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Friday, August 29, 2008


sarah palin

i've previously bemoaned the decline in standards of political vetting by highlighting the curiously low pragmatic hurdle presented barack obama on his way to becoming the democratic nominee for the presidency.

but next to this, obama is a political methuselah.

Before her meteoric rise to political success as governor, just two short years ago Sarah Palin was the mayor of Wasilla. I had a good chuckle at’s claim that she had been the mayor of “Wasilla City”. It is not a city. Just Wasilla. Wasilla is the heart of the Alaska “Bible belt” and Sarah was raised amongst the tribe that believes creationism should be taught in our public schools, homosexuality is a sin, and life begins at conception. She’s a gun-toting, hang ‘em high conservative. Remember… this is where her approval ratings come from. There is no doubt that McCain again is making a strategic choice to appeal to a particular demographic - fundamentalist right-wing gun-owning Christians.

And Republican bloggers are already gushing about how she has ‘more executive experience’ than Obama does! Above is a picture of lovely downtown Wasilla, for those of you unfamiliar with the area. Behind the Mug-Shot Saloon (the first bar I visited when I moved to Alaska long ago) is a little strip mall. There are street signs in Wasilla with bullet holes in them. Wasilla has a population of about 5500 people, and 1979 occupied housing units. This is where your potential Vice President was two short years ago. Can you imagine her negotiating a nuclear non-proliferation treaty? Discussing foreign policy? Understanding non-Alaskan issues? Frankly, I don’t even know if she’s ever been out of the country. She may ‘get’ Alaska, but there are only a half a million people here. Don’t get me wrong… . I love Alaska with all my heart. I’m just saying.

this is a joke, isn't it? and she's corrupt to boot, currently under a state ethics investigation for a clumsy abuse of power and a yet more clumsy political coverup! please someone tell me that self-serving short-term demographic calculation of what must be the most diluted and abstract kind hasn't so thoroughly infected the american political system that THIS has become possible.

oh, but it has -- and worse.

the democratic party has taken an immense gamble on obama, ignoring the intrinsic weakness of their appeal as a cosmopolitan party in the rust belt, south and mountain west. hillary clinton was hardly an ideal candidate, but nominating obama has put swing states in play by making the defection of conservative democrats to the mccain ticket far more probable. there are foreseeable reasons that -- in spite of widespread frustration, antipathy and even outrage directed at republican political practice nationally -- the presidential race is essentially a dead heat. while her elected political experience is itself rather wanting, clinton is at least as thoroughly vetted as national political figures can be. obama, still wet behind the political ears, is not. democracies, particularly old democracies, frequently excel at making stupid choices. the democratic party, however, has helped the idiocy of the electorate along by rejecting thoroughgoing policy competence in favor of what i am compelled to call entertainment value.

the republican selection of sarah palin, however, scotches any idea that the decline in the standards of elected politicians is a democratic phenomena. indeed this is probably the most ridiculous selection for a vice president since the 19th century, when the office was perfunctory.

UPDATE: by the monday following it has become clear, in spite of campaign protestations to the contrary, that palin hadn't really even been thoroughly vetted.

Shortly after Palin was named to the ticket, McCain's campaign dispatched a team of a dozen communications operatives and lawyers to Alaska. That fueled speculation that a comprehensive examination of Palin's record and past was incomplete and being done only after she was placed on the ticket.

UPDATE: it's very rare that caligula merits a mention in the washington post, much less incitatus. and that itself pales in comparison to this incisive paragraph from richard cohen:

Probably the most depressing thing about Palin is not her selection but the defense of it. It has produced a parade of GOP spokesmen intent on spiking the needle on a polygraph. Looking right into the camera, they offer statement after statement that they hope the voters will swallow but that history will forget. The sum effect on the diligent news consumer is a feeling of consummate contempt for the intelligence of the American people -- a contempt that will be justified should Palin be the factor that makes McCain a winner in November.

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Is Dan Quayle still available?

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The race for the position of "imperial" president of this country has become little more than an entertaining distraction. The members of congress have much to gain from the public's puffy indignation over executive abuses of power as it distracts that same public from too carefully scrutinizing the other branches profound incompetance. If there's any merit to David Walker's crusade, bickering over who will preside over the eventual insolvency of this, apparently, failed experiment is an exercise in futility.

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Thursday, August 28, 2008


china PMI shows contraction

per the telegraph:

"They are now more worried about growth than overheating, and you are seeing that play out in the currency markets. There has been a remarkable change of view," said Simon Derrick, exchange rate chief at the Bank of New York Mellon.

China's PMI purchasing managers index fell below 50 for the first time in July, signalling an outright contraction in manufacturing output. Hong Kong's economy contracted 1.4pc in the second quarter. The Politburo has rushed through special rebates for textile producers now caught in a ferocious downturn.

Much of the clothing, footwear and furniture industry has been hit, leading to mass plant closures in the Pearl River Delta.

"During the first half of this year, about 67,000 small and medium-sized companies went bankrupt throughout China, leaving more than 20m people out of work," said the National Development and Reform Commission. "Bankruptcies of textile and spinning companies have numbered more than 10,000. Two thirds are on the brink of bankruptcy."

Last week's rebound on the Shanghai stock market stalled on fading hopes of a fiscal stimulus package. "It is unrealistic to expect the government to rescue the market," said Li Ka-shing, chairman of Hutchison. "Speculators should be very cautious now. The worst is not over in the global credit crisis."

Lehman Brothers warns of a risk that a housing slump and the 55pc equity crash since October could combine with a global downturn to set off a "vicious cycle". House prices have already fallen 18pc in Guangzhou and 9pc in Beijing. Prices are now falling in cities that make up over half China's population.

does this sound like an economy that is going to mark 9% growth? i don't think so.

more from chinastakes as the chinese leadership is making crisis planning a priority.

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sentiment warning

following on a preliminary volatility sell (and this related and interesting view) -- my simple ISEE all-securities moving average options sentiment tracker is showing an optimism spike.

the chart tells the story -- this obviously isn't 100% reliable, and even if it is signaling a downturn it could still be quite a ways off. but the indication would seem to be that the profile has shifted from reward to risk.

note too that the 50-day average of the ISEE is not particularly low on an absolute level as it was in april of this year. the result is that the most recent ratio spike was achieved on a slightly lower absolute level of the 5-day. the last time the ratio on an absolute level was this high (138.2) was in december 2007; april got as high as 136.2.



2q gdp revised up to +3.3%

widely reported, but some points:

  1. barry ritholtz cries foul, but as was earlier hashed out the GDP deflator does not account for import price increases -- such as oil -- and that's the source of american inflation. are we experiencing inflation? yes. is it in domestic products? no, at least not yet. if anything, the domestic environment is deflationary -- which makes the 1.2% GDP deflator altogether plausible. one can, however, certainly argue -- as stefan karlsson does -- that terms of trade are important and the method of GDP calculation is therefore flawed and not representative of the reality.

  2. as dean baker pointed out previously, 3q GDP is so far looking to be fairly strongly negative. a stronger dollar should also cut into the export growth that accounted for much of the 2q pop. this might in fact be the W-shaped recession that some forecast, with negative quarters broken up by an interlude.

  3. karlsson noted the ongoing crushing of corporate profit margins.

    [W]hat seemed to be ignored was that the report also said that corporate profits fell again-and this despite the fact that the BEA definition of profits is unaffected by write-downs. Overall corporate profits fell in nominal terms by an annual rate of 9.2% compared to the previous quarter and by 7% compared to Q2 2007. If you adjust for inflation, then we're talking about double digit declines in corporate profits.

    And moreover, this number would have been even more dismal if it hadn't been for the rising profits from the foreign subsidiaries of American companies compared to the profits of the subsidiaries of foreign companies in America. The profits of domestic non-financial companies fell in nominal terms as much as 21.8% at an annual rate compared to the previous quarter and by 17,4% compared to Q2 2007. Adjusted for inflation, these declines are even larger.

    The point about that is first of all is that it will likely cause companies to reduce their investments in the future.

    this fact is showing up clearly in the more pronounced decline of gross domestic income (GDI), as opposed to GDP, which was revised negative for both 4q2007 and 1q and showed just 1.9% growth in 2q. this does not bode well for the near-term future of employment, and therefore of both consumption and GDP.

UPDATE: as an addendum to points 2 and 3 -- incomes fell in july 0.7%, the biggest jump down since katrina. consumer spending correspondingly collapsed 0.4%.

UPDATE: more from menzie chinn.

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ownership society

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easing perceptions of the GSE crisis

paul jackson at housing wire:

A recent report from Citigroup Inc. (C: 18.38 +1.43%) analyst Bradley Ball suggested similar sentiment. In a report put out last Friday, Ball characterized the most recent sell-off of shares as “surprising, since the only catalyst was apparently a press report suggesting that federal officials are likely to recapitalize the GSEs soon.”

He said that any nationalization of the GSEs was “unlikely,” although he did allow for the potential for a “Chrysler-like Federal loan.” The report also stressed that shareholders’ interest would likely be preserved, regardless, although Ball said that any near-term Treasury action was highly unlikely.

“We are not convinced that Treasury needs to take any action over the near-term,” the report said. “While the decline in the GSEs’ stock prices, if they persist, may pose challenges to any capital raising efforts down the road, the short-term stock price performance does not have any bearing on the success of the ‘Paulson Plan.’”

In other words: everyone, just calm down. ...

That’s not to say the GSEs don’t have capital constraints; they most certainly do, and those constraints are being seen in how Ginnie Mae has vaulted in front of both Fannie and Freddie in fixed mortgage security issuance during August. But most analysts well-versed in GSE watching have suggested that both companies could continue to operate in the current adverse credit market and maintain current reserving activity without putting current regulatory capital requirements at risk at least through the end of this year, or perhaps even longer.

Even then, as Citi’s Ball suggested, the GSEs are not without options; among them, HW’s sources said, is the ability of both GSEs to allow portfolio assets to run-down. While not necessarily the best outcome from a mortgage lending perspective, such a run-down would offer plenty in the way of liquidity; which means that any debate over the GSEs shouldn’t be about solvency or a nationalization that seems increasingly unlikely to take place any time soon.

a better than anticipated debt auction for GSE issues has goven some cover for optimism regarding fannie mae and freddie mac. i've read the citi research and can't say i disagree with the ground it covers -- FNM/FRE may be insolvent by a considerable margin but are certainly increasing loss reserves and can put part of the portfolio into runoff to raise cash, shrinking their retained portfolios ot the tune of $4bn a year.

the key point to feature, however, from the citi report:

As evidence, the recent notes issued by FRE, which were oversubscribed and included 40% participation from non-U.S. investors (30% Asian) showed the success of the backstop plan, regardless of the price paid (which is more of a business issue than an access to funding issue). The $3 billion 5 year note issuance was priced at 113 bps over Treasuries, which was an unusually high price; however, once the securities were free to trade, their spread compressed to around 90 bps. We believe the success of this debt issuance reflects FRE’s solid access the capital markets and is a positive indicator of the success of the “Paulson Plan”.

spreads are way out (for "government-backed" debt) for this issue, which was after all just $3bn. but continued foreign central bank participation is essential -- close observers have noted a deep retraction from GSE issuance, and FNM/FRE have something like $220bn in debt to roll in the next month. we talk about the GSEs pushing some of their portfolio into runoff; what of the FCBs, particularly if china needs funds to stimulate its economy? and what of the nervousness of japanese holders of american debt?

wary eyes will continue to be cast at GSE auctions through september; the sanguine picture painted by citi could turn on a dime. further retrenchment on the part of FCBs will show up as wider spreads, tighter credit and higher mortgage rates, if not failed (or treasury-supported) auctions. if FCB support for GSE issuance falters meaningfully, with the GSEs already having had to reduce their efforts to support the mortgage marketplace, treasury will be faced with irresistable political pressure to intervene in an effort to pump liquidity into a crashing housing market during an election cycle.

UPDATE: bank of china is dumping FNM/FRE -- just in case treasury isn't getting the hint!

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Wednesday, August 27, 2008


why indeed?

i don't typically find much use for mainstream news articles aside entertainment value, but this via yahoo, linked to their frontpage under the title, "Why have the candidates made no mention of the financial crisis?", brought a smile to my face.

The U.S. is facing the worst financial crisis since the Depression. You would never know that from the Democrats' platform in Denver or its Republican counterpart, or from listening to Barack Obama or John McCain.

While both candidates have bemoaned the ravages of the subprime crisis, they have yet to spell out steps for tackling it, such as using taxpayer money to shore up banks and housing.

the reason why, of course, is because neither political party has in its construct of political fable the faintest link to reality. this is primarily so because reality is difficult, and difficult doesn't win elections in a democracy with a wide franchise.

moreover, it has more than a little to do with culpability -- who is responsible for this mess? fannie mae and freddie mac, for example. who got them into such a mess? the truthful answer neither party wants to breathe is that it took the bipartisan efforts of republicans and democrats in congress with the approval and encouragement of successive executive administrations of both parties. in the words of charlie reese as relayed by jeff saut:

Politicians are the only people in the world who create problems and then campaign against them. Have you ever wondered why, if both the Democrats and the Republicans are against deficits, we have deficits? Have you ever wondered why, if all the politicians are against inflation and high taxes, we have inflation and high taxes?

You and I don't propose a federal budget. The president does. You and I don't have the Constitutional authority to vote on appropriations. The House of Representatives does. You and I don't write the tax code. Congress does. You and I don't set fiscal policy. Congress does. You and I don't control monetary policy. The Federal Reserve Bank does.

100 senators, 435 congressmen, 1 president and 9 Supreme Court justices - 545 human beings out of the 300 million - are directly, legally, morally and individually responsible for the domestic problems that plague this country. I excluded the members of the Federal Reserve Board because that problem was created by the Congress.

In 1913, Congress delegated its Constitutional duty to provide a sound currency to a federally chartered but private central bank. I excluded all the special interests and lobbyists for a sound reason. They have no legal authority. They have no ability to coerce a senator, a congressman or a president to do anything. I don't care if they offer a politician $1 million in cash. The politician has the power to accept or reject it.

No matter what the lobbyist promises, it is the legislator's responsibility to determine how he votes. Confidence conspiracy: Those 545 human beings spend much of their energy convincing you that what they did is not their fault. They cooperate in this common con regardless of party. What separates a politician from a normal human being is an excessive amount of gall.

...Replace the scoundrels. It seems inconceivable to me that a nation of 300 million cannot replace 545 people who stand convicted -- by present facts -- of incompetence and irresponsibility. I can't think of a single domestic problem, from an unfair tax code to defense overruns, that is not traceable directly to those 545 people. When you fully grasp the plain truth that 545 people exercise power of the federal government, then it must follow that what exists is what they want to exist.

If the tax code is unfair, it's because they want it unfair. If the budget is in the red, it's because they want it in the red. If the Marines are in IRAQ, it's because they want them in Iraq.

There are no insoluble government problems. Do not let these 545 people shift the blame to bureaucrats, whom they hire and whose jobs they can abolish; to lobbyists, whose gifts and advice they can reject; to regulators, to whom they give the power to regulate and from whom they can take this power.

Above all, do not let them con you into the belief that there exist disembodied mystical forces like ‘the economy,’ ‘inflation’ or ‘politics’ that prevent them from doing what they take an oath to do.

Those 545 people and they alone, are responsible. They and they alone, have the power. They and they alone, should be held accountable by the people who are their
bosses – provided the voters have the gumption to manage their own employees. We should vote all of them out of office and clean up their mess.

while there are no insoluble government problems, however, there are insoluble situations that can arise out of persistent government neglect, stupidity and malfeasance. the housing bubble-cum-crash, as a symptom of the much larger dollar debt bubble which is showing cracks, is one.

there is simply no getting around these basic facts. the united states -- both in terms of its government accounts and the accounts of the private banking industry which the government purports to regulate -- has been managed in a nakedly malfeasant and utterly incompetent fashion for well over twenty years. the men and women who managed it so are either republican politicians or democratic politicians, and often in that time politicians of the two parties colluded to increase the degree of their malfeasance and ineptitude. moreover, the consequences of that malfeasance have now grown so large that they are well beyond the control of these same managers -- shots are now being called in american monetary and fiscal policy in significant part from the overseas capitals upon which america now heavily relies for financing.

these are horrifying turns of event, truly rife with parallels to the decline and fall of history's dead empires. following years of growing imbalance, we are faced with massive adjustments now. it calls for bold leadership in rejecting the reaganite agenda of debt-fueled economy that has spiralled out of control and setting a new program of sustainable growth from a smaller base. and the predictable response of would-be-culpable politicians from both parties facing election, much less trying to avoid public lynching, is to deny that any such problem even exists -- to instead construct a telegenic and "patriotic" fairy tale smothered in billowing flags, laughing children and endless empty bloviation.

the trickier part, however, and where the rubber meets the road is the aspect which reese -- despite nailing the home of culpability -- patently ignores: american voters install and reinstall these politicians with remarkable reliability. re-election rates for house seats consistently exceed 90%; senate seats are not far behind. as the state of fiscal affairs has deteriorated, re-election rates have trended up, not down. there is now a strong question of efficacy to be posed for the american democratic experiment.

it comes as a surprise to most americans that this country was not founded as a democracy.

If it were probable that every man would give his vote freely, and without influence of any kind, then, upon the true theory and genuine principles of liberty, every member of the community, however poor, should have a vote? But since that can hardly be expected, in persons of indigent fortunes, or such as are under the immediate dominion of others, all popular states have been obliged to establish certain qualifications, whereby, some who are suspected to have no will of their own, are excluded from voting; in order to set other individuals, whose wills may be supposed independent, more thoroughly upon a level with each other.

these are not the words of some african oligarch or central asian despot; the man who said them is on the american ten-dollar bill. the american culture of debt fostered by the rise and political ingratiation of financial corporatism -- what the younger prof. galbraith has so perfectly captured with the term predator state -- has so altered our moral conception of indebtedness that some of us may laugh to think our votes could be bought by vice of our financial vulnerability to such an extent that our democracy would be rendered ineffective and even dangerous. and yet so huge in number and extent is the proportion of americans that have reaped the illusory and temporal benefits of borrowing from future income for current expenses that there is hardly one among us who understands exactly how far above our means we have been living, how distorted our perception of a sustainable lifestyle really is. that illusion has worked to unnaturally increase our support of political incumbency over these last decades; for many of us, our support for our chosen political party has been bought quite surreptitiously with us none the wiser -- with funds borrowed by the united states treasury against our future prosperity, with us plebes in the main too stupid and deluded to understand how or why.

but i would venture that the more cynical power brokers in washington and new york very certainly understand both the reason why and the lengths to which government policy has gone to manufacture and maintain the illusion of rapidly and reliably increasing standards of living in the period of american empire. some fewer may further understand that the illusion may be lifting, and that a reckoning may be afoot -- and this realization has caused some to redouble their efforts at any ridiculous and desperate cost. the last thing on their agenda is an acknowledgement of difficulty, at least prior to the next election if ever. much more likely, we will hear from washington pronouncements of fine fiscal and economic fitness all the way down to the bottom.

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Tuesday, August 26, 2008


china bears

now that the spectacle of the olympics has gone, people might start growing a little more objective about china and its economic prospects. even with stock and property market crashes of (sans hyperbole) 1929-proportions underway there, many sinophile analysts are still glued to a mild-growth-slowdown-at-worst scenario.

but the reality now coming into focus might be very different. more from yves smith on a chinese government fiscal stimulus package which is being assembled even in the face of rampant monetary inflation.

China is considering a 370 bln yuan package of fiscal expenditures and tax cuts to stimulate the economy, the Economic Observer reported, citing a source close to the matter.

The report said said the plan includes 220 bln yuan in government spending and 150 bln worth of tax cuts.

she cites michael pettis:

If there really is such a program and if it is executed, and the newspaper cites an unnamed MoF official who claims that the proposal would have to go through many more stages before it became policy, the total fiscal stimulus would amount to a little under 1.5% of GDP.

Meanwhile Gregor Neuman alerted me to an article in today’s ChinaStakes. According to the article, in July, for the first time since 2003, tax growth has experienced a dramatic decline:

According to Ministry of Finance (MoF) statistics, China’s total revenue in July was RMB 532.325 billion, an increase of 13.8% over the same month last year. But this growth rate is 19.3 percentage points lower than in July, 2007, and 19.7 percentage points lower than the growth rate in the first half of the year.

The article goes on to say most sources of tax revenues showed sharp declines in growth rates, with corporate income tax actually down 4.2% from last July....

[I]t is worth noting that these numbers seem extremely volatile....

Meanwhile, tax from land and real estate, a major source of the local governments’ incomes, has also declined drastically ... Land transfer income has also decreased, due to the real estate market doldrums....

Liu Heng thinks the tax decline “won’t be a big problem”, since China has put a certain amount of money from its tax income every year into a rainy day account.

Perhaps. Unfortunately, as the saying goes, when it rains, it pours.

one may easily recollect that the decline in tax receipts to the states here in america was one of the coincident indications that something fairly severe was in the pipeline. that condition has worsened significantly.

all mainstream projections for global growth are predicated on relatively strong growth in asia, particularly in china and india. in yves smith's words:

I seem to remember that the assumption heretofore that China would still have 8% growth (versus its recent 11%-12%) even with a global slowdown. But anything much below that level would be deemed to be a Very Bad Outcome.

but what of an outright contraction in china? i think one of the reasons so few countenance the possibility is that the potential implications are so diabolical as to scare off comment, which would in several quarters quickly be deemed "irresponsible". jim hamilton recently set out the dynamics of economic contraction, how a recession is far different from a growth slowdown because of the nonlinear flow of malefactory feedback loops set up by negative income expectations.

there are a lot of american and indeed global jobs predicated on very positive chinese income expectations. recession and the resulting financial instability in china would have massive global ramifications -- including quite possibly a rapid fall of the curtain of vendor finance, precipitating the end of the empire.

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"jaws of death"

i recently noted a preliminary sell signal in the volatility measures i examine. but here is something else related to volatility that i hadn't seen before. via the ft, the comments of john hussman.

... the continued widening of credit spreads ... increasingly suggests that default risk may be starting to spread beyond the financial sector into the broader economy. Meanwhile, there is a relative complacency in the stock market because investors are still convinced that the extreme “tail risk” in the markets has been removed by the Federal Reserve and the U.S. Treasury.

... the markets are presently trading on a theme that largely overlooks the potential (and in my view, the reality) of a significant U.S. recession. At the point of recognition, we may very well observe abrupt weakness in both stock prices and the U.S. dollar.

adds the ft:

The Vix shows equity markets anticipating a fall in volatility, but credit indicators suggest otherwise.

Are we again seeing the return of the credit/equity decouple? With interbank lending rates still sky high, there’s perhaps still a case to say equity is looking overpriced.

the credit-equity disconnect is a standing feature of this downturn -- while equity has arguably not even priced in a recession, credit is pricing for something closer to depression. but this widening of the discrepency may have actionable short-run implications.



still not there

calculated risk highlights the latest results from case-shiller.

i previously noted that some distant glimmer of optimism may be warranted in housing as starts have fallen to the level of new home sales. but that is of course a very early leader -- typically, year-over-year real price changes won't go positive until 8-12 quarters following the bottom in new sales and starts.

new home sales for july will be out shortly (UPDATE: here they are), but as was seen in june -- even though new home inventories are now falling -- new home sales are also still falling. and this is in spite of radical price cutting and buyer incentivizing on the part of homebuilders, most of whom are screaming for liquidation.

july data for existing sales and inventory continued to be apocalyptic -- and that in spite of huge numbers of distressed sales.

It's important to note that a large percentage of these sales were foreclosure resales (banks selling foreclosed properties). The NAR suggested last month that "short sales and foreclosures [account] for approximately one-third of transactions". Although these are real transactions, this means that normal activity (ex-foreclosures) is running around 3.3 million SAAR.

many banks are attempting to clear subprime REO from their books with steep discounting, and as a result they've become a huge slice of existing sales. while those are clearing sales, they also indicate that the non-distressed existing home market is in worse shape that it would at first glance appear. inventory is at cycle highs and near all-time highs as a function of sales. a lot of that inventory growth is probably unrealistically (ie, backward-looking) priced housing that will not move until -- like new homes and distressed existing property -- steep discounts are accepted. note in the commentary of paul jackson at housing wire:

Our own guess at HW is that we’re seeing a small seasonal effect, combined with a strong REO effect in some of the hardest-hit local markets to date. REO agents we’ve spoken to in California’s Inland Empire have suggested to us that their listings are moving, relatively speaking, while retail listings are still sitting unsold; beyond that, early surveillance on recent mortgage vintages is showing a strong uptick in borrower delinquencies and defaults starting with July’s data.

that implied force should keep price change negative for the anticipated few years to come.

UPDATE: from calculated risk on july new home sales:

I now expect that 2008 will be the peak of the inventory cycle ... and could be the bottom of the sales cycle for new home sales. But the news is still grim for the home builders. Usually new home sales rebound fairly quickly following a bottom (see the 2nd graph above), but this time I expect a slow recovery because of the overhang of existing homes for sales (especially distressed properties). If the recession is more severe than I currently expect, new home sales might fall even further.

Looking forward, I'm much more pessimistic about existing home sales, and existing home prices, than new home sales.

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Monday, August 25, 2008


the huge news out of jackson hole

underreported and underappreciated as far as i can tell, but mentioned in the new york times.

former bank of england policymaker and credit iconoclast willem buiter savaged the federal reserve's policy response to the credit crisis at the fed's annual hoedown in jackson hole. he accused bernanke of being the kept man of wall street banks, doing their bidding at the expense of the fed's reputation as an inflation fighter, putting efforts to sustain the mispricing of credit ahead of sound monetary policy.

but that is not news. what is news is that five of the eleven voting members of the federal open markets committee essentially agree.

The view expressed by Professor Buiter, however — that a central bank’s overriding concern should be fighting inflation, while a sinking economy is left to be refloated by other means — is welcome thinking for the five or so Fed policy makers, all of them presidents of regional Fed banks, who say that the Fed must begin to raise rates right away.

Mr. Bernanke, in a speech here, said that inflation is likely to moderate as commodity prices come down and the dollar stabilizes. But the Fed bank presidents who want a rate increase now say that he is missing the point. Unless the Fed takes action, they say, people will lose faith in it as a guardian against a rising inflation rate.

“These hawks at the Fed are arguing in effect that we have to throw people out of work more quickly than we already are to ensure against inflation,” said Jan Hatzius, chief domestic economist at Goldman Sachs.

So far, only one of the policy makers is pushing for higher rates. Richard W. Fisher, president of the Federal Reserve Bank of Dallas, has voted for a rate increase at recent Fed policy-making meetings, casting the lone dissenting vote among the Fed’s 11 voting governors and regional bank presidents. The other dissenters have voted with the majority to keep the key federal funds rate at 2 percent, actions that have muted their criticism of this approach.

Now, however, Charles I. Plosser, president of the Federal Reserve Bank of Philadelphia, is likely to join Mr. Fisher. Twice in the past, Mr. Plosser had cast a dissenting vote along with Mr. Fisher, the last time at the April 30 meeting, when the policy makers completed their rate cuts, bringing the federal funds rate to 2 percent. Ever since, he has voted with the majority and in doing so, he has maintained a silence that he says he intends to end soon.

“If we don’t reverse our accommodative stance sooner rather than later,” Mr. Plosser said in an interview here, “we will face rising inflation, which may be costly to deal with, and we will face a risk to the Fed’s credibility to contain inflation.”

meanwhile, the parry of bernanke's defenders is well contained here.

Assigned the task of critiquing the paper was Alan Blinder, the former Fed vice chairman, who gave high marks to the central bank. Mr. Blinder brought his point home to the crowd with a tale of a little Dutch boy (Mr. Buiter was born in the Netherlands), entertaining the crowd of international central bankers, academics and Wall Street economists:

One day a little Dutch boy was walking home when he noticed a small leak in a dike that protected the people in the surrounding town. He started to stick his finger in the hole, but then he remembered his moral hazard lesson. “The companies that built this dike did a terrible job,” the boy said. “They don’t deserve a bailout. And doing that would just encourage more shoddy construction. Besides, the dumb people who live here should never have built their homes on a floodplain.” The boy continued on his way home. Before he arrived, the dike burst and everyone for miles around drowned, including the little Dutch boy.

Mr. Blinder continued: “You might have heard an alternative version of this story circulating around the Fed.”

In this kindler, gentler version, the little Dutch boy, somewhat desperate and very worried about the horrors of the flood, stuck his finger in the dike and held it there until help arrived. … It was painful. The little Dutch boy would much rather have been somewhere else. But he did it anyway. And all the foolish people who live behind the dike were saved from the error of their ways.

this is a rather unfortunate analogy. while it must greatly assuage the egos of the central bankers involved, elevating their role to the heroic, it is false.

a more honest analogy would be to replace the dike with a dam -- holding back not a passing storm surge but the accumulating force of a river. while storms pass and their effects are transient, rivers continue to flow -- and the force of their retained water, rather than abating, inexorably grows.

central banking policy over the last seventy years (and more acutely the last twenty) have prevented at each potential intersection the credit market from reaching the clearing prices of maximum pessimism. in this revised analogy, the policy aim has been not to maintain the dam but to narrow the spillways designed to ensure that the force of the water behind the dam does not endanger the dam itself. the absence of those episodic cathartic events over a long span has already encouraged the buildup of systemic (as opposed to cyclical) debts, which have grown so large as to represent a mortal threat to systemic integrity -- the accumulated water behind the dam is very high now, and forcing the dam to crack. this leaves men like bernanke with the opportunity to cast themselves as heroes as they, while feverishly filling the cracks with their fingers, manage also lay the last few bricks to seal up the spillways completely.

central bankers like bernanke and blinder talk about moral hazard like it is a potential problem; this highlights just how narrow their view and tenuous their grasp of the underlying reality is, deluded by decades of apparent success that really amount to consistently storing up bigger trouble for the future. moral hazard has been the problem since monetary policy became a countercyclical weapon in the 1930s, indeed since the founding of the federal reserve bank in 1913.

i sympathize with blinder's view -- if rates are raised, the dam may well break. but what blinder does not seem to realize -- even in light of graphs like this -- is that if the dam isn't allowed to break today, it will shortly overtop and come crashing down. their little dutch policy, far from having nobly attempted to save the ageing baby-boom generation from "unnecessary" pain, will have surely imperiled and summarily destroyed them in their dotage and their children besides.

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Your 'Army Corps of Engineers' analogy is both apt and well articulated-I've used this myself (another apt one is 'The Sorcerer's Apprentices' from Fantasia...)
Storing up trouble for THE BIG ONE.

Whom the gods would destroy, and all that...


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ps Gaius-your blog is fantastic: your knowledge of history and geopolitics lend a gravity that other 'finance' blogs will never have...Thank you!


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thanks chuck -- that's too high of praise!

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the big squeeze

bill moyers on the burgeoning crisis of middle america through the lens of the suburbs of denver, colorado.

barry ritholtz reiterates today the disparity between econometrics and sentiment data. one need look no further than moyers' 15-minute documentary to see what the middle-class reality increasingly is and how it's driving sentiment. real wages have been falling for a decade; savings have fallen to nil and consumer debt has been skyrocketing for twenty years (as evidenced in this excellent reading via seeking alpha); and real asset prices are falling hard.

i think people are parading around like there might be a middle class, but i think they're so in debt that... that i don't think that really exists anymore. one paycheck and they'd be out there on the street.

this is more than the repo of luxury, though it is also that -- this is the return of hardship. it is probably the last thing on their minds in these times, but if these poor people cannot see how the policies of not only the bush administration but the political dynamic put in place since reagan and thatcher has precipitated their condition, then god help them. republican-voting middle-class suburbanites in colorado have been supporters, unwitting or no, of the development of the predator state. it is no exoneration of the democrats, of course, to say as much. they are reaping what they -- probably quite obliviously and stupidly, in a cloud of ideology and rhetoric -- have sown, and they need help. they need change.

UPDATE: more on middle class decline in this aged posting by yves smith.

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hi gm - been awhile. hey, nice post - see my blogpost's link for "faking the good life" (don't you love the way that sounds?). thanks for your info.

best regards - darkcloud.

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Friday, August 22, 2008


foreign central banks quit buying agencies

agency spreads over treasuries have, to most everyone's surprise, widened dramatically in recent weeks even after it became apparent that hank paulson's treasury was making plans to bail out fannie mae and freddie mac. one would think that, as agencies got closer to becoming de facto treasuries, spreads would have narrowed. just the opposite has happened, raising mortgage rates.

via brad setser and the economist -- the reason why has been the near-total abandonment of GSE debt instrument purchasing by their last sizable buyers, foreign central banks. it's no wonder the GSEs have downscaled their operations. setser:

The Chinese government took currency risk that private investors in China weren’t willing to take. The US government turn mortgages into liquid bonds that risk-adverse central banks would hold out by promising — implicitly — to take the credit risk.

And the resulting flow has been huge — and until recently, it was getting bigger. It now seems to have come to something close to a stop. Unless it restarts quickly, I suspect the US government will have to make its role in the process explicit.

In the short-run, the US needs this directed credit program to continue. Demand for non-Agency MBS has disappeared. And if credit isn’t available to buy homes, home prices will fall further, faster — adding to the distress of the US financial sector.

and that is why the treasury will be intervening to explicitly nationalize the mortgage market -- which now has a vanishingly small private component and very soon will have none, being crowded out by the treasury -- sooner and not later. with spreads having blown out, and with the two leviathans facing a debt roll of $223bn between now and the end of september, paulson will have no choice. freddie had to pay a borrowing cost to issue just $3bn in debt recently that makes their business model impossible. the chances of the GSEs turning over a sum 75 times that size without turning to the treasury are nearly nil.

once the debt guarantees of the GSEs become the explicit guarantees of the american taxpayer, one can hope that foreign central banks will return to funding american housing markets. indeed a successful nationalization of the obligations of the GSEs will probably bring mortgage rates down significantly, particularly if treasury (and congress, ostensibly) get serious about pouring borrowed money into mortgages in an effort to support prices.

that doesn't mean, however, that money will get borrowed. as with the ineffective reduction in policy rates engineered by the fed, one might fairly characterize a decline in mortgage rates as pushing on a string. the truth is that credit standards have become much, much tougher and only a small slice of the people who could've obtained a mortgage in 2005 can do so today. moreover, we may be experiencing a shift in social mood that creates a decline in the demand for credit regardless of its availability -- particularly as profit margins are crushed and joblessness becomes more common.

the other important point that has to be made -- this is the first example in my recollection of a shock in the financial balance of terror. china cutting off the GSEs inarguably damages the performance of their stock of agencies by aggravating housing conditions in the united states -- exactly the kind of tradeoff that most westerners have steadfastly presumed china would never make. very probably, china and other GSEs are simply forcing the hand of hank paulson -- the first explicit example of systemic financial blackmail against the united states by its rivals, something nouriel roubini recently implied we should get used to. (note too that russia too is a large foreign holder of american government and agency debt instruments.) but the use of debt as a policy weapon in this instance should put the united states and particularly the bush administration on notice -- through our debilitating profligacy, we have effectively outsourced a great deal of our monetary policy, and do not alone determine our fate.

UPDATE: ben bernanke made some comments today that might be relevant to the upcoming GSE bailout.

A statutory resolution regime for nonbanks, besides reducing uncertainty, would also limit moral hazard by allowing the government to resolve failing firms in a way that is orderly but also wipes out equity holders and haircuts some creditors, analogous to what happens when a commercial bank fails.

i cannot imagine he is laying the groundwork for refusing to make GSE debt instruments money good, but it bears watching.

UPDATE: accrued interest relays merrill's view that no GSE takeover will come down this weekend. the intention of keeping the GSEs shareholder-owned may not bring the FCBs back to the table, though -- it would be interesting to listen in on the conversations which are (hopefully) now taking place between washington and beijing.

UPDATE: yves smith on the chinese threat to "end... the current international financial system".

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volatility curve warning

this SPX volatility curve screen via futuresource is showing that the somnolent cash volatility commented on by adam warner is low enough vis-a-vis its 3- and 6-month futures that it may be reflecting complacency. at least in the recent past, when the cash VIX has approached 80% of its forward futures, a turn down has been in the cards. note the signal of the may high in the chart capture; the picture looked very similar around the time of the christmas 2007 high point as well.

bill luby also comments.

i further run a simple analytical screen of both VIX and VXN, a standard MACD of which is good at catching turns, particularly in bear markets (or at least such was the case 2001-2003 and since 2007). it's flashing another potential warning of a downturn, with a confirmatory crossover signal due in short order.



recognizing the real world order

via john mauldin -- stratfor's take on the russia-georgia conflict. in short, russia's foray into georgia is a response to and consequence of a weakly-supported american imperial expansion in the former soviet union.

Through the 1990s, the successor states, particularly Russia, were inert. Undergoing painful internal upheaval - which foreigners saw as reform but which many Russians viewed as a foreign-inspired national catastrophe - Russia could not resist American and European involvement in regional and internal affairs. From the American point of view, the reshaping of the region - from the Kosovo war to the expansion of NATO to the deployment of U.S. Air Force bases to Central Asia - was simply a logical expansion of the collapse of the Soviet Union. It was a benign attempt to stabilize the region, enhance its prosperity and security and integrate it into the global system.

As Russia regained its balance from the chaos of the 1990s, it began to see the American and European presence in a less benign light. It was not clear to the Russians that the United States was trying to stabilize the region. Rather, it appeared to the Russians that the United States was trying to take advantage of Russian weakness to impose a new politico-military reality in which Russia was to be surrounded with nations controlled by the United States and its military system, NATO. In spite of the promise made by Bill Clinton that NATO would not expand into the former Soviet Union, the three Baltic states were admitted. The promise was not addressed. NATO was expanded because it could and Russia could do nothing about it.

quid pro quo -- russia expanded into georgia because it could and the united states (with or without its imperial institution of NATO) could do nothing about it.

From the Russian point of view, the strategic break point was Ukraine. When the Orange Revolution came to Ukraine, the American and European impression was that this was a spontaneous democratic rising. The Russian perception was that it was a well-financed CIA operation to foment an anti-Russian and pro-American uprising in Ukraine. When the United States quickly began discussing the inclusion of Ukraine in NATO, the Russians came to the conclusion that the United States intended to surround and crush the Russian Federation. In their view, if NATO expanded into Ukraine, the Western military alliance would place Russia in a strategically untenable position. Russia would be indefensible. The American response was that it had no intention of threatening Russia. The Russian question was returned: Then why are you trying to take control of Ukraine? What other purpose would you have? The United States dismissed these Russian concerns as absurd. The Russians, not regarding them as absurd at all, began planning on the assumption of a hostile United States.

wise old bear -- ever the realist. as stratfor earlier noted, "Protests -- much less revolutions -- just do not happen often in this part of the world. ... there is more than a grain of truth to their assertions that the West orchestrated the social/political movements in Georgia and Ukraine."

The Russians have now proven two things. First, contrary to the reality of the 1990s, they can execute a competent military operation. Second, contrary to regional perception, the United States cannot intervene. The Russian message was directed against Ukraine most of all, but the Baltics, Central Asia and Belarus are all listening. The Russians will not act precipitously. They expect all of these countries to adjust their foreign policies away from the United States and toward Russia. They are looking to see if the lesson is absorbed. At first, there will be mighty speeches and resistance. But the reality on the ground is the reality on the ground.

We would expect the Russians to get traction. But if they don't, the Russians are aware that they are, in the long run, much weaker than the Americans, and that they will retain their regional position of strength only while the United States is off balance in Iraq. If the lesson isn't absorbed, the Russians are capable of more direct action, and they will not let this chance slip away. This is their chance to redefine their sphere of influence. They will not get another.

The other country that is watching and thinking is Iran. Iran had accepted the idea that it had lost the chance to dominate Iraq. It had also accepted the idea that it would have to bargain away its nuclear capability or lose it. The Iranians are now wondering if this is still true and are undoubtedly pinging the Russians about the situation. Meanwhile, the Russians are waiting for the Americans to calm down and get serious. If the Americans plan to take meaningful action against them, they will respond in Iran. But the Americans have no meaningful actions they can take; they need to get out of Iraq and they need help against Iran. The quid pro quo here is obvious. The United States acquiesces to Russian actions (which it can't do anything about), while the Russians cooperate with the United States against Iran getting nuclear weapons (something Russia does not want to see).

stratfor is implying that perhaps russian threats of military action in response to polish-american agreements over missile system basing -- ludricrously passed off by american officials as directed against some kind of iranian missile threat! -- are not entirely hollow, even if the two are separated by belarus and ukraine.

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Thursday, August 21, 2008


the crash of 1929

a film via google video -- interesting for its documentation of social mood.

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a question of efficacy

remember this chart -- particularly the spectacular acceleration seen in it since 2000? remember "deficits don't matter"? remember the words of joseph stiglitz?

The national debt has increased 50% in eight years, with almost $1-trillion of this increase due to the war — an amount likely to more than double within 10 years. Who would have believed that one administration could do so much damage so quickly?

how then to attempt to reconcile all that with this from fivethirtyeight?

Our popular vote projection shows a literal tie, with each of Barack Obama and John McCain projected to earn 48.5 percent of the vote, and third-party candidates receiving a collective 3 percent.

as i've noted several times previously, i'm a burkean conservative (what would now probably be called paleoconservative in some respects) with a historical tendency to vote republican. i am also a quiet admirer of the republic our founders attempted to organize in the constitution all those many years ago, and many of those who helped to define it in its early years.

but my disaffection with and disdain for what it has mutated into knows few bounds. i have said previously that the once-noble experiment has ended. if indeed the american people can return for a third term to the executive office the republican party following what has been -- differences of ideology aside -- the two least competent and counterproductive terms of executive administration in the whole 230-odd years of the nation's existence, it will severely damage my implicit support for the continuation of democracy in the united states. our current mode of governance would have to be seen as being broken.

i hardly think the democratic party and barack obama are some sort of panacea for american ills, as many of the yet-to-be-jaded young and liberal seem wont to hope. and a general tendency of favoritism toward the status quo is laudable and right in my view. we should be slow to change. but no voting body whose unresponsiveness to not only repeated, sometimes spectacular failure but aggressive and outright fraud and even criminality so profound as to mimic a national suicide attempt as durable as twelve years should be allowed or expect to retain the responsibilities of the ballot box.

as paul volcker rightly notes, "we'll see whether a democracy can deal with an obvious problem that's going to be present in not too many years -- and the earlier we take action to deal with it, the better." color me skeptical, even cynical, but i would say the answer is obviously not.

sulla's proscriptions were anything but democratic, but the evolution of government that they put in motion resulted in the establishment of the principate which for at least two centuries prior to the crisis of the third century reasonably managed politically and economically the senescence and decline of the roman empire. such an outcome, reviling though it is to jeffersonian sensibilities and fiery though the path to attaining it could well be, is probably too optimistic -- rome is remembered as the greatest of empires for a reason. but the alternative would seem to me to be the acceptance of a much more rapid fracturing and dissolution of the western anglophone universal state into a chaotic and multipolar dark age.

many a philosopher of the imperial period lionized the men and events of the republic -- that model of roman society was not abandoned lightly but of necessity. i sometimes fear that we too are fast approaching the analog of that time, much more quickly than most realize.

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leading indicators dive; profit margins being crushed

via bloomberg -- the conference board's index of leading economic indicators, reported this morning, surprised to the downside.

The Conference Board's index of leading indicators fell 0.7 percent in July, more than triple the drop forecast by economists surveyed by Bloomberg News. Separate reports showed the number of Americans collecting unemployment insurance remained near a five- year high last week and manufacturing in the Philadelphia region shrank for a ninth straight month.

``The economy has really shown one sign after another of weakening,'' Martin Feldstein, a Harvard University economist, said in a Bloomberg Television interview in Jackson Hole, Wyoming, where he's attending an annual Federal Reserve conference. Feldstein said he is ``much more pessimistic than a year ago'' about the outlook.

see the LEI chart here. (UPDATE: going further back, via barry ritholtz.)

it isn't hard to understand how the leading indicators could be getting beat down. kevin depew refocuses away from the headline PPI number to examine what the underlying components are saying.

In today's PPI report, the Finished Goods PPI was up 1.2%. The Intermediate Goods PPI was up 2.7%. The Crude Goods PPI was up 4.2%. What does this mean? Think about it for a moment.

If the prices you receive for your finished goods are rising at 1.2% month-over-month, while the prices for intermediate and crude goods are rising at a faster level - as they have been for almost six consecutive years now - then that means you are finding it difficult to pass through price increases to your customers.

that's a chart of profit destruction, and demonstrates how corporate incomes are contracting more severely now than at any point since 1980. corporate income sustains corporate debt, and moreover makes possible the wage gains that could fuel something more than a transitory increase in inflation expectations. rather, it is a signal that job losses are going to become much more severe in the near future as companies either cut back of go bankrupt. which ties in neatly with crashing leading indicators.

note particularly the seemingly miniscule dips that correspond to the 1990 and 2001 recessions.

unless or until the federal reserve cranks up the printing presses and starts debasing the dollar, this is a profoundly deflationary report.

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Wednesday, August 20, 2008



via yahoo -- an interesting way to track CGM focus fund.


Tuesday, August 19, 2008


getting small

via john mauldin -- merrill's david rosenberg.

consider his points on debt coverage, savings rate and vacancy rate with the context of these charts from russ winter.

we have a long way to go to the bottom.

UPDATE: more powerful warnings -- from jim rogers, marc faber and -- perhaps more novel -- richard russell. note the terminology -- "crash", "super-crash", "blow up" -- these are not unusual words for rogers and faber, but they are for russell.

particularly interesting in the context of nouriel roubini's recent comments is rogers' comparison to the decline of the british empire.

(Q): Is there a point in time or something you’re looking for that will signal that the U.S. economy has reached the inflection point in this crisis?

Rogers: Well, yeah, but it’s a long way away. In fact, it may not be in our lifetimes. ...

If you look back at previous countries that have declined, you almost always see exchange controls – all sorts of controls – before failure. America is already doing some of that. America, for example, wouldn’t let the Chinese buy the oil company, wouldn’t let the [Dubai firm] buy the ports, et cetera.

But I’m really talking about full-fledged, all-out exchange controls. That would certainly be a sign, but usually exchange controls are not the end of the story. Historically, they’re somewhere during the decline. Then the politicians bring in exchange controls and then things get worse from there before they bottom.

Before World War II, Japan’s yen was two to the dollar. After they lost the war, the yen was 500 to the dollar. That’s a collapse. That was also a bottom. ...

It was similar in the United Kingdom. In 1918, the U.K. was the richest, most powerful country in the world. It had just won the First World War, et cetera. By 1939, it had exchange controls and this is in just one generation. And strict exchange controls. They in fact made it an act of treason for people to use anything except the pound sterling in settling debts.

(Q): Treason? Wow, I didn’t know that.

Rogers: Yes…an act of treason. It used to be that people could use anything they wanted as money. Gold or other metals. Banks would issue their own currencies. Anything. You could even use other people’s currencies.

Things were so bad in the U.K. in the 1930s they made it an act of treason to use anything except sterling and then by ’39 they had full-exchange controls. And then, of course, they had the war and that disaster. It was a disaster before the war. The war just exacerbated the problems. And by the mid-70s, the U.K. was bankrupt. They could not sell long-term government bonds. Remember, this is a country that two generations or three generations before had been the richest most powerful country in the world.

rogers is clearly a believer that the policy response to incipient deflation will be an episode of inflation that will precipitate a dollar crash and render the united states a non-credit -- though he is careful to qualify, as was roubini, that the end of the american empire will be a process taking decades to complete (though it may well have begun in the late 1990s).

(Q): Is there a specific signal that this is “over?”

Rogers: Sure…when our entire U.S. cabinet has Swiss bank accounts. Linked inside bank accounts. When that happens, we’ll know we’re getting close because they’ll do it even after it’s illegal – after America’s put in the exchange controls. ... [Y]ou look at people like the Israelis and the Argentineans and people who have had exchange controls – the politicians usually figured it out and have taken care of themselves on the side.

(Q): We saw that in South Africa and other countries, for example, as people tried to get their money out.

Rogers: Everybody figures it out, eventually, including the politicians. They say: “You know, others can’t do this, but it’s alright for us.” Those days will come. I guess when all the congressmen have foreign bank accounts, we’ll be at the bottom.

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deflation strengthens

another month, another step down in credit supply. following on the last update, via yves smith comes reporting from the telegraph's ambrose evans-pritchard.

Data compiled by Lombard Street Research shows that the M3 ''broad money" aggregates fell by almost $50bn (£26.8bn) in July, the biggest one-month fall since modern records began in 1959.

"Monthly data for July show that the broad money growth has almost collapsed," said Gabriel Stein, the group's leading monetary economist.

On a three-month basis, the M3 growth rate has fallen from almost 19pc earlier this year to just 2.1pc (annualised) for the period from May to July. This is below the rate of inflation, implying a shrinkage in real terms.

The growth in bank loans has turned negative to a halt since March.

"It's obviously worrying. People either can't borrow, or don't want to borrow even if they can," said Mr Stein.

Monetarists say it is the sharpness of the drop that is most disturbing, rather than the absolute level. Moves of this speed are extremely rare....

Monetarists insist that shifts in M3 are a lead indicator of asset prices moves, typically six months or so ahead. If so, the latest collapse points to a grim autumn for Wall Street and for the American property market. As a rule of thumb, the data gives a one-year advance signal on economic growth, and a two-year signal on future inflation.

"There are always short-term blips but over the long run M3 has repeatedly shown itself good leading indicator," said Mr Stein...

there has been further amplification of the debate within the economic community regarding inflation versus deflation. in spite of steve waldman's very cogent view -- and historically informed at that, as policymakers have generally opted for inflation over deflation as the more politically palatable -- i have subscribed to the eventuality of a surprising and fairly severe deflation as a result of the nascent deleveraging of the economy, rather along the lines of the japanese example. while i qualitatively agree with waldman in some respects, the size of the credit bubble makes it difficult for me to envision the requisite speed of monetary expansion that would be required to offset deflationary deleveraging.

at this time, the federal reserve isn't expanding the aspects of money supply that it controls. it has lowered rates, but credit supply and demand are declining anyway as banks and consumers both seek balance sheet repair. it has provided the use of its balance sheet to large banks and broker/dealers, but offset those facilities through open market operations. as credit supply evaporates, this is resulting in the near-crash of broad money aggregates that the telegraph is reporting.

the debate will be settled if or when the fed sees fit to respond to this collpase by expanding money supply in an attempt to offset the contraction of credit supply.

the first question is this: will the fed try? that is deeply debatable, and depends on our view of what the fed is. karl denninger would tell you and correctly that the fed is a bank owned and operated not by government but by banks, and it is deflation -- not inflation, but deflation -- that better suits banking.

The banker makes money in terms of real value in a deflationary environment. You, on the other hand, being debt, get rammed.

Ok, now let's look at hyperinflation. ... what happens to the banker? He gets reamed in both holes. ...

Those who argue that Bernanke will "hyperinflate" have a tiny little problem with their thesis. That thesis depends on Bernanke and the rest of the banks (who are, in fact, his masters as well as his servants) acting in a fashion that is explicitly against their own self-interest.

See, banks normally want a small amount of inflation. Just enough to make it not worth it for you to hoard cash, as it slowly devalues. This forces you to spend and invest, lest you see your purchasing power disappear.

But what a bank never wants to see is an inflation rate that is above their lending "spread", or the difference between their cost of funds and what they charge. If that ever happens then they lose big; remember, all banks are leveraged and as such small "percentage" base losses get multiplied by their leverage ratio!

whether or not denninger is correct depends largely on the extent to which the fed remains politically independent and loyal to its constituency of bankers. as deflation really gathers momentum and becomes a populist cause celebre, i sincerely doubt it will retain even its somewhat questionable current level of political independence. the zeitgeist of demotic america seems to suggest it cannot hold as the naked tool of oligarchs.

secondly, however, there is the question of whether or not printing can as a pragmatic matter proceed with sufficient pace from a base of several hundreds of billions to offset the unwinding of tens of trillions in debt. what is theoretically possible may not as a realistic matter be achieveable.

yves smith sees first deflation and then ultimately a policy response of currency devaluation and inflation -- a mechanism similar to that operated in the great depression in britain and the united states, and also in japan in the 1990s, both with mixed success. but the difficulty of that policy response will be the massive net international debtor position of the united states today. the potential of foreign creditors fleeing the dollar in revulsion of a soft default to precipitate a currency crisis and deep depression is the elephant in the reflationary room. while waldman sees this as shifting the pain of adjustment onto external parties, the result would be a much more intense form of credit collapse within the united states than we've seen.

at the moment, the evidence of monetary aggregates and falling asset and commodity prices demonstrate that deflation is clearly pushing through the system. the deleveraging is underway. interested observers will now have to wait for the fed and treasury to return serve -- the ball is in their court.

UPDATE: clarification via mish.

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Monday, August 18, 2008


the end of empire?

the new york times lionized nouriel roubini over the weekend.

What economic developments does Roubini see on the horizon? And what does he think we should do about them? The first step, he told me in a recent conversation, is to acknowledge the extent of the problem. “We are in a recession, and denying it is nonsense,” he said. When Jim Nussle, the White House budget director, announced last month that the nation had “avoided a recession,” Roubini was incredulous. For months, he has been predicting that the United States will suffer through an 18-month recession that will eventually rank as the “worst since the Great Depression.” Though he is confident that the economy will enter a technical recovery toward the end of next year, he says that job losses, corporate bankruptcies and other drags on growth will continue to take a toll for years.

Roubini has counseled various policy makers, including Federal Reserve governors and senior Treasury Department officials, to mount an aggressive response to the crisis. He applauded when the Federal Reserve cut interest rates to 2 percent from 5.25 percent beginning last summer. He also supported the Fed’s willingness to engineer a takeover of Bear Stearns. Roubini argues that the Fed’s actions averted catastrophe, though he says he believes that future bailouts should focus on mortgage owners, not investors. Accordingly, he sees the choice facing the United States as stark but simple: either the government backs up a trillion-plus dollars’ worth of high-risk mortgages (in exchange for the lenders’ agreement to reduce monthly mortgage payments), or the banks and other institutions holding those mortgages — or the complex securities derived from them — go under. “You either nationalize the banks or you nationalize the mortgages,” he said. “Otherwise, they’re all toast.”

For months Roubini has been arguing that the true cost of the housing crisis will not be a mere $300 billion — the amount allowed for by the housing legislation sponsored by Representative Barney Frank and Senator Christopher Dodd — but something between a trillion and a trillion and a half dollars. But most important, in Roubini’s opinion, is to realize that the problem is deeper than the housing crisis. “Reckless people have deluded themselves that this was a subprime crisis,” he told me. “But we have problems with credit-card debt, student-loan debt, auto loans, commercial real estate loans, home-equity loans, corporate debt and loans that financed leveraged buyouts.” All of these forms of debt, he argues, suffer from some or all of the same traits that first surfaced in the housing market: shoddy underwriting, securitization, negligence on the part of the credit-rating agencies and lax government oversight. “We have a subprime financial system,” he said, “not a subprime mortgage market.”

Roubini argues that most of the losses from this bad debt have yet to be written off, and the toll from bad commercial real estate loans alone may help send hundreds of local banks into the arms of the Federal Deposit Insurance Corporation. “A good third of the regional banks won’t make it,” he predicted. In turn, these bailouts will add hundreds of billions of dollars to an already gargantuan federal debt, and someone, somewhere, is going to have to finance that debt, along with all the other debt accumulated by consumers and corporations. “Our biggest financiers are China, Russia and the gulf states,” Roubini noted. “These are rivals, not allies.

The United States, Roubini went on, will likely muddle through the crisis but will emerge from it a different nation, with a different place in the world. “Once you run current-account deficits, you depend on the kindness of strangers,” he said, pausing to let out a resigned sigh. “This might be the beginning of the end of the American empire.

roubini expounded at length in his blog.

... [S]ince 2001 the further worsening of the US current account deficit was driven instead by growing fiscal deficits - especially in the 2001-2004 period – caused by unsustainable tax cuts and by the buildup of spending on foreign wars and on domestic security and since 2002 by the collapse of household savings and boom in investment in unproductive stock of housing capital that the housing bubble induced. And while the weak dollar is now inducing a modest improvement of the external deficit the looming sharp increase in fiscal deficits - that the current recession and financial crisis is inducing - will cause a return of twin deficits in the coming years. By now the US is the biggest net borrower in the world – running current account deficits still in the 700 billion dollars range – and the biggest net debtor in the world with its foreign liabilities now over 2.5 trillion dollars.

The trouble with these twin deficits is multi-fold. First, superpowers and empires - like the British Empire at its peak - tend to be net lenders – i.e run current account surpluses – and be net creditors, not net debtors; The decline of the British Empire started in World War II when the British fiscal deficits in the war and the current account deficits turned that empire into a net borrower and a net debtor both in its public debt and external debt. That financial switch into an external debtor and borrower position was also the reason for the decline of the British pound as the leading reserve currency. And the British twin deficits were being financed by a rising economic and financial power that was a net lender and a net creditor, the US.

Second, the last time the US was running large twin deficits in the 1980s the main financiers of these deficits were the friends and allies of the US, i.e Japan, Germany and Europe as the US external deficit was against these economies. Today instead the economic powers financing the US twin deficits are the strategic rivals of the US – China and Russia – and unstable petro-states, i.e Saudi Arabia, the Gulf States and other shaky petro-states. This system of vendor financing – with these US creditors providing both the goods being imported and the financing of such deficits – has led to a balance of financial terror: if these creditors were to pull the plug on the financing of the US twin deficits the dollar would collapse and US interest rates would go through the roof.

few americans understand that empire, often undertaken with beneficial economic premises in mind, is an intensely expensive activity for any organization.

the rise of the united states from expanding emerging market circa 1870 to global power circa 1918 to superpower in 1945 was fueled by real economic growth -- a blessed combination of inexpensive territorial expansion, massive population growth and rampant industrialization underpinned that line of development -- in conjunction with the near-complete lack of a standing armed forces or need of the other standard expenses of imperial maintenance. but 1945 brought empire -- specifically the inheritance of the rump of the british commercial empire -- and with it a permanent and voracious military-industrial complex. the diversion thereafter of a significant share of national income to the unproductive constructs of the imperial security state we euphemized as 'the cold war' eroded the dynamism of the america economy, which has since the late 1940s gradually fallen back to the field as a share of global production. as economic output refused to keep pace with the growth of the imperial siphon, a spiral of degradation set in, the symptoms of which were visible by the late 1970s -- a devalued currency, chronic indebtedness, economic stagnation.

the solution, so called, arrived in 1981 with the election of the reagan administration -- which did nothing so well as to begin the deregulation of finance private and public and spark the birth of the financial services industry. against an inflationary background which penalized domestic savings, social mood changed and the concept of american indebtedness caught fire. debt as a percentage of GDP began its harrowing ascent, the result being a somewhat illusory prosperity as current consumers, corporations and governments began to borrow eagerly against future income with ever greater ease. the emergent facilitators of that borrowing -- stepping into the role that the united states itself had played for the desiccating european empires of the 19th and early 20th centuries -- were east asian industrial powers, first japan and europe, thereafter 1997 china, russia, korea and a host of others, as well as petrostates both inside and outside the mideast.

roubini is here countenancing the end of this dynamic of vendor finance that has nourished and indeed made possible american empire, hubris and contentedness for nearly three decades.

roubini validly cites the decline of the british empire -- one that had been underway since the bleeding of 1914 -- but i would forward another for further context. the soviet union, which had been experiencing a perhaps even more rapid decline in its share of world production in the aftermath of the second world war, finally found itself unable to reconcile a massive growth in its imperial military/security spending with the halving of global oil prices in the 1980s. the soviets were compelled to move away from autarky and became progressively more reliant on western financing as their energy export revenues declined without concomitant declines in spending -- even as they financed a bloody and corrupting long war in central asia. indeed american engineering of a global oil glut with the obedience of its saudi client state sought to manufacture this outcome and achieved it. the rate of increase of soviet foreign indebtedness rapidly grew on the accession of mikhail gorbachev in 1985, as he borrowed from the west to finance his attempts to improve the society's manufactured goods export competitiveness, hoping to pay back the debt by returning the soviet union to a trade surplus. this never happened, as western banks cut moscow off as its debt-to-GDP ratio rose to uncomfortable levels with the soviet government budget deficit running at about 15%, effectively precipitating the abandonment of imperial possessions beginning in 1989. phyllis schlafley was irate about it then, as was the wall street journal -- i wonder if they eventually understood what a critical lever western banks proved to be in destroying the soviet union.

the result, even ten years after the collapse of the soviet union, was a humiliated post-soviet russia reduced to barter and unrestricted asset sales for hard currency, following the default on soviet-era rouble debt that famously precipitated the august 1998 long-term capital management crisis on wall street -- saddled with such metrics as 80% total external debt to GDP, 200% total external debt to exports, and 550% total external debt to revenues.

thinking about the collapse gap gives me the shakes. however, while the worst outcome is certainly on the spectrum of the possible, does anyone really expect the united states to follow the soviet union's comprehensive dissolution?

yet, in spite of the seemingly ludicrous comparison, while the economic cases may be quantitatively different it must be said that they are qualitatively of a kind. joseph stiglitz can call the american economy "war-torn" with credibility. the united states being crippled by high-price energy imports is the inverse analog to the soviets being crippled by low-price energy exports. as a result, the pace of foreign borrowing has accelerated monstrously, per stiglitz:

Moreover, this war has been funded differently from any other war in America’s history... Normally, countries ask for shared sacrifice... Taxes are raised. ... When America went to war, there was a deficit. Yet remarkably, Bush asked for, and got, a reckless tax cut for the rich. That means that every dollar of war spending has in effect been borrowed.

For the first time since the Revolutionary War, ... America has had to turn to foreigners for financing, because US households have been saving nothing. The numbers are hard to believe. The national debt has increased 50% in eight years, with almost $1-trillion of this increase due to the war — an amount likely to more than double within 10 years. Who would have believed that one administration could do so much damage so quickly?

as a result of that damage, the united states indeed may be facing a foreign financing crisis of great importance in the near future. that possibility seemed some several steps closer today as foreign buyers of fannie mae and freddie mac securitized debt appeared to be not only backing away from further purchases but selling.

it is also quite important, i think, to note that no one envisioned the collapse of the soviet union even in 1988. western bankers prattled about the USSR's excellent payment history, never envisioning sovereign default as they made tens of billions in non-recourse loans. correspondingly, that few would publicly expound on the possibility of an imperial collapse for the united states is little comfort. the fact of the matter is that -- while roubini and others think it unlikely -- china has more to gain than to lose by increasing the pace of withdrawal from the vendor finance scheme and accelerating the depegging of the yuan. on the strength of external research i've read, this is a process that -- if central bank policy in the united states remains rampantly easy in light of the insolvency of the banking system, thereby transmitting inflation into china through the exchange rate support -- could be compressed into as little as 36 months as chinese government seeks to rein in the expansion of money supply. in that case, the collapse of both american economy and empire could be shockingly sudden.

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"...a balance of financial terror: if these creditors were to pull the plug on the financing of the US twin deficits the dollar would collapse ...."

If the dollare collapses, China et al. take a huge hit on their dollare holding. Sounds a little like mutual assured destruction. Maybe, like nuclear war, it won't happen.

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it has to end simply because it isn't sustainable, ae. but i do agree there's reason to hope that the transition could be gradual.

that would be rare, however, in the historical record compared to crisis transitions.

moreover, china has much to gain from letting the yuan go to free-float.

this would have the great intermediate-term benefit of moderating chinese inflation and cutting speculative inflows to the country, even though the transition could be disruptive. it is also the long term policy goal of the chinese government as they move to a free floating currency from a dollar peg, which will likely allow the yuan to become the de facto reserve currency of the far east (with all the implied benefits). as demonstrated by private research i've had the pleasure of reading, many highlight the potential cost to china -- particularly forex losses on its massive dollar-debt holdings -- but ignore the manifold benefits. a stronger yuan would reduce the cost of oil for china in local terms, and this benefit alone given the rate of oil consumption in china would all but offset all the forex losses. its export sector would be hampered on the lowest end, but china is already in the process of moving its manufacturing capacity up the scale of finished goods into more complicated products (such as cars and semiconductors) where there are simply no viable competitors in the world on quantity and price. the net cost to china of revaluation is widely overestimated in the united states -- largely out of wishful thinking, i suspect.

the end of boom-tail commodity inflation and the onset of deflation has put china in a similar position to what the united states found itself in 1930. inflation control won't be a problem there again soon, so the pressure is off there.

but the intermediate term realization should be, i think, that the american current account deficit will close as china transitions away from vendor finance.

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