The line that caught my attention was "The finding that demand shocks working through the composition of trade ... explained the bulk of the drop and recovery in trade suggests the stronger the rebound in GDP, the faster the recovery in trade in proportionate terms."  This is exactly what we are not seeing in the present recession/recovery.  The GDP is not growing fast enough to reduce unemployment and the government is not exercising fiscal policy to reduce unemployment and everyone is surprised that consumers are not spending.  Consumer spending is not going to bring recovery if unemployment remains high.  A weak dollar is not going to sufficiently drive exports when it also appreciates foreign currencies and inflation in other countries.  To lay this problem on the door step of China is disingenuous.  China has internal problems, and perhaps more complicated problems, just as the Untied State, the eurozone, Japan, and Germany have internal economic problems which must be addressed internally.  The failure of these countries and others to not address their economic problems which have a global economic impact only aggravates the tension among those who would rather blame than act.  The G20 and the PR show on currency accords and trade collapsed before the delegate departed the airport.  The failure of the G20 to address and resolve the different trade and capital needs of emerging and developed countries, foreign currency reserves, current trade imbalances, and the vastly different saving and borrowing needs of emerging and developed countries is a failure to acknowledge the differences and the necessity of each country to implement different internal fiscal policies.  It is not a global chess board which can be mended by duck tape.  It is also not resolvable by including emerging nations currencies in a new reserve currency basket.  Emerging nations do not want their currencies to be a reserve currency.  For instance, there is presently no way the Chinese renminbi can be accumulated by foreigners who are not allowed to have renminbi accounts.  It will take China a very long time to reduce its current accounts surplus and develop a deficit.  Given its internal problem of cheap capital which transfers income from households and reduces household consumption, it would be very politically and economically difficult for China to rebalance internally in the short time that a fast appreciating renminbi would demand.  It is more likely that China's capital outflows could be matched by foreign capital inflows in the form of investments, which would require a gross change in the form of ownership and governance in China.  That is an unrealistic expectation, particularly, when the Untied States refuses to deploy the fiscal policy necessary to reduce high unemployment and kick start GDP growth.

Quantitative easing (QE) is designed to lower long term interest rates, but The Pragmatic Capitalist argues that it fails historically to do so and the attempt actually increases asset prices without any underlying change in fundamental value.  QE is merely an asset swap with little real impact on the economy.  In fact, historically the market has collapsed following the end of each of the last three major QE programs.  Models and Agents cites a 2003 Eggertsson and Woodford paper and argues that its conclusion that QE is redundant and the optimal policy should be price level targeting historically based rule will not work, because the rule lacks credibility since its implementation is only a verbal intention and, consequently, only a bluff.  She wants to call a spade a spade and call the purchases "debt monetization", because the only true way, in her opinion, to boost aggregate demand at this stage is to implement a fiscal operation whose goal is to protect productive capacity and assist companies and households in their deleveraging efforts.  In such an operation, the role of the Fed would be to provide the financing.  Econbrowser believes the market has already priced in a trillion dollar QE and that the QE is being justified by the Fed as a means of combating negative real interest rates, which mean people can get a positive real return by stuffing money under a mattress, in disinflationary, deflationary times.  The Fed can help but it cannot solve the zero lower bound problem with QE and one should keep an eye on commodity prices and real rates.  A fiscal stimulus would not only target the creation of jobs now but also assisting the states and local governments who are under revenue pressures and have been reducing employees to the extent that government layoffs and terminations exceed growth in private hiring.  This could be partially accomplished by the Fed and Treasury buying state and local municipal bonds.

In a recent paper on the correlation of bonds and stocks, it found "...the changing risks of nominal bonds are related to the changing relationship between inflation and economic growth."  If the stock-bond correlation implies investors believe government bonds are a hedge against the possibility of deflation and low growth, while at the same time, despite being uncertain about the direction of inflation over the next five years, believing any increase in inflation will likely be accompanied by growth, making it less painful for their portfolios,  then bonds should carry a negative inflation risk premium and higher prices.  The question becomes whether investors are correct.  Another question is the study assumed the CAPM (Capital Asset Pricing Model) use of the stock market as a proxy for the economy, but CAPM also assumes an efficient market which is not substantiated by modern experience and more modern economic/finance models.  Consequently, in my opinion, the determination of a bond bubble could be lagging information and/or a divergence from the mean.  The use of a negative or positive trend based on the assumption of an efficient market is not enough information to make an investor decision.

When talking about the current high unemployment, low interest rate, slow growth economy and the use of quantitative easing and fiscal stimulus, political gridlock and austerity policies become all the more destructive.

In John Hussman's weekly commentary from Monday the 25th, he provides a different analysis of a liquidity trap and the inevitable failure of QE through his dislike of "unproductive" fiscal spending and the invocation of the velocity of money.  Yet, he manages to end up with the proper conclusions that QE will not induce businesses and households to spend when their gut tells them to save save save and that fiscal spending targeted at economically productive targets is useful.  Of more interest is his references to the work of Nathaniel Mass whose work involved the application of microeconomic methods to macroeconomics.  Hussman still finds the market overvalued, overbought, and overbullish with a negative trend and high risk profile which could result in a sharp downturn after a string of new highs, 2-3 day pullbacks followed by sharp recoveries.

Consumer Metrics Institute, in their October 25 commentary, shows that the current contraction has surpassed the recent "Great Recession" in length and there is no end in sight.

Wells Fargo is refiling 55.000 foreclosures, because they have found no faults with them.  This drew the immediate objection of the Ohio Attorney General, who said the quick turnaround of Wells Fargo does not speak well of the review process.  Attorney General Cordray followed with letter to several banks indicating it was not proper or sufficient to just replace false court document with new, "fixed" documents.  Of additional concern in the mortgage mess is the exposure of home builders who originated $205 billion in loans and may now face $1 billion or more in put backs.  Pulte, Hovnanian, DR Horton, and Lennar may have the most risk.

Treasury concealed $40 billion in tax payer losses on the AIG bailout, according to the Inspector General of TARP.  Treasury refused to correct the report after information was sent by the Inspector General to Treasury.  Representative Issa indicated he thought the report was misleading and, if it had been issued by a private company, it would have been subject to a SEC investigation.  At the same time Treasury has thumbed its nose at the Bloomberg FOIA request for information on Citi guarantees, which is information at least two years old.  Bloomberg has won in court, but Treasury has a history of stringing these FOIA TARP related requests out.  In this vein, it is relevant that Washington's Blog had a post on how fraud contributed to the Great Depression.

The CFTC has found repeated attempts to influence and control the price of silver in the markets.  This is a subject we have commented on in the past.  It remains to be seen if the CFTC will do anything about their findings.  Here is the complete CFTC statement.

Protests in France against an increase of the retirement age to 62 failed as the measure became law.  The retirement age is a big issue in many countries, particularly those in which have an aging population with a low birth rate.  Retirement ages are all over the map from as low as 45.  Most discussion of increasing retirement ages never touches on age discrimination in job seeking and the work place or the productive value of experience and knowledgeable workers; it is all about the cost of retirement.

Market Report  No banks failed this week == 139 (140 last year); Unofficial Problem bank list = 894

                               DOW/Volume                                           NASDAQ/Volume
Mon
                       31.49/ up 30.7%                                           11.46/ up 7.4%
Tue
                          5.41/ down 4.1%                                          6.44/ up 9.3%
Wed
                      <43.18>/ up 5.9% distribution day                     5.97/ up 7.0%

Thu
                      <12.33>/ down 1.4%                                        4.11/ sown .2%
Fri
                           4.54/ up 2.7%                                                .04/ up 2.7%

Total               <14.07>                                                        28.02

Mon: Oil up 87 cents to $82.52; Dollar weaker; chemicals offset financials; highest close since April 29th but still closed near session lows.

Tue: Oil up 3 cents to 82.55; Dollar stronger but mixed against the pound; highest close since April 26 on low volume and struggle during day.

Wed: Oil down 61 cents to 81.94; Dollar stronger; markets pummeled by worries over Fed easing but pared losses at end; oil supplies were up 5 million barrels; gas supplies were down 4.4 million barrels; distillate supplies were down 1.6 million barrels.

Thu: Oil up 24 cents to 82.18; Dollar weaker; market could not make up its mind with several economic reports due Friday; weekly jobless claims were down 21,000 to 434,000 (lowest since July); 4 week moving average was down 5500 to 453,250, and continuing claims were down 122,000 to 4,356,000 (but number of workers with exhausted benefits is increasing).

Fri: Oil down 75 cents to 81.45; Dollar weaker; market ended flat at end of higher volume day despite mediocre GDP report; trade below average for 6th day i row on NYSE -- what will happen after next week's election and Fed meeting?

United States:

Bernanke (Fed) said regulators are reviewing foreclosure practices of large financial institutions and will publish a report next month.

Freddie Mac says foreclosure pipeline is slowing down (8 months --- 2 months longer than normal).

In the last two months, the U.S. dollar was effectively devalued 14% by the market.

Chicago Fed economic activity index was down to <.33> September from <.32> ; national activity was down to <.58> from <.49>.

Core Logic August housing prices were down in 78 of 100 metro areas.

NAR existing home sales were up 10% September to 4.53 million (19.1% vs year ago) but inventory is 10.7 months, which is down 1.9% September but up 8.9% vs year ago.

Case-Schiller 20 City house prices index (3 month average) was up 1.7 vs August 2009 (slower) with 15 reporting lower prices.

Dallas Fed manufacturing activity showed production up to 6.9 from 4.0 (2nd month up); new orders were down to <4.3> from <3.0> (5th month); finished inventory was down to <12.5> from 1.0; prices paid for raw materials was up to 29.9 from 24.4 (15th month); prices received for finished goods was down to <3.5> from .5.

Volcker said inflation is not the problem and will not be the problem for several years; no possibility of deflation.

Berkshire Hathway is disputing SEC claims that their Q2 should have written down $1.9 billion in losses from Kraft, US Bancorp, and other firms; contends the losses are temporary and expected to rebound.

Bank write-offs of credit card uncollectibles were up to 10.03% August from 9.45%; 30 day past due was down to 4.7% n a small decline.

Ford Q3 EPS were up 48 cents per share ex items (expected 38 cents); sales were up 6% ex Volvo which was sold; paid $2 billion in debt and $3.6 billion to retirees health trust.

September new home sales were up to an annual rate of 307,000 from 288,000 with months of supply down to 8.0 from 8.6; still weakest September on record.

Mortgage defaults Q3 were up 18.9% from prior quarter but down 25.5% vs Q3 2009.

Philadelphia Fed State Coincident Index for September increased in 24 states, down in 14 states, and unchanged in 12 states; this shows sluggish recovery.

U.S. durable goods orders in September were up 3.3%; exclude transportation and orders were down .8%; exclude defense orders were up 2.9%; shipment were down .4% for 2nd month; inventory was up .5% for 9th month.  Capital goods new orders, non-defense, were up 8.6%; inventory was up 1.3%.

On Wednesday cotton prices were the highest since the U. S. Civil War.


Hedge funds have been advised by law firms specialists and MBS traders at a conference that the coming wave of MBS put backs will cost banks at least %97 billion.


Freddie Mac 90 day delinquencies were down to 3.89% from 3.83%.

P&G Q1 EPS were down 4% to $1.02 per share (expected $1); sales were up 2% but below views; expects Q2 to suffer from higher commodities prices and marketing costs.

Kansas City Fed manufacturing survey showed continued moderate expansion.  Increased activity was reports by 10 down from 14; new orders were up to 16 from 9 firms.

GM is preparing for an IPO; it will repay $2.1 billion to Treasury and make payments to pension and retiree health plan ($2.8 billion); after IPO it will pay $4 billion cash and $2 billion common stock to treasury and buy back preferred at a 2% premium.  It has an agreement with ten large banks for a five year, $5 billion credit facility for backup liquidity.

Institute of Supply management (ISM) Chicago PMI (Purchasing Manager's Index) was up to 60.6 from 60.4; new orders were up to 65.0 from 61.4.

Reuters survey of 80 economists project GDP in 2011 will only be 2.4%.

ECRI Weekly Leading Index was up to <6.5> from <6.9> the prior week.

Hoenig (Kansas City Fed) said there are real risks to QE; it is "very dangerous", hazardous bet which could set in motion a boom-bust cycle.

Dudley (New York Fed) said the Fed cannot wave a magic wand but can provide essential support for the long bumpy road.

U. S.Treasury Auctions:

2 yr Treasury, $35 billion, yield .40%, bid to cover 3.46, foreign 39.98%, direct 15.9%.

5 yr treasury, $35 billion, yield 1.33% (1.26% last month), bid to cover 2.82, foreign 39.5%, direct 11.7% (highest since May).

International: 

UBS Q3 was a massive miss 50% below consensus due to investment bank and wealth management results; fixed income plunged due to "negative debt valuation adjustment".

Japanese exports were up 14.4% September (slowest gain this year).

Ireland will attempt to cut $21 billion form their annual budget in 4 years; deficit set to hit 32% of GDP on the bank bailouts which favored management and bond holders at the expense of the public.


Portugal budget talks have collapsed Wednesday on political gridlock.

The French lower house voted for the Senate bill on pension reform and the bill goes to President Sarkozy.

Greece is experiencing lower than expected tax revenue growth after austerity tax hikes.

Japan cut its GDP estimate to 2.1% from 2.6% and sees 1.8% for next year down from 1.9%.

China says it will cut its trade surplus by encouraging consumer spending.

Eurzone October inflation was up 1.9% (1.8% September).

French refinery workers returned to their jobs on Friday ending the strike.

Japanese factory output was down 1.9% in the 4th straight monthly decline; consumer prices fell for the 19th month vs year ago.

A weak U. S. dollar, which will result from any new Fed QE, will hurt Europe more than it will help the U.S.


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Price Level Targeting

As began reviewing my notes for my Weekly Commentary, I noticed that a subject which was briefly noted in the 10/22/2010 Commentary seemed to more important than just reporting comments.  It is the concept of central banks using price level targeting rather than inflation targeting as a means of boosting an economy, particularly in times of near zero rate interest.

Last week Charles Evans (Chicago Fed), as we noted in the Weekly commentary, made a speech in which he said price level targeting may be something about which the Fed should be talking.  This last week, the Bank of Canada publicly discussed it was studying price level targeting and the research has been generally positive.

In price level targeting, a central bank responds to inflation above or below its inflation target, not by adjusting the inflation target, but by policy which is designed to make up the difference in the future.  CPI growth above or below the inflation target in one year is offset in subsequent years in such a way that the price level aggregate does not move.

Last week the Atlanta Fed blogged on whether this might be a good time to adopt price level targeting.  Potential problems exist in its temporary use as a central bank transitions back to inflation targeting and the blogger sees some benefits in it being a permanent, consistent policy.  The St. Louis Fed published a paper in 2009 on price level targeting and concluded that it could successfully stabilize short-run aggregate shocks and improve welfare.  By adhering to a targeted price path, a "... central bank reduces the nominal interest rate via monetary injections to expand consumption and output."  An optimal policy would work through a liquidity effect, such as a liquidity trap.  This might also remove the volatility found in New Keynesian models in which the nominal interest rate is quite volatile.

For those who appreciate a more in-depth academic research on the subject of price level targeting, here is a paper (Adobe download) by Barnett and Engineer and discussion by Boivin.

It appears that price level targeting has been, and is, picking up steam in the debate and thinking of central banks in dealing with the current near zero interest rate environment.  This debate just appears to be emerging publicly as a serious consideration.



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Economy & Market Week Ended 10/22/2010

QE2 (quantitative easing) expectations dominated the market with Fed meeting scheduled for November 3rd.  Edward Hugh sees QE2 as inevitable, because the Fed has decided it is necessary to devalue the dollar in order to improve trade balances and unemployment.  Still, this has global impact and does not solve the internal problems and structural imbalances of China and the United State or other countries, including the eurozone.  He also makes an argument that the current reserve currency basket - yen U.S. dollar, euro, and pound - should be devalued.  Although he sees QE2 as inevitable he does not look forward to the pressure on the euro and others have also argued against the risk and its probable failure to impact unemployment.  Joseph Stiglitz in "Why Easier Money Won't Work" is adamant that easy money will not work, because it runs the risk of rising equity prices, rising expectations of inflation despite low interest rates, a potential bursting of the bond bubble, and a weak dollar hurting the very countries to which we want to export.  While the Fed is considering what is in effect only a switching of assets on their balance sheet from the purchase of short term treasuries to longer term treasuries, David Blanchflower has heard them discussing the possibility that they could purchase municipal bonds and mortgage backed securities from Freddie Mac and Fannie Mae bailing out both the housing market and state governments.

The incontrovertible evidence of growing income inequality, as we discussed last week and at other times in the past, continues to be a current topic of economic concern as it has vast impact on the future of a democratic society and the vitality of an economy.  Mark Thoma shows a chart of the huge divergence since the 1970's and has listed several of his posts on the subject.

A finance and economic academic assessment of the Dodd-Frank Reform Bill has been published.  It sees a derivatives market reform as comprehensive when it was not; it sees the Volcker rule and the framework for resolving systemically risky financial institutions as having its heart in the right place despite the incomplete approach and application.  The assessment finds problems with the mispricing of government guarantees throughout the financial sector, financial firms are made to bear the cost of their own losses (imagine how revolutionary it is to have a private company responsible for its own losses!) but fails to make them bear the cost impose on others, it often regulates by form rather than function, and it makes important omissions in reforming and regulating the shadow banking system.  The assessment completely ignores the blunted consumer protection agency and the failure to make it independent as well as ignoring financial advisor fiduciary duty by letting the salespeople's regulatory agency (SEC) to float what ideas will be acceptable to the financial sales organizations.  It took five people to write this very weak and short assessment.

The economist Bill Mitchell sees the mortgage mess as proof that government leaders are unwilling to demonstrate leadership and use fiscal policy.  This leads him into a discussion of quantitative easing in the United States and the United Kingdom and he also references the David Blanchflower article also reference above as well as how austerity impacts an economy and how targeted fiscal spending could be more successful.  Besides the macroeconomics, Bill Mitchell also makes several proposals to resolve the mortgage mess while totally ignoring the fraudulent aspects of the contract process and documentation.  He sees it as just a normal part and development of a financial crisis.  Still, his article strikes at the heart of the arguments against moving the economy to growth, reducing unemployment, and making life better for the middle class and not just the wealthy and elite.

John Hussman in his October 18th weekly commentary deconstructs the prospect of another round of quantitative easing (QE2) as reckless. QE2 would have two goals: 1) lowering long term interest rates to hopefully stimulate loan demand and discourage saving and 2) to increase the ability and need of banks to lend.  On the demand side of constraints on QE2, the United States is in or approaching a liquidity trap in which interest rates are already low enough to not be primary drivers of loan demand; businesses want customers and opportunities for profitable investments before they go seeking loans and individuals lack confidence that there is sufficient income future to spend rather than save and reduce debt.  On the supply side, there is already sufficient liquidity in the financial system to provide loans, although banks have been allowed to carry toxic assets at inflated values, which means their balance sheets are not an accurate reflection of assets and liabilities.  Because the constraints are not binding, QE2 will have little effect in stimulating increased economic activity or employment.  The banks have profited by massive write-ups of assets on the balance sheet and large reductions in loan loss reserves on the income statement.  The Fed expects the ensuing weaker dollar to improve exports, but data has shown that imports are more elastic to fluctuations in the dollar than exports have been.  Consequently, further dollar devaluation is more likely to have negative global economic effects and create a negative wealth effect in the U.S. lowering consumption. Besides future difficulties for the Fed in reducing its balance sheet may create a situation in those Fed sales could risk pressuring interest rates higher and choke off any recovery. Historically, both internationally and in the U.S., Hussman finds "...that suppressed interest rates are not correlated with an acceleration of real economic activity, but rather the hoarding of commodities."  The prices of commodities rise and the investment in commodities becomes riskier.  He believes QE2 has already been reflected in the current stock, bond, and commodities markets and this demands that the QE2 be successful, which is a dangerous proposition.

The blog Pragmatic Capitalist believes there is at a risky position with an air pocket beneath risk assets and QE2 is only going to make it worse, because it will not increase wages, jobs, or economic output.  "QE adds no net new financial assets to the private sector."  This earnings season compounds the irrationality because they are "better than expected" as the result of analysts reduced estimates, companies have purposefully sandbagged estimates to create "better than expected" results, and past year poor economic performance comparisons.  Any turn towards austerity and less government stimulative action will create headwinds.  Political gridlock removes a powerful tailwind.  Pragmatic Capitalist uses an indicator it calls "qualified disequilibrium" to quantify disequilibrium in the market with successful investing results and is currently finding that the risk component has only been at current levels or higher twice in the last five years: September 24, 2007 and January 5, 2009.  It is possible the U.S. dollar is oversold and equities overextended on false hopes of QE2.  Consequently, the market is over concerned with inflation while we are moving closer to disinflation and the risks of deflation.

Pragmatic Capitalist observes that the macroeconomic trends indicate a double dip is unlikely but prolonged economic sluggishness is a growing reality.  The past 18 months of inventory restocking and government stimulus are slowing down and ceasing based on ISM new orders and inventory data, which is correlated by the ADS Conditions Index.  Economic growth will remain weak, because the private sector has not recovered and the lack of sufficient and continuing government stimulus.

The Consumer Metrics Institute, in their October 19 news , show the current number of days in contraction, even assuming a bottom has been reached, are approaching the duration of the financial crisis recession which ended in June 2009.

The Fed Beige Book of anecdotal business information from all Federal Reserve Districts conveys that economic activity is continuing to rise but at a modest pace.  Manufacturing activity continued to expand; retail spending was flat to moderately positive; housing markets remained weak; input prices rose slightly but finished goods and services prices were stable; commercial real estate conditions remained subdued; lending activity was stable at low levels; wage pressures remained minimal; and hiring remained limited.  Fed speak has a way of sugar icing a "modest pace".

The G20 meeting got off to a predictable start, despite Germany accusing the U.S, of manipulating the dollar
and concerns voiced by host South Korea, among other nations.  Much was made of Europe giving up some of its IMF voting seats to emerging countries.  The Saturday (October 23) ending with a promise to avoid currency devaluations left no one with any expectation that the possibility of currency wars and trade sanctions were not still a looming probability given the Federal Reserve's likelihood to begin QE2 the day after the November election.

With respect to the PPACA, regulators have clarified that changes in one employer health insurance plan does not risk the grandfathered status of other employer health plans.

Market Report:  7 banks failed = 139; unofficial problem bank list is 871.

                               DOW/Volume                                      NASDAQ/Volume
Mon
                     80.91/ down 29.6%                                   11.89/ down 21.5%
Tue
                   <165.07>/ up 27.8%                                  <43.71>/ up 28.5%
Wed
                     129.35/ down 13.3%                                 20.44/ down 7.2%
Thu
                       38.60/ down 4.3%                                     2.28/ up 5.3%

Fri
                     <14.01>/ down 26.9%                               19.72/ down 26.0%

Total                     69.78                                                         10.62

Mon: Oil up $1.83 to $83.08; Dollar weaker but mixed against the pound; bans up and techs down.

Tue: Oil down 3.59 to 70.49; Dollar stronger; China raises interest rates on 1 year deposits and loans; Apple disappoints on iPad sales and profit projection; Bank of America sued to pay back $47 billion of mortgage loans; commodities fell on China interest rate.

Wed: Oil up 2.28 to 81.77; Dollar weaker; Boeing and banks up; Fed Beige Report shows mixed and modest growth; oil supplies up 700,000 barrels, gas supplies up 1,2 million barrels, and distillate down 2.2 million barrels.

Thu: Oil down 1.98 to 80.56; Dollar stronger; wide, volatile swings; markets near resistance highs; weekly jobless claims down 23,000 to 452,000, 4 week moving average down 4250 to 458,000, and continuing claims down 9000 to 4,441,000.

Fri: Oil up 1.13 to 81.69; Dollar stronger but mixed against the euro; lightest Dow volume since September 10; restaurants and big cap techs led.

United States:

U.S. industrial production down .2% September and capacity utilization down to 74.7 (5.9 points below average).

Housing starts were up .3% September.

GMAC has found no evidence of inappropriate foreclosures.  In Citi conference call, there were no questions on the foreclosure mess and only one on securitization.  Bank of America is lifting a halt on foreclosures in all 23 states which require a judge's approval.  J. P. Morgan and Morgan Stanley both came out with independent reports which both said the foreclosure mess is fixable and both said the probable cost for all banks would be only $55 billion.  Citi said the foreclosure process is sound.

The Federal Home Loan Bank of Chicago is suing Bank of America, Goldman Sachs, Citi, and Wells Fargo for failure to disclose lax underwriting standards which caused losses.

The3 New York Fed, Pimco, Blackrock, and fifty other large investment firms are suing Bank of America to buy $47 billion in mortgage bonds.

FDIC will not raise deposit insurance fees as planned, because the costs may be "only" $52 billion as opposed to the original estimate of $60 billion for 2010-14.

U.S. commercial property prices fell 3.3% August to the lowest level in 8 years (Moody's).

The Financial Fraud Enforcement Task Force is looking into whether mortgage servicers misled federal housing agencies.

Wells Fargo said its foreclosure procedures are sound and there will be no moratorium on foreclosures.

Philadelphia Fed Mid-Atlantic business activity index up to 1.0 October from <.7> (economists expected 2.0) and new orders were up to <5.0> from <8.1>.

Bair (FDIC) expects U.S. banks capital will have to be higher than the capital requirements in Basel III agreement, but she needs to confer with the Fed, which regulates the large banks.

Fannie Mae and Freddie Mac may need another $215 billion in addition to capital already received ($148 billion) from the U.S. Treasury through 2013 to offset losses.

The ECRI Weekly Leading Indicators continue to improve and is up to <6.8> from <7.0>.

Illinois unemployment was 10.1 in August (10.3 in July).  Nevada had the highest unemployment at 14.4%.

Of the seven banks which failed this week, one in Arizona found no buyers and the FDIC will pay out to depositors.

U.S. Treasury yield spreads between 2 year and 10 year increased to 2.204% with 10 year down to 2.55% and 2 year down to .35% (record low is .327) in anticipation of QE2.

Citi net income was down 20% with diluted EPS of 7 cents per share ($2.2 billion) which was $529 million less than the previous quarter, but it still beat estimates as income was higher, because Citi lowered loan loss reserves by $2 billion.  Profits suffered from lower trading volume.

Yahoo profit beats estimates but sales disappoint.

Wells Fargo loan losses were down 20% to $4.1 billion; EPS up 7% to 60 cents per share (expected 55 cents).

Boeing profit up to $1.12/share (expected $1.05); revenue up 1.7%; and it raised full year views to $3.80-4.00 (expected $3.69).

Caterpillar Q3 EPS up 91% to $1.22 per share (expected $1.09); sales up 53%, but warned on future profit margin and growth.

Pension costs cut Honeywell profits by 18 cents per share with Q3 profit down 20% to 64 cents per share (expected 66 cents); net sales up 9%; Q3 EPS up 14% to 80 cents per share (expected 79 cents).

AIG Asian Life IPO raised $17.9 billion.

Fisher (Dallas Fed) said the Fed needs fiscal and regulatory authorities to help if the economy is to grow at a faster pace.

Lockhart (Atlanta Fed) said quantitative easing is insurance against disinflation.

Dudley (New York Fed) said the economy is "wholly unsatisfactory" with slow growth, weak job creation, and declining inflation.

Fisher (Dallas Fed) said a foreclosure halt could hurt economic growth and prevents the housing market from clearing.  His statement was echoed by the FDIC and other government officials throughout the week.

Lockhart (Atlanta Fed) said further central bank bond purchases must be large enough to jump start the economy --- maybe $100 billion a month.

Bullard (St. Louis Fed) supports QE2 in $100 billion tranches on a meeting by meeting decision basis.

Plosser (Philadelphia Fed) does not see the benefits of more asset purchases, because they do not sufficiently impact unemployment and there is no necessity with respect to the inflation forecast.

Hoenig (Kansas City Fed) said the Fed runs the risk of creating new problems if it floods the economy with cash.  He is unhappy with unemployment but fears a "quick fix" will create the next problem.

International:

China intends to restructure and rebalance its economy over the next five years.  The five year plan pledges to boost household income and spending, particularly among farmers to address growing inequality.  China raised interest rates on one year deposits 25 bps to 2.5% for the first time in three years and one year lending rates 25 bps to 5.56% surprising the international markets.  The interest rate had fallen below headline inflation (3.5% August and 3.6% September).  This is a very serious signal they are concerned about overheating and the will also test a trial property tax in some cities.  It may also cause more foreign capital inflow which could sustain inflation growth.  It also told commercial banks to stop offering loans to buyers of third house and extended the 30% down payment to all first home buyers.  There is still large political opposition to slowing loan growth in China.

Internationally, China is not seen as the lone culprit in any potential currency wars as many nations are concerned about the impact of a weaker U. S. dollar resulting from more quantitative easing will have on their currencies and economies.

Rioting in France over retirement reforms which would increase retirement age from 60 to 62 continues to spread and harden in France.  It is causing major disruptions in fuel refining and distribution.

U.K. will cut 490,000 jobs (8%), raise the retirement age to 66, and cut $28.5 billion in welfare.

Brazil increased the tax on foreign investment in fixed income securities for the second time to 6%.

Thailand put 15% tax on income on its bonds.  Both Brazil and Thailand are trying to cool their economies from overheating caused by the weak U.S. dollar.

An unofficial Chinese Commerce Ministry person said China, which produces 95% of world's rare earth materials used in high tech manufacturing, plans to cut exports 30% by year end to conserve resources; the next day an official Commerce ministry official denied this.

Chinese GDP was up 9.6% vs year ago in Q3 (10.3% in Q2) and consumer inflation was up to 3.6% (a 23 month high).

Eurozone PMI (Purchasing Managers Index) was down .9 to 53.2 October (lowest since February); slower growth in France was offset by unexpected growth in Germany.

Bank of Japan will consider, at its October 28th meeting, buying BBB and a-2 commercial paper (lower quality) to help companies borrow money.

The French Senate passed the pension reform and increase in the retirement age but the bill now requires both houses to reconsider to resolve language difficulties in the bills passed by each house and new votes in both.

A researcher for the Chinese Academy of Governance, which is a government advisory board, said China must raise interest rates one more time this year.

Japan is close to signing a deal to mine for rare earth metals in Vietnam after the recent temporary halt of exports from China.

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