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Wednesday, June 03, 2009

Recovery a matter of perception

The US economy is in a state of continuing decline. The mass media, meanwhile, is constantly praising confidence and the rebound to come, the so-called "green shoots."

Now if the US should experience a rapid exit out of the recession, it will be because the giant credit bubble has been re-inflated. If the US intends to re-inflate, it might be because the debt load is too large to repay. Another reason might be the political price of raising taxes. I saw that US payroll tax receipts were 44% below last years, an indicator of higher unemployment and a drop in wages lost as our manufacturing base tanks.

Attempting to rebound by even more lending is an admission that our monetary system is in fact a house of cards, a Ponzi scheme where later investors are paid with older money.

Assuming that we're back on our way to record borrowing might not be that good of a destination. The America that will emerge from the recession will be a stronger one only if it's shaken some of the burden of debt, rather than re-inflated through more borrowing.

Expansion has not been sustainable because as consumer were paid more, they spent even more, to the point Americans' net saving rates were negative. It's not enough to print money and distribute it--things must be bought. In the modern period, perhaps not coincidentally from about the time the Fed was created, credit has been the way our consumption-oriented economy has grown. By lending, banks encouraged an expansion of economic activity and hiring, house-building and buying, while bolstering their profits, assuming their loans get repaid.

No healthy consumer would consider getting in debt a model for sustainable growth, although I'm sure the financial companies lending the money can made billions by lending. Now though, even for them, the price of too much lending has become quite high as foreclosures rise and job losses mount, increasing defaults on credit card debt.

We don't simply lend for lending sake, not the bankers' alone. It's the underlying economic activity that borrowing encourages, and is sought after by macroeconomists. Still, looking at debt in isolation distorts the broader policy framework needed for macroeconomic change. In plain English, debt is a bad thing-- a way not out but to be trapped in. Savings will reduce that debt to the point it's manageable. Then of course will come the natural predilection to overspend once again, but we can worry about that later.

The slowdown is actually be a wholly natural response to an overheated economy, and a healthy reaction. Rather than try to re-heat the economy by lending out billions to people and corporations struggling under too much debt, perhaps we need to focus on paying down debt. Instead our federal government has decided to intervene spending trillions on top of trillions. If anything this over-borrowing will accelerate the decline of the value of the dollar, whether by causing a lenders to forestall their purchases of US government-issued debt, or by inflation caused by monetizing the debt--basically printing money to pay for bonds we issue.

One major factor that could curtail the recovery is also the availability of credit for lending banks from foreign sources. We've grown dependent on foreigners to finance our government's borrowings. This cannot change, unless of course we simply print and distribute dollars ad nauseum, to the point the grow utterly worthless over time. We need to anchor our dollar and Government debt in sound monetary policy. Inflating the debt may be preferable to facing the consequences of higher taxation, an almost certain inevitability under the budget deficits of the present. Still, if Americans save, and spend less on imports--the natural consequence of economic contraction--we can have more money available to invest herein home, for our long-term benefit.

So quickly the size of these inter-bank and hedge fund derivatives grew. The companies involved made record profits, even if they weren't entirely sure what they were seling, or how risky it was.

Their size and importance to the US economy--at least on paper--grew massively. The US economy has become increasingly a product of financial services corporation output, which now accounts for some 40% of GDP.

I keep raising this point because that portion of the economy doesn't make anything real. Profits are generated by washing piles of electronic dollars, or selling securitized debt through a shadow banking, or private credit money system. By creating money in debt-backed securities, these financial companies were then able to speculate, with electronic dollars created out of thin air by churning huge sums of credit derivatives among each other, in private money transactions.

How much more capital will the banks need? This question can only be determined by a rigorous and objective audit of the banks. Such a review should be transparent, in order to inspire public confidence.

In order to assess the financial strength of the financial companies, the extent of their liabilities needs to be uncovered. That task may be impossible, judging by the sheer number of derivatives bought, sold, or owed by one financial entity to another. And there are the CDSs. I've talked about complex insurance policies called Credit Default Swaps which kick in if the value of the underlying debt security declines beyond a certain point.

The assessment of CDS-insured prices becomes a futile exercise, kind of like the question "which came first the chicken or the egg?" Should the debt securities all decline in value to the point that the CDSs kick in, it's likely that the companies underwriting the risk will go bankrupt, in what is called systemic risk--the ripple effect of one insolvency leading to others. The possibility of a meltdown which was the chief reason for TARP and the federal interventions with AIG last fall.

Containing a potential system wide collapse may have averted a crisis but that's hardly the same as helping the economy, and dodging a crisis does not a recovery make.

We are now being told to turn the other cheek, at least on torture. After so much fear-mongering, how can Americans really believe that what they're told is true?

Even the recovery is perception managed as if building public confidence were an end in itself. The reaction to the crisis so far--all in the past we are told as if the current reality could be transposed on the past, washing it out--appears to be nothing more than a methodology to put more money in the hands of the bankers.

Basically the whole crisis we face today, while real, is stage-managed to engender maximum popular support for financial assistance for government, in this case directed towards the financial entities who have the most influence in government, thereby shaping policy around their interests.

Every wisp of potentially good news about home sales is blown into unrealistic expectation as part of the media happy train on the economy the truth is home sales are going up because their prices have come down. Lower prices, more sales. Nothing more or less need be read into the data.

Under these circumstances, it's hard not to get conspiratorial about why the US economy seems so prone to cyclical upheaval, as much as we are told that we'd advance into a "service economy" which transcends peaks and valleys in the economy. In the past I've brought up the reality that the conclusion of each economic cycle in this country results in greater wealth being concentrated in fewer hands. Essentially the wealthy can use their capital more effectively, and capture better rates of return on investments long before wages recover. We can't blame the rich for causing the crisis or can we? After all, it was persistent efforts to change longstanding regulations, and operate a extremely loose money policy that triggered the crisis.

Increasing home "ownership" ( a misnomer because this term is better described as "home borrowship") has long been a stated policy of the (command and control) political economy, a monster we've been feeding, one wrapped around unsustainable borrowing, not to mention the machinery of the State, the Tapeworm Economy, a system created for the benefit of insiders. Perhaps the fate of the economy rests in the hands of the militiary industrial complex and other feeders at the federal trough, a most ignoble procession now led by the banks. Perhaps our state of permanent war nurtures a war economy that can't stop. Kill the parasite and you kill the host.

Unlike past crisis, much of the fiscal resources devoted to a recovery have been directed to financial companies, under the shaky premise that the loosening credit would act as a giant stimulus. Now while lending could help, it may well be that things happen for a reason. The lower lending were now seeing is the direct result of higher savings rates. People are rightfully worried about their job security. Accordingly they act to reduce consumption, which slows the general economy.

Media environment

The media consolidation occurring under Bush has contaminated coverage of the markets. The idea is that by controlling the media, right wing causes get preferential coverage, while stories negative to the prevailing media myths of the moment get zero coverage. Case in point: Geithner's recent trip to China and speech to Peking University. In Tuesday's New York Times, no mention was made of the Chinese reaction to Geithner's statement that US Treasuries were basically sound. Chinese there laughed, a reaction that shows just how rhetoric-driven Geithner is, and how much more knowledgeable Chinese were about the true state of the US's finances. See the BBC article here.

For a more accurate picture of what really happened, look at fund manager Axl Merk's article and video at SafeHaven.com. Writing in advance of Geithner visit, Merk protests the idea that the Chinese "need to be sold US Treasuries. The Chinese are very well aware about all the issues surrounding Treasuries...the structural deficits, and the insatiable appetite of the US Congress..."

Merk runs a hard currency fund, which invests in currencies from countries with "sound monetary policies" which obviously doesn't include the US. In the past I've considered these types of funds, but can't say for sure when the dollar will depreciate, and against which currencies. So I guess I'd be hesitant to recommend any currency. Besides, the dollar may devalue, but interest rates might allow the investor to better stay up with inflation, although as always I mention I hold silver and no equity, not exactly a balanced portfolio, but then again I don't have much capital.

Every day a cheering squad on CNBC led by Larry Kudlow talks up the resurgent US economy. The over-optimism has led some to conclude that this more recent rally, with the market having a great May, might be for suckers. That idea is that the more the insiders talk about how much better things are, the more they are looking to sell, kind of like Enron's top management shortly before that company fell. Of course no one with a lot of money at risk wants to scare potential investors or raise doubts about the market. Kudlow does have a genuine affection for the marketplace, beyond just seeing his millions appreciate--he and the rest of the investor class need to see the promise of economic vitality preserved, if not in reality than at least in the perpetually rosy prognosis on a gateway for a conservative company, GE, parent of NBC.

Confidence-building can't replace sound bookkeeping. The truth has a way of getting out anyway.

Additional Sources

Banks are still trying to use shortcuts, just like the debt securitization and over-leverage which led to the crisis. See this article by Ryan Grim in HuffPo about the banks fluffing up their earnings through accounting chicanery. See also this postin moneymorning.com, too. Also, I thought this commentary by Howard Davidowitz on yahoo was quite striking.

I was pleased to see my earlier reference to Andy Kroll's "Six Ways to Scam the Bailout Scams" (kind of like a Letterman list) made a few months ago pop up at tomdispatch.com. Engelhardt refers to the bailout as an instrument of investor class insider like Geithner, who's tied to the same investor class bozos who got us into this mess.

For more on a tool of the investor class who's someone made his way into Obama's circle of toxic advisors is this March truthout.org column by Robert Scheer about Gary Gensler, nominated for the position of Commodity Futures Trading Commission.

Last year, I'd blogged about testimony by a former chairman of that body, Michael Greenberger, concerning the regulations subverted, which in turn allowed massive speculation on oil and other commodities. The C-Span video was down, lost I guess to the digital memory hole. NPR's Terry Gross does interview Greenberger, available courtesy Tony Wikrent at epluribusmedia.net.

In the May Atlantic is Jeffrey Goldberg's entertaining article "Why I Fired My Broker."


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