Sunday, August 30, 2009

Have Physicists Cracked the Stock Market?


New Scientist is reporting that physicists have largely figured out how to predict the end of bull markets:

A team of physicists and financiers have ... successfully predict[ed] a steep fall in the Shanghai Stock Exchange.

Their model, which employs concepts from the physics of complex atomic systems, was developed by Didier Sornette of the Financial Crisis Observatory in Zurich, Switzerland, and Wei-Xing Zhou of the East China University of Science and Technology in Shanghai. The idea is that if a plot of the logarithm of the market's value over time deviates upwards from a straight line, it's a clear warning that people are investing simply because the market is rising rather than paying heed to the intrinsic worth of companies. By projecting the trend, the team can predict when growth will become unsustainable and the market will crash.

Sornette, Zhou and colleagues applied their model to the Shanghai Composite Index, which tracks the combined worth of all companies listed on the Shanghai Stock Exchange, the world's second largest.

Early this year, the index gained 50 per cent in just four months. In July, the
team predicted that the index would start to fall sharply by 10 August (www.arxiv.org/abs/0907.1827). The index duly began to slide
on 4 August, falling almost 20 per cent in the subsequent two weeks.

So we can all predict the stock market and make a ton of cash, right?


Not so fast:
"If enough investors take action based on our predictions, the evolution of prices will probably be affected," says Zhou.

In other words, everyone will start factoring in the predicative power of the model, and selling out of late-stage bull markets earlier.


Print this post

Insiders Selling Stocks at Highest Level Since May 2008


Best buying opportunity since the Great Depression?

TrimTabs is reporting that insiders know better:

Selling by corporate insiders in August has surged to $6.1 billion, the
highest amount since May 2008. The ratio of insider selling to insider buying
hit 30.6, the highest level since TrimTabs began tracking the data in 2004.

"The best-informed market participants are sending a clear signal that the
party on Wall Street is going to end soon," said Charles Biderman, CEO of
TrimTabs.

TrimTabs explained that insider activity is not the only sign the rally is
about to end. The TrimTabs Demand Index, which tracks 18 fund flow and sentiment
indicators, has turned very bearish for the first time since March.

For example, short interest on NYSE stocks plummeted by 10.3% in the second
half of July and margin debt on all US listed stocks spiked 5.9% in July, while
51.6% of advisors surveyed by Investors Intelligence are bullish, the highest
level since December 2007.

"When corporate insiders are bailing, the shorts are covering and investors
are borrowing to buy, it generally pays to be a seller rather than a buyer of
stock," said Biderman.

TrimTabs also reports that the actions of U.S. public companies have been
bearish. In the past four months, companies have been net sellers of a record
$105.2 billion in shares.

"Investors who think the U.S. economy is recovering are going to get a big
shock this fall," said Biderman. "Companies and corporate insiders are signaling
that the economy is in much worse shape than conventional wisdom believes."


Print this post

Deflation Round -Up

As Absolute Return Partners wrote in its July newsletter:

The most important investment decision you will have to make this year and possibly for years to come is whether to structure your portfolio for deflation or inflation.

So which is it, inflation or deflation?

This is obviously a hot topic of debate, and experts weigh in on both sides. I’ve analyzed this issue in numerous previous posts (and try to make argue the case for inflation here), and every day there are new arguments one way or the other from some very smart people.

But deflation seems to be winning.

Who Says?

Nobel prize winning economist Joseph Stiglitz says:

Deflation is definitely a threat right now.

Alan Greenspan said on September 30th:

We are still, by any measure, in a disinflationary environment.

And the President of the Chicago Federal Reserve Bank, Charles Evans, said on September 9th:

Disinflationary winds are blowing with gale-force effect.

How Bad Could It Get?

The biggest deflation bears are rather pessimistic:

  • Former chief Merrill Lynch economist David Rosenberg says that deflationary periods can last years before inflation kicks in
  • PhD economist Steve Keen says that – unless we reduce our debt – we could have a “never-ending depression”

These are the most pessimistic views I have run across. Most deflationists think that a deflationary period would last for a shorter period of time.

The Best Recent Arguments for Deflation

Following are some of the best arguments for deflation.

Unemployment

Wall Street Journal’s Scott Patterson writes that we won’t get inflation until unemployment is down below 5%:

A rule of thumb is that inflation doesn’t become sticky until the unemployment rate dips below 5%…

“I see very little prospect of accelerating inflation” partly because of the employment outlook, said Mark Zandi, chief economist of Moody’s Economy.com. “I don’t think the risk shifts toward inflation until 2011, or even 2012.”

It could take a lot longer for unemployment to go back down to 5% (and for consumers to have more money to spend again).

Job losses are accelerating.

JPMorgan Chase’s Chief Economist Bruce Kasman told Bloomberg:

[We've had a] permanent destruction of hundreds of thousands of jobs in industries from housing to finance.

A new report from Advance Realty and Rutgers - America’s New Post-Recession Employment Arithmetic - argues that we will not have a full recovery in unemployment until until 2017, and that:

• The Great 2007–2009 recession is the worst employment setback in the United States since the Great Depression.

• In the twenty months from December 2007 (the start of the recession) to August 2009 (the last month of available data as of this analysis), the nation lost more than 7.0 million private-sector jobs.

• The recession followed a very much-below-normal economic expansion (November 2001–December 2007) that was characterized by relatively weak private-sector employment growth of approximately 1 million jobs per year.

• This was less than one-half of the job-growth gains of the two preceding expansions (1982–1990 and 1991–2001), when average annual private-sector employment grew by 2.4 million jobs per year and 2.2 million jobs per year, respectively.

• In the preceding two expansions combined, private-sector employment growth per year was approximately 435,000 jobs higher than the annual growth in the number of people in the labor force.employment deficit.

• The weak economic expansion sandwiched between two recessions (2001, and 2007–2009) produced a lost employment decade.

• As of August 2009, the nation had 1.3 million (1,256,000) fewer private- sector jobs than in December 1999. This is the first time since the Great Depression of the 1930s that America will have an absolute loss of jobs over the course of a decade.

• From 1980-2000, the US gained a 35.5 million private-sector jobs. During the current decade, America has lost more than 1.7 million private-sector jobs.

• Total “employment deficit” could approach 9.4 million private-sector jobs by December 2009.

New jobs aren't being created.

Even Larry Summers says unemployment will remain 'unacceptably high' for years.

The New York Times points out that U.S. job seekers exceed openings by record ratio.

2 out of 5 Californians out of work.

Almost half of 16-24 year olds are unemployed.

(Note: hyperinflation is obviously an entirely different animal. For example, there was rampant unemployment in the Weimar Republic during its bout with hyperinflation ).

Debt Overhang and Deleveraging

Steve Keen argues that the government’s attempts to increase lending won’t work, consumers will keep on deleveraging from their debt, and that – unless debt is slashed – the massive debt overhang will keep us in a deflationary environment for a long time.

Edward Harrison notes:

Nomura’s Chief Economist Richard Koo wrote a book last year called "The Holy Grail of Macroeconomics" which introduced the concept of a balance sheet recession, which explains economic behaviour in the United States during the Great Depression and Japan during its Lost Decade. He explains the factor connecting those two episodes was a consistent desire of economic agents (in this case, businesses) to reduce debt even in the face of massive monetary accommodation.

When debt levels are enormous, as they are right now in the United States, an economic downturn becomes existential for a great many forcing people to reduce debt. Recession lowers asset prices (think houses and shares) while the debt used to buy those assets remains. Because the debt levels are so high, suddenly everyone is over-indebted. Many are technically insolvent, their assets now worth less than their debts. And the three D’s come into play: a downturn leads to debt deflation, deleveraging, and ultimately depression. The D-Process is what truly separates depression from recession ...

See a presentation by Koo here.

Leading investment advisor Ray Dalio says the same thing.

So does Albert Edwards, who argues that - even as the government tries to inflate its way out of all its problems and printing trillion in new treasuries - it is unable to catch up with the non-governmental balance sheet collapse:

The US Federal Reserve recently published their comprehensive flow of funds data for the US. This showed that the household sector continued to pay down debt for the fourth consecutive quarter. Corporates also started to pay down debt sharply in Q2 at a similar $200bn pace. The non-financial private sector paid down debt at a $435bn pace in Q2. This compares to a $2,116bn pace of expansion in 2007 (see chart below). Add to that the financial sector unwind and the total private sector is unwinding debt faster than the government is able to pile it up (hence the red line is still negative)! The lesson from the balance sheet recession in Japan is that the massive private sector headwind to growth has a long, long way to run.

If that is the case, we can expect, just like Japan, frequent relapses back into recession. The market now understands how an end of inventory de-stocking can boost GDP, i.e. it is the change in the change that matters. Similarly as Dylan Grice points out - link, it is the change in the fiscal deficit that is a net stimulus or drag to GDP. A massive 6pp stimulus last year is likely to turn into a 2pp drag on growth next year (see chart below). With continued private sector de-leveraging likely next year and beyond, how can one seriously not expect the global economy to relapse back into recession next year taking nominal GDP deep into an abyss?

Mish writes:

An over-leveraged economy is one prone to deflation and stagnant growth. This is evident in the path the Japanese took after their stock and real estate bubbles began to implode in 1989.

Leverage is increasing again, according to an article in Bloomberg:

Banks are increasing lending to buyers of high-yield company loans and mortgage bonds at what may be the fastest pace since the credit-market debacle began in 2007…

“I am surprised by how quickly the market has become receptive to leverage again,” said Bob Franz, the co-head of syndicated loans in New York at Credit Suisse…

Indeed, as I have repeatedly pointed out, Bernanke, Geithner, Summers and the chorus of mainstream economists have all acted as enablers for increasing leverage.

Mish continues:

Creative destruction in conjunction with global wage arbitrage, changing demographics, downsizing boomers fearing retirement, changing social attitudes towards debt in every economic age group, and massive debt leverage is an extremely powerful set of forces.

Bear in mind, that set of forces will not play out over days, weeks, or months. A Schumpeterian Depression will take years, perhaps even decades to play out.

Thus, deflation is an ongoing process, not a point in time event that can be staved off by massive interventions and Orwellian Proclamations “We Saved The World”.

Bernanke and the Fed do not understand these concepts, nor does anyone else chanting that pending hyperinflation or massive inflation is coming right around the corner, nor do those who think new stock market is off to new highs. In other words, almost everyone is oblivious to the true state of affairs.

Flattening Yield Curve Points Toward Deflation

PIMCO's Bill Gross said:

There has been significant flattening on the long end of the curve,” Gross said in an interview from Newport Beach, California, with Bloomberg Radio. “This reflects the re- emergence of deflationary fears. The U.S. is at the center of de-levering as opposed to accelerating growth.

David Rosenberg, Tyler Durden and Mish also believe that a flattening yield curve indicates deflation.

Bloomberg notes:

The difference in yield between nominal and inflation-protected Treasury securities maturing in one year is negative 0.4 percent, suggesting investors expect deflation during the next 12 months.

Pension Crisis

Pension expert Leo Kolivakis writes:

The global pension crisis is highly deflationary and yet very few commentators are discussing this.

Collapse of the Shadow Banking System

Hoisington’s Second Quarter 2009 Outlook states:

One of the more common beliefs about the operation of the U.S. economy is that a massive increase in the Fed’s balance sheet will automatically lead to a quick and substantial rise in inflation. [However] An inflationary surge of this type must work either through the banking system or through non-bank institutions that act like banks which are often called “shadow banks”. The process toward inflation in both cases is a necessary increasing cycle of borrowing and lending. As of today, that private market mechanism has been acting as a brake on the normal functioning of the monetary engine.

For example, total commercial bank loans have declined over the past 1, 3, 6, and 9 month intervals. Also, recent readings on bank credit plus commercial paper have registered record rates of decline. The FDIC has closed a record 52 banks thus far this year, and numerous other banks are on life support. The “shadow banks” are in even worse shape. Over 300 mortgage entities have failed, and Fannie Mae and Freddie Mac are in federal receivership. Foreclosures and delinquencies on mortgages are continuing to rise, indicating that the banks and their non-bank competitors face additional pressures to re-trench, not expand. Thus far in this unusual business cycle, excessive debt and falling asset prices have conspired to render the best efforts of the Fed impotent.

Ellen Brown argues that the break down in the securitized loan markets (especially CDOs) within the shadow banking system dwarfed other types of lending, and argues that the collapse of the securitized loan market means that deflation will – with certainty – continue to trump inflation unless conditions radically change.

Support for Brown’s argument comes from several sources.

As the Washington Times notes:

“Congress’ demand that banks fill in for collapsed securities markets poses a dilemma for the banks, not only because most do not have the capacity to ramp up to such large-scale lending quickly. The securitized loan markets provided an essential part of the machinery that enabled banks to lend in the first place. By selling most of their portfolios of mortgages, business and consumer loans to investors, banks in the past freed up money to make new loans. . . .“The market for pooled subprime loans, known as collateralized debt obligations (CDOs), collapsed at the end of 2007 and, by most accounts, will never come back. Because of the surging defaults on subprime and other exotic mortgages, investors have shied away from buying the loans, forcing banks and Wall Street firms to hold them on their books and take the losses.”

Senior economic adviser for UBS Investment Bank, George Magnus, confirms:

The restoration of normal credit creation should not be expected, until the economy has adjusted to the disappearance of shadow bank credit, and until banks have created the capacity to resume lending to creditworthy borrowers. This is still about capital adequacy, where better signs of organic capital creation are welcome. More importantly now though, it is about poor asset quality, especially as defaults and loan losses rise into 2010 from already elevated levels.

And McClatchy writes:

The foundation of U.S. credit expansion for the past 20 years is in ruin. Since the 1980s, banks haven’t kept loans on their balance sheets; instead, they sold them into a secondary market, where they were pooled for sale to investors as securities. The process, called securitization, fueled a rapid expansion of credit to consumers and businesses. By passing their loans on to investors, banks were freed to lend more.

Today, securitization is all but dead. Investors have little appetite for risky securities. Few buyers want a security based on pools of mortgages, car loans, student loans and the like.

“The basis of revival of the system along the line of what previously existed doesn’t exist. The foundation that was supposed to be there for the revival (of the economy) . . . got washed away,” [economist James K.] Galbraith said.

Unless and until securitization rebounds, it will be hard for banks to resume robust lending because they’re stuck with loans on their books.

Credit Still Constrained

US credit has shrunk at Great Depression rate prompting fears of double-dip recession:

Professor Tim Congdon from International Monetary Research said US bank loans have fallen at an annual pace of almost 14pc in the three months to August (from $7,147bn to $6,886bn).

"There has been nothing like this in the USA since the 1930s," he said. "The rapid destruction of money balances is madness."

The M3 "broad" money supply, watched as an early warning signal for the economy a year or so later, has been falling at a 5pc annual rate.

Similar concerns have been raised by David Rosenberg, chief strategist at Gluskin Sheff, who said that over the four weeks up to August 24, bank credit shrank at an "epic" 9pc annual pace, the M2 money supply shrank at 12.2pc and M1 shrank at 6.5pc...

US banks are cutting lending by around 1pc a month. A similar process is occurring in the eurozone, where private sector credit has been contracting and M3 has been flat for almost a year.

The Independent notes:

A second credit squeeze and a £200bn national "funding gap" threatens to sabotage the recovery in the British economy, the IMF warned yesterday.

In its latest Global Financial Stability Report, the fund said that a combination of a soaring government deficit and the borrowing needs of British companies and consumers – coupled with a still broken banking system – would leave the UK with a national "funding gap" of 15 per cent of GDP, or around £200bn next year, much higher than in either the US or the euro area.

Housing

Moody's forecasts that housing won't return to pre-bust levels until 2020, "Florida and California will only regain their pre-bust peak in the early 2030s"

Treasury says millions more foreclosures are coming.

Fannie Mae's serious delinquency rate is skyrocketing.

Half of all borrower who are getting help with loan modifications end up redefaulting.

And apartment rental prices are falling world-wide.

Business

The creation of small businesses is way down.

Experts are projecting unprecedented corporate defaults.

Ghost fleets of unused ships lie rusting in port.

States

State tax revenues have plunged 17%.

More Signs of Deflation

Bloomberg writes:

The U.S. faces the possibility of deflation for the first time since the Eisenhower administration...

Consumer prices are experiencing deflation, with the consumer price index sliding for six straight months from year- earlier levels, the longest stretch of declines since a 12-month drop from September 1954 to August 1955, according to the Labor Department...

While the economy contracted 2.7 percent during the 1953 recession, it shrank 3.8 percent in the current recession, the most since the 1930s. Economists at New York-based JPMorgan Chase & Co. and Goldman Sachs Group Inc., the second- and fifth- biggest U.S. banks by assets, say there’s so much deflationary excess labor and plant capacity in the economy that the Fed won’t raise interest rates until at least 2011.

Paul Krugman writes:

A new report from the International Monetary Fund shows that the kind of recession we’ve had, a recession caused by a financial crisis, often leads to long-term damage to a country’s growth prospects. “The path of output tends to be depressed substantially and persistently following banking crises.”

The U.S. Census Bureau reports that 40 million Americans are living in poverty.

AP writes:

As in the 1980s, much of that shift will be driven by baby boomers. For the 78 million people born from 1946 through 1964, the Great Recession hit at a particularly inopportune time – during peak years of earning and saving before retirement. Boomers range from 44 to 63 today – the youngest is nearly 10 years older than the oldest was in 1982. They are running out of time and are most likely to remain cautious spenders and become aggressive savers even as the economy improves.

The housing bubble mistakenly led boomers and millions of others to believe their home was their retirement nest egg. If they left their home equity alone during the boom, they've taken a hit the last couple years but are still ahead. But many treated their home like a personal bank and spent the gains by tapping a home equity line of credit.

Alix Partners finds:

While American industry is struggling to get through what could become the worst recession since the Great Depression, Americans say that even after the recession ends, their spending will return to just 86% of pre-recession levels, which would take a trillion dollars per year out of the U.S. economy for years to come. According to this in-depth survey of more than 5,000 people, Americans plan to save (and therefore not spend) an astounding 14% of their total earnings post-recession, with the replenishment of their 401(k) and other retirement savings leading the way among their biggest long-term concern.

As Huffington Post notes:

"There will be a fundamental shift in the kind of cars we buy, a fundamental shift in the homes we buy, and a fundamental shift in consumption generally," says Matt Murray, an economist at the University of Tennessee. "And that is not something that took place in the 1980s."

Fed Paying Interest on Reserves

And Naufal Sanaullah writes:

So if all of this printed money is being used by the Fed to purchase toxic assets, where is it going?

Excess reserves, of course. Counting for $833 billion of the Fed’s liabilities, the reserve balance with the fed has skyrocketed almost 9000% YoY. Excess reserves, balances not used to satisfy reserve requirements, total $733 billion, up over 38,000%!

Excess Reserves of Depository Institutions

The Fed pays interest on these reserves, and with an interest rate (return on capital) comes opportunity cost. Banks hoard the capital in their reserves, collecting a risk-free rate of return, instead of lending it out into the economy. But what happens as more loan losses occur and consumer spending grinds to a halt? The Fed will lower (or get rid of) this interest on reserves.

And that is when the excess liquidity synthesized by the Fed, the printed money, comes rushing in and inflates goods prices.

Of course, most people who are arguing we will have deflation for a while believe that we might eventually get inflation at some point in the future.

Saturday, August 29, 2009

The Case for Deflation

As Absolute Return Partners wrote in its July newsletter:

The most important investment decision you will have to make this year and possibly for years to come is whether to structure your portfolio for deflation or inflation.

So which is it, inflation or deflation?

I've analyzed this issue in numerous posts, but every day there are new arguments one way or the other from some very smart people.

The biggest deflation bears are rather pessimistic:

  • David Rosenberg says that deflationary periods can last years before inflation kicks in

The Best Recent Arguments for Deflation

Following are some of the best arguments for deflation.

Wall Street Journal's Scott Patterson writes that we won't get inflation until unemployment is down below 5%:

A rule of thumb is that inflation doesn't become sticky until the unemployment rate dips below 5%...

"I see very little prospect of accelerating inflation" partly because of the employment outlook, said Mark Zandi, chief economist of Moody's Economy.com. "I don't think the risk shifts toward inflation until 2011, or even 2012."

It could take a lot longer for unemployment to go back down to 5%.

Pension expert Leo Kolivakis writes:

The global pension crisis is highly deflationary and yet very few commentators are discussing this!!!

Hoisington's Second Quarter 2009 Outlook states:

One of the more common beliefs about the operation of the U.S. economy is that a massive increase in the Fed’s balance sheet will automatically lead to a quick and substantial rise in inflation. [However] An inflationary surge of this type must work either through the banking system or through non-bank institutions that act like banks which are often called “shadow banks”. The process toward inflation in both cases is a necessary increasing cycle of borrowing and lending. As of today, that private market mechanism has been acting as a brake on the normal functioning of the monetary engine.

For example, total commercial bank loans have declined over the past 1, 3, 6, and 9 month intervals. Also, recent readings on bank credit plus commercial paper have registered record rates of decline. The FDIC has closed a record 52 banks thus far this year, and numerous other banks are on life support. The “shadow banks” are in even worse shape. Over 300 mortgage entities have failed, and Fannie Mae and Freddie Mac are in federal receivership. Foreclosures and delinquencies on mortgages are continuing to rise, indicating that the banks and their non-bank competitors face additional pressures to re-trench, not expand. Thus far in this unusual business cycle, excessive debt and falling asset prices have conspired to render the best efforts of the Fed impotent.

Ellen Brown argues that the break down in the securitized loan markets (especially CDOs) within the shadow banking system dwarfed other types of lending, and argues that the collapse of the securitized loan market means that deflation will - with certainty - continue to trump inflation unless conditions radically change.

Mish writes:

Conventional wisdom regarding money supply suggests there is massive pent up inflation in the works as a result of the buildup of those reserves. The rationale is that 10 times those excess reserves (via fractional reserve lending) will soon be working its way into the economy causing huge price spikes, a collapse in the US dollar, and possibly even hyperinflation.

However, conventional wisdom regarding the money multiplier is wrong. Australian economist Steve Keen notes that in a debt based society, expansion of credit comes first and reserves come later.

Indeed, this is easy to conceptualize: Banks lent more than they should have, and those loans are going bad at a phenomenal rate. In response, the Fed has engaged in a huge swap-o-rama party with various banks (swapping treasuries for collateral of dubious value) in addition to turning on the printing presses.

This was done so that banks would remain "well capitalized". The reality is those excess reserves are a mirage. Banks need those reserves for credit losses coming down the pike, as unemployment rises, foreclosures mount, and credit card defaults soar.

Banks are not well capitalized, they are insolvent, unwilling and unable to lend...

Total U.S. debt as a percent of GDP surged to 375% in the first quarter, a new post 1870 record, and well above the 360% average for 2008. Therefore, the economy became more leveraged even as the recession progressed.

An over-leveraged economy is one prone to deflation and stagnant growth. This is evident in the path the Japanese took after their stock and real estate bubbles began to implode in 1989.
Leverage is increasing again, according to an article in Bloomberg:

Banks are increasing lending to buyers of high-yield company loans and mortgage bonds at what may be the fastest pace since the credit-market debacle began in 2007...

“I am surprised by how quickly the market has become receptive to leverage again,” said Bob Franz, the co-head of syndicated loans in New York at Credit Suisse...

Indeed, as I have repeatedly pointed out, Bernanke, Geithner, Summers and the chorus of mainstream economists have all acted as enablers for increasing leverage.

Mish continues:

Creative destruction in conjunction with global wage arbitrage, changing demographics, downsizing boomers fearing retirement, changing social attitudes towards debt in every economic age group, and massive debt leverage is an extremely powerful set of forces.

Bear in mind, that set of forces will not play out over days, weeks, or months. A Schumpeterian Depression will take years, perhaps even decades to play out.

Thus, deflation is an ongoing process, not a point in time event that can be staved off by massive interventions and Orwellian Proclamations "We Saved The World".

Bernanke and the Fed do not understand these concepts, nor does anyone else chanting that pending hyperinflation or massive inflation is coming right around the corner, nor do those who think new stock market is off to new highs. In other words, almost everyone is oblivious to the true state of affairs.

And Naufal Sanaullah writes:

So if all of this printed money is being used by the Fed to purchase toxic assets, where is it going?

Excess reserves, of course. Counting for $833 billion of the Fed's liabilities, the reserve balance with the fed has skyrocketed almost 9000% YoY. Excess reserves, balances not used to satisfy reserve requirements, total $733 billion, up over 38,000%!

Excess Reserves of Depository Institutions

The Fed pays interest on these reserves, and with an interest rate (return on capital) comes opportunity cost. Banks hoard the capital in their reserves, collecting a risk-free rate of return, instead of lending it out into the economy. But what happens as more loan losses occur and consumer spending grinds to a halt? The Fed will lower (or get rid of) this interest on reserves.

And that is when the excess liquidity synthesized by the Fed, the printed money, comes rushing in and inflates goods prices.

Of course, most people who are arguing we will have deflation for a while believe that we might eventually get inflation at some point in the future.


National Debt Clock





Friday, August 28, 2009

Trying to Inflate Our Way Out of Debt Is Like a Monkey Trying To Outrun a Lion


Commonly-accepted wisdom says that we can inflate our way out of our debt crisis.

Ben Bernanke and Paul Krugman apparently think we should force inflation on the economy. University of Oregon economics professor Tim Duy thinks the U.S. will ultimately try to inflate its way out of debt.

Warren Buffet says:
A country that continuously expands its debt as a percentage of GDP and raises much of the money abroad to finance that, at some point, it’s going to inflate its way out of the burden of that debt.
But as I have previously noted, UBS economist Paul Donovan has demonstrated that governments can't inflate their way out of debt traps, saying:
The problem with the idea of governments inflating their way out of a debt burden is that it does not work. Absent episodes of hyper-inflation, it is a strategy that has never worked.
Megan McArdle points out:
It is a commonplace on the right that we're going to have enormous inflation, not because Ben Bernanke will make an error in the timing of withdrawing liquidity, but because the government is going to try to print its way out of all this debt.

Joe Weisenthal notes that it doesn't quite work this way:

As this chart shows, instances of declining debt-to-GDP rarely coincide with periods of inflation. If it did If it did, we'd see more dots in the lower right-hand quadrant.

The bad news for central bankers is that creating currency isn't like, say, diluting shareholders in a company. You're always rolling your debt, and the market's response to an inflationary strategy is (not surprisingly) higher interest rates. It's a treadmill, and it's extremely hard to get ahead.

Inflating your way out of debt works if you're planning to run a pretty sizeable budget surplus--big enough that you won't have to roll your debt over. Otherwise, your debt starts to march upward even faster, as old notes come due, and you have to roll them at ruinous interest rates. Hyperinflation might wipe out that debt, but also your tax base.

Financial Week notes:
Analysis shows even a sizable hike in CPI won't do much for companies or households that owe money.

Analysis released by Leverage World, a publication of debt research firm Garman Research, showed that companies that have issued debt at a coupon rate of 8%, as is typical for non-investment grade issuers, would have to see inflation hit 23% to inflate away the amount of debt they owe in 5.5 years. That’s the average amount of time that investors would have to hold such debt to compensate for the risk of default.

But investors would refuse to do so under such a scenario, Chris Garman, principal in the research firm, noted—not with yields on such debt currently running at 18%.

As Mr. Garman put it in the publication, inflation at that level “would crush the appeal of an 8% coupon.”

And while issuers would have to roll over their debt, they would find it impossible to do so. As he put it in an interview with Financial Week, “They’re staring down the barrel of an 18% coupon.”

Investment grade companies are in better shape. The same can’t be said for other public—or government—borrowers. Indeed, overall debt levels for the private and public sectors now run at roughly 3.5 times nominal GDP. That compares with 1.5 times from 1945 to 1980 and in the early 1920s.

To return to that level, Mr. Garman estimated that inflation would have to rise to around 12% or GDP increase by 75% over the next five years. Either scenario, he said, is hardly likely to materialize.

At a more realistic level of 3% real GDP growth and 2% inflation, Mr. Garman said, it would take 15 years before the overall U.S. debt level fell back under 1.7 times nominal GDP.

“There has been some talk of a rise in inflation as a panacea for distress and default,” he wrote in his report.

His analysis shows that such expectations vastly underestimate what’s required.
Prominent economist Michael Hudson wrote in February:
The United States cannot “inflate its way out of debt,” because this would collapse the dollar and end its dreams of global empire by forcing foreign countries to go their own way. There is too little manufacturing to make the economy more “competitive,” given its high housing costs, transportation, debt and tax overhead. The economy has hit a debt wall and is falling into Negative Equity, where it may remain for as far as the eye can see until there is a debt write-down...

The Obama-Geithner plan to restart the Bubble Economy’s debt growth so as to inflate asset prices by enough to pay off the debt overhang out of new “capital gains” cannot possibly work. But that is the only trick these ponies know...

The global economy is falling into depression, and cannot recover until debts are written down.

Instead of taking steps to do this, the government is doing just the opposite. It is proposing to take bad debts onto the public-sector balance sheet, printing new Treasury bonds to give the banks – bonds whose interest charges will have to be paid by taxing labor and industry...

The economy may be dead by the time saner economic understanding penetrates the public consciousness.

In the mean time, bad private-sector debt will be shifted onto the government’s balance sheet. Interest and amortization currently owed to the banks will be replaced by obligations to the U.S. Treasury. It is paying off the gamblers and billionaires by supporting the value of bank loans, investments and derivative gambles, leaving the Treasury in debt. Taxes will be levied to make up the bad debts with which the government now is stuck. The “real” economy will pay Wall Street – and will be paying for decades.

Wolfgang M√ľnchau writes:

What I hear more and more, both from bankers and from economists, is that the only way to end our financial crisis is through inflation. Their argument is that high inflation would reduce the real level of debt, allowing indebted households and banks to deleverage faster and with less pain...

The advocates of such a strategy are not marginal and cranky academics. They include some of the most influential US economists...

The best outcome would be a simple double-dip recession. A two-year period of moderately high inflation might reduce the real value of debt by some 10 per cent. But there is also a downside. The benefit would be reduced, or possibly eliminated, by higher interest rates payable on loans, higher default rates and a further increase in bad debts. I would be very surprised if the balance of those factors were positive.

In any case, this is not the most likely scenario. A policy to raise inflation could, if successful, trigger serious problems in the bond markets. Inflation is a transfer of wealth from creditors to debtors – essentially from China to the US. A rise in US inflation could easily lead to a pull-out of global investors from US bond markets. This would almost certainly trigger a crash in the dollar’s real effective exchange rate, which in turn would add further inflationary pressure...

The central bank would eventually have to raise nominal rates aggressively to bring back stability. It would end up with the very opposite of what the advocates of a high inflation policy hope for. Real interest rates would not be significantly negative, but extremely positive...

Stimulating inflation is another dirty, quick-fix strategy, like so many of the bank rescue packages currently in operation ... it would solve no problems and create new ones.

And Mike "Mish" Shedlock argues:
Inflationists make two mistakes when it comes to government debt. The first is in assuming government debt is more important than consumer debt. (It will be after consumer debt is defaulted away, but it's not right now.) The second is that it's not so easy to inflate government debt away either...

Inflationists act as if unfunded liability costs and interest on the national debt stay constant. Also ignored is the loss of jobs and rising defaults that will occur while this "inflating away" takes place. Tax receipts will not rise enough to cover rising interest given a state of rampant overcapacity and global wage arbitrage.

Yet in spite of these obvious difficulties, the mantra is repeated day in and day out.

Inflating debt away only stands a chance in an environment where there is a sustainable ability and willingness of consumers and businesses to take on debt, asset prices rise, government spending is controlled, and interest on accumulated debt is not onerous. Those conditions are now severely lacking on every front.
Just as a hungry lion will not leave prey alone unless his hunger is reduced, our massive debt can only be dealt with by starting to pay down the debt.

Instead of trying to outrun the hungry lion, the monkey should (climb a tree) grab any food he can find and start throwing it towards the lion. If he gives the lion enough food, the lion may leave him alone for the time being. And if he gets busy finding food to keep giving the lion, the lion may eventually learn to see him as an ally, instead of a meal, and make sure the monkey is safe.

And as I have previously written, abolishing the central bank and taking over the money and credit creation functions from the private banks may be an important part of the solution to our debt trap. See this and this.




Physicists Untangle Complicated Webs to Reveal that the World's Finances are Controlled by "Just a Few Mutual Funds, Banks, and Corporations"


Inside Science - a news service supported by the American Institute of Physics - is breaking an important story:

A recent analysis of the 2007 financial markets of 48 countries has revealed that the world's finances are in the hands of just a few mutual funds, banks, and corporations. This is the first clear picture of the global concentration of financial power, and point out the worldwide financial system's vulnerability as it stood on the brink of the current economic crisis.

A pair of physicists at the Swiss Federal Institute of Technology in Zurich did a physics-based analysis of the world economy as it looked in early 2007. Stefano Battiston and James Glattfelder extracted the information from the tangled yarn that links 24,877 stocks and 106,141 shareholding entities in 48 countries, revealing what they called the "backbone" of each country's financial market. These backbones represented the owners of 80 percent of a country's market capital, yet consisted of remarkably few shareholders.

"You start off with these huge national networks that are really big, quite dense," Glattfelder said. “From that you're able to ... unveil the important structure in this original big network. You then realize most of the network isn't at all important."

The most pared-down backbones exist in Anglo-Saxon countries, including the U.S., Australia, and the U.K. ... But while each American company may link to many owners, Glattfelder and Battiston's analysis found that the owners varied little from stock to stock, meaning that comparatively few hands are holding the reins of the entire market.

“If you would look at this locally, it's always distributed,” Glattfelder said. “If you then look at who is at the end of these links, you find that it's the same guys, [which] is not something you'd expect from the local view.”

Matthew Jackson, an economist from Stanford University in Calif. who studies social and economic networks, said that Glattfelder and Battiston's approach could be used to answer more pointed questions about corporate control and how companies interact.

"It's clear, looking at financial contagion and recent crises, that understanding interrelations between companies and holdings is very important in the future,” he said. "Certainly people have some understanding of how large some of these financial institutions in the world are, there's some feeling of how intertwined they are, but there's a big difference between having an impression and actually having ... more explicit numbers to put behind it"...

The results will be published in an upcoming issue of the journal Physical Review E.
The physicists name names. As Inside Science notes:
Based on their analysis, Glattfelder and Battiston identified the ten investment entities who are “big fish” in the most countries. The biggest fish was the Capital Group Companies, with major stakes in 36 of the 48 countries studied.
While it is true that the paper in the Physical Review E has not yet been published, I have found a draft version of their article from February which shows that the top 10 list of most powerful financial institutions (from most to least powerful) is as follows:
1. The Capital Group of Companies

2. Fidelity Management & Research

3. Barclays PLC

4. Franklin Resources

5. AXA

6. JP Morgan Chase

7. Dimensional Fund Advisors

8. Merrill Lynch

9. Wellington Management Company

10. UBS
Other tidbits:
  • Non-American players Deutsche Bank, Brandes Investment Partners, Societe Generale, Credit Suisse, Schroders PLC and Allianz are also in the top 21 positions.
  • The government of Singapore is number 25.
  • The world's largest banking group - HSBC Holdings PLC - only chimes in at number 26.
The data analyzed in the study is from 2007, and the playing field may have changed substantially since then.

Further analysis using this new methodology may yield important information. For example, given the massive government intervention in the markets, it is important to ask who controls stock now.


Roubini: “When Governments Reach the Point Where They Are Borrowing to Pay the Interest on Their Borrowing They Are ... Running a Ponzi Scheme"


In a new essay in Forbes, Nouriel Roubini writes:

Net public debt is going to double as a share of GDP between 2008 and 2014. Even using the very optimistic forecasts of the Congressional Budget Office, which anticipate growth of around 4% over the next few years, the net debt burden will rise from 40% of GDP to 80%--that's an increase in the debt stock of about $9 trillion. The interest charge alone on that increased debt will be in the region of $300 billion to $400 billion a year, which in turn may mean more borrowing to pay the interest if primary deficits are not reduced. When governments reach the point where they are borrowing to pay the interest on their borrowing they are coming dangerously close to running a sovereign Ponzi scheme.

Ponzi schemes have a way of ending unhappily...

Roubini also touches on the issue of the credit ratings of sovereign nations:

Independent rating agencies have already downgraded the sovereign risk rating of countries like Greece and Ireland, and it cannot be ruled out that core economies of the OECD, including the U.S., could eventually be downgraded.
For background on sovereign credit issues, see this, For background on sovereign risk issues in general, see this.

Thursday, August 27, 2009

China Deploys Rare Earth Metals For Strategic Leverage


As I've previously noted, China has cornered well over 90% of the market for rare earth metals, which are essential in various high-tech products.

The Telegraph ran an article on August 24th pointing out that China is now deploying these resources to gain strategic advantage:

Beijing is drawing up plans to prohibit or restrict exports of rare earth metals that are produced only in China and play a vital role in cutting edge technology, from hybrid cars and catalytic converters, to superconductors, and precision-guided weapons.

A draft report by China’s Ministry of Industry and Information Technology has called for a total ban on foreign shipments of terbium, dysprosium, yttrium, thulium, and lutetium. Other metals such as neodymium, europium, cerium, and lanthanum will be restricted to a combined export quota of 35,000 tonnes a year, far below global needs.

China mines over 95pc of the world’s rare earth minerals, mostly in Inner Mongolia. The move to hoard reserves is the clearest sign to date that the global struggle for diminishing resources is shifting into a new phase. Countries may find it hard to obtain key materials at any price...

No replacement has been found for neodymium that enhances the power of magnets at high heat and is crucial for hard-disk drives, wind turbines, and the electric motors of hybrid cars. Each Toyota Prius uses 25 pounds of rare earth elements. Cerium and lanthanum are used in catalytic converters for diesel engines. Europium is used in lasers.

Blackberries, iPods, mobile phones, plasma TVs, navigation systems, and air defence missiles all use a sprinkling of rare earth metals. They are used to filter viruses and bacteria from water, and cleaning up Sarin gas and VX nerve agents...

New uses are emerging all the time, and some promise quantum leaps in efficiency. The Tokyo Institute of Technology has made a breakthrough in superconductivity using rare earth metals that lower the friction on power lines and could slash electricity leakage.

The Telegraph points out that Japan is also taking steps to secure a supply of rare earths, but the West has not:

The Japanese government has drawn up a “Strategy for Ensuring Stable Supplies of Rare Metals”. It calls for 'stockpiling' and plans for “securing overseas resources’. The West has yet to stir.

The Telegraph also notes that China is not necessarily using its near-monopoly of rare earths to dominate the world, and that other countries may be able to extract more rare earths after slowly ramping up production:

Alistair Stephens, from Australia’s rare metals group Arafura, said ... “This isn’t about the China holding the world to ransom. They are saying we need these resources to develop our own economy and achieve energy efficiency, so go find your own supplies”...

It will take years for fresh supply to come on stream from deposits in Australia, North America, and South Africa.

The bottom line is that the West has been asleep while China has amassed tremendous control over scarce resources which are vital for both technological innovation and security. China's deployment of its dollar reserve holdings (which may lose value) to purchase these key strategic assets is very clever, indeed.


UN Rights Chief Says Torture Probe Must Go To The Top . . . Paging Mr. Cheney


The head of the U.N.'s human rights arm is demanding that the torture investigation go to the very top:

The U.S. prosecutor's investigation into alleged criminal CIA interrogation techniques must go right to the top political level, the chief U.N. rights official said on Thursday.

U.N. High Commissioner for Human Rights Navi Pillay, 67, in a wide-ranging interview with Reuters, urged European and other countries to resettle Guantanamo detainees so that President Barack Obama can close the U.S.-run prison in Cuba by year-end...

The former United Nations war crimes judge [said] "Whenever people come under the jurisdiction of the United States, the United States has to be seen to be upholding the very high standards that they claim for their own citizens" ...

Any torture or death inflicted on suspects held by U.S. authorities in places including Bagram detention centre in Afghanistan should be part of this investigation, she said.

Asked whether it should go beyond establishing the criminal liability of CIA interrogators, Pillay replied: "That is international law on accountability -- that you do not stop at the foot soldiers, you go right up to the ultimate authority that is legally responsible."

And these would include those who devised the policy, those who ordered it," said Pillay, a Tamil from South Africa.

Former U.S. Vice-President Dick Cheney, a vocal defender of the Bush administration's security policies, has said intelligence obtained from harsh interrogation techniques had saved lives.

Of course, it has been proven beyond a shadow of doubt that torture did not save lives. See this, this, and this.

Moreover, Cheney is the guy who:

And - to cap it off - the torture program which Cheney created was specifically aimed at producing false confessions in an attempt to link Iraq and 9/11, even though Cheney (and everyone else) knew that no link existed.

Cheney is definitely one of the people at "the top" in the whole torture fiasco.


Update: As former constitutional lawyer Glenn Greenwald notes today, the Founding Fathers would have been sickened by Cheney's rationalizations:

In his 1795 essay, which he entitled Dissertations on First Principles of Government Thomas Paine wrote this as his last paragraph:

An avidity to punish is always dangerous to liberty. It leads men to stretch, to misinterpret, and to misapply even the best of laws. He that would make his own liberty secure must guard even his enemy from oppression; for if he violates this duty he establishes a precedent that will reach to himself.

Can that be any clearer? Of course, Paine also wrote in Common Sense that "so far as we approve of monarchy, that in America the law is king" and "in free countries the law ought to be king; and there ought to be no other." And in his Dissertations, he also wrote:

The executive is not invested with the power of deliberating whether it shall act or not; it has no discretionary authority in the case; for it can act no other thing than what the laws decree, and it is obliged to act conformably thereto. . . .

For anyone who believes in the basic principles of the founding, the fact that these acts of torture are illegal -- felonies -- ought to end the discussion about whether they were justified.


Wednesday, August 26, 2009

The Rising Tide of Unemployment in America: How Bad Will It Get, And What Can We Do?


Unemployment is disastrous on both the individual and societal level.

Individuals who look for work but can't find it are miserable.[1]

On the national level, high unemployment is both cause and effect concerning other problems with the economy. As we'll see below, high unemployment results from a weak economy and - in turn - weakens the economy.

Until the causes of, and solutions to, high levels of unemployment are understood, we will not be able to solve the problem.

How High is Unemployment?

Before we can even start looking at causes or solutions, we have to understand what the current level of unemployment really is, and what the trends portend for the future.

Let's use America as an example. With the largest economy in the world, it has often been said that "when America sneezes, the rest of the world catches cold". And much of the rest of the world has adopted the "Washington Consensus" - America's neoliberal view of economics.[2] Moreover, the rest of the world has been infected by many types of "toxic assets" invented in America, such as credit default swap derivatives[3], as well as Wall Street style banking strategies. So I will use the United States has a case example, but will also touch on global trends.

Official figures put unemployment in the United States somewhere between 9 and 10 percent. But the official figures use a very different measure for unemployment than was used during the Great Depression and for many decades afterwards.

Specifically, the official unemployment reports of the Department of Labor's Bureau of Labor Statistics (BLS) provide conventional "U-3" figures and various alternative measures including "U-6". [4]

For example, as of December 2008, U-3 unemployment was 7.2 percent, while U-6 was 13.5 percent. [5]

U-6 is actually more accurate, because it includes those who would like full-time work, but can only find part-time work, or have given up looking for work altogether.

As can be seen by the December 2008 figures, U-6 unemployment rate can almost double the more commonly-cited U-3 figures.

But those in the know argue that the real rate is actually even higher than the U-6 figures.

For example, Paul Craig Roberts [6] - former Assistant Secretary of the Treasury and former editor of the Wall Street Journal - and economist John Williams both said in December 2008 that - if the unemployment rate was calculated as it was during the Great Depression - the December 2008 unemployment figure would actually have been 17.5%.

Williams says [7] that unemployment figures for July 2009 rose to 20.6% [8].

According to an article [9] summarizing the projections of former International Monetary Fund Chief Economist and Harvard University Economics Professor Kenneth Rogoff and University of Maryland Economics Professor Carmen Reinhart, U-6 unemployment could rise to 22% within the next 4 years or so.

As the New York Times pointed out in July[10] :

Include [those who have given up looking for a job and those part-time workers who want to be working full time] — as the Labor Department does when calculating its broadest measure of the job market — and the rate reached 23.5 percent in Oregon this spring, according to a New York Times analysis of state-by-state data. It was 21.5 percent in both Michigan and Rhode Island and 20.3 percent in California. In Tennessee, Nevada and several other states that have relied heavily on manufacturing or housing, the rate was just under 20 percent this spring and may have since surpassed it.

Indeed, the chief of the Atlanta Federal Reserve Bank -Dennis Lockhart - said in August 2009:

If one considers the people who would like a job but have stopped looking -- so-called discouraged workers -- and those who are working fewer hours than they want, the unemployment rate would move from the official 9.4 percent to 16 percent. [11]

Former Labor Secretary Robert Reich notes:

Over the past three months annual wage growth has plummeted to just 0.7%. At the same time, furloughs -- requiring workers to take unpaid vacations -- are on the rise: recent surveys show 17% of companies imposing them. [12]

Temporary employment is still falling as well. [13]

And economist David Rosenberg points out:

65% of companies are still in the process of cutting their staff loads...

The Bureau of Labor Statistics also publishes a number from the Household survey that is comparable to the nonfarm survey (dubbed the population and payroll-adjusted Household number), and on this basis, employment sank — brace yourself — by over 1 million, which is unprecedented...[14]

In addition to the failure of official BLS unemployment figures to take into account discouraged and underemployed workers, many analysts argue that BLS' "Birth-Death Model" severely understates unemployment during recessions. [15]

Many people - including economists and financial reporters - say that unemployment is much lower than it was during the Great Depression. What they mean when they say that is that current U-3 figures in America are under 10%, while unemployment hit 25% during the Great Depression.

But most people forget that the worst unemployment numbers during the Great Depression did not occur until years after the initial 1929 crash . Specifically, unemployment did not hit 25% until at least 3 years after the start of the Depression.[16]

As of this writing (2009), we are only a year into the current economic crisis. Therefore, we have at least 2 more years to go until we hit the same period that unemployment peaked during the Great Depression.

Indeed, former Secretary of Labor Robert Reich wrote in April that the unemployment figures show that we are already in a depression.[17]

And Chris Tilly - director of the Institute for Research on Labor and Employment at UCLA - points out that some populations, such as African-Americans and high school dropouts, have been hit much harder than other populations, and that these groups are already experiencing depression-level unemployment.[18]

Assuming that Williams, Roberts or Lockhart's calculations of unemployment are correct (using the same methods of measuring unemployment as were used during the Great Depression), and depending on when we deem the current crisis to have commenced, then - as shown by the following charts - unemployment percentages may actually be worse than they were during a comparable period in the Great Depression:

[19 and 20]

[21]

We also know that, in terms of total numbers of unemployment people (as opposed to percentages), more people will be unemployed than during the Great Depression. [22]

What Are the Unemployment Trends?

If unemployment is anywhere near as bad as during a comparable period during the Great Depression, the obvious question is where the trends are heading.

It is well known among economists that unemployment is a "lagging" indicator. [23] In other words, there is a lag time. When the economy hits a rough patch, the economic weakness will not show up in the unemployment numbers until several months or years later.

For example, as Europe’s largest bank - RBS - warns:

Even if the economy starts to turn up the headwinds will be formidable,” [the company's CEO] warned. “The green shoots are short in duration and you need to be cautious about interpreting them. Even if growth returns, unemployment will rise for some time afterwards ...[24]
Because of the lag time between conditions in the economy and unemployment, we have to ask the following two questions in order to forecast future unemployment trends:

1) How bad were conditions in 2008 and early 2009?

and

2) What will economic conditions be like in the future?

How Bad Did It Get?

Unfortunately, many experts - including the following people - have said that the economic crisis which started in 2008 could be worse than the Great Depression:

  • Federal Reserve chairman Ben Bernanke said on July 26, 2009:

    A lot of things happened, a lot came together, [and] created probably the worst financial crisis, certainly since the Great Depression and possibly even including the Great Depression. [25]
  • Economics professors Barry Eichengreen and and Kevin H. O'Rourke said that world-wide conditions are worse than during a comparable period during the Great Depression [26] (updated in June 2009 [27])
  • Investment advisor, risk expert and bestselling author Nassim Nicholas Taleb said that the current crisis could be "vastly worse" than the Great Depression [28]
  • Former Fed Chairman Paul Volcker believes the current crisis may be even worse than the Depression [29]
  • Nobel prize winning economist Joseph Stiglitz said "this is worse than the Great Depression" [30]
  • Economics scholar and former Federal Reserve Governor Frederick Mishkin said that conditions were worse than during the Depression [31]
  • Well-known PhD economist PhD Economist Marc Faber believes this could be far worse than the Great Depression[32]
  • Former Goldman Sachs chairman John Whitehead thinks that the current slump is worse than the Depression [33]
  • Morgan Stanley’s UK equity strategist Graham Secker predicts economic collapse worse than the Great Depression [34]
  • Former chief credit officer at Fannie Mae Edward J. Pinto said in January 2009 that the current housing crisis was worse than the Depression, and that current efforts to rescue the mortgage industry are less successful than those used during the 1930s. [35]
  • Billionaire investor George Soros said in February 2009 that the current economic turbulence is actually more severe than during the Great Depression, comparing the current situation to the demise of the Soviet Union. [36]
What Will Economic Conditions Be Like In the Future?

As of this writing, the fact that unemployment will substantially increase is quite controversial. Most people still assume that the benefits of the government's policies will soon kick in, the economy will recover, and then jobs will recover soon afterwards.

In order to accurately determine how bad general economic conditions - and thus unemployment - might be in the future, it is necessary to look at a variety of trends, including residential real estate, commercial real estate, toxic assets held by banks, loan loss rates, consumer spending, age demographics, the decline in manufacturing, and destruction of credit.

Residential Real Estate

Citigroup is projecting that unemployment in Spain will rise from its current 17.9% to 22% next year. [37]

Spain's unemployment is largely driven by the bursting of its housing bubble. [38]

Housing bubbles are now bursting in China [39], France [40], Spain [41], Ireland [42], the United Kingdom [43], Eastern Europe [44], and many other regions. [45]

(And unemployment in Japan is apparently at the highest level since the government began collecting the data in 1953, a year after the U.S. military occupation ended.)[46]

Unfortunately, while the peak in subprime mortgages is behind us, many analysts say that Alt-A mortgage defaults have not yet occurred (as of this writing), but will not peak until 2010.[47]

Indeed, the crash in real estate and rising unemployment together form a negative feedback loop. As McClatchy notes, foreclosures rise as jobs and income drop. [48]

Former chief IMF economist Simon Johnson notes that a vicious cycle also exists between unemployment and property foreclosures:
Unemployment is always a lagging indicator, and given the record low number of average hours worked, it will turn around especially slowly this time. Until then, people will continue to lose their jobs and wages will remain flat, and any small rebound in housing prices is unlikely to help more than a few people refinance their way out of unaffordable mortgages. So unless the other part of the equation – monthly payments – changes, the number of foreclosures should just continue to rise.[49]

Indeed, the Washington Post notes:

The country's growing unemployment is overtaking subprime mortgages as the main driver of foreclosures, according to bankers and economists, threatening to send even higher the number of borrowers who will lose their homes and making the foreclosure crisis far more complicated to unwind. [50]
Commercial Real Estate

Moreover, a crash in commercial real estate is now picking up speed. Unlike the subprime mortgage meltdown - which affected mainly the biggest banks - the commercial meltdown will apparently affect a huge number of small to medium-sized banks. [51]

On August 11, 2009, the Congressional Oversight Panel on the bailouts issued a report saying that small and medium sized banks are especially vulnerable, the report will say, in part they hold greater numbers of commercial real estate loans, "which pose a potential threat of high defaults." [52]

That could spell real trouble for employment by small businesses since (1) smaller institutions are disproportionately responsible for providing credit to small businesses [53], (2) credit is essential for many small businesses, (3) commercial real estate is crashing even faster than residential [54], and (4) industry experts forecast that the commercial real estate market won't bottom out for three more years.[55]

Indeed, largely because of the commercial real estate crash, the FDIC expects 500 banks to fail in the coming months. [56]

Unfortunately, the crash in commercial real estate is occurring world-wide. [57]

Toxic Assets

The Congressional Oversight Panel report also says that banks remain threatened by billions of dollars of bad loans on their balance sheets, more could fail if the economy worsens, and that - if unemployment rises sharply or the commercial real estate market collapses – the banking system could again crash:

The financial system [still remains] vulnerable to the crisis conditions that [the bailout] was meant to fix...

Financial stability remains at risk if the underlying problem of toxic assets remains unresolved.[58]
As Reuters notes:
The chairman of the congressional oversight panel, Elizabeth Warren, said no one even knows the value of the toxic assets still on banks' books...

"No one has a good handle how much is out there," Warren said. "Here we are 10 months into this crisis...and we can't tell you what the dollar value is."[59]

Loan Loss Rates

Loan loss rates in could also be worse than the Great Depression, at least in the United States. Specifically, during the depths of the Great Depression, the loss rate which banks suffered on their loans climbed as high as 3.4% (it is normally well under 2.0%).[60]

Last month, banking analyst Mike Mayo predicted that loan loss rates could go as high as 5.5%, which is substantially higher than during the 1930s.[61]

But the Federal Reserve's more adverse scenario for the stress tests - which everyone knows is too rosy concerning most of its assumptions - predicts a loan loss rate of 9.1%, nearly three times higher than during the 1930s.[62]

As US News and World Report wrote in May 2009:

For most of the past 50 years, the loss rate on all bank loans has stayed well under 2 percent. The Fed estimates that over the next two years the loss rate could reach 9.1 percent. You know all those historical comparisons that end with "the worst since the Great Depression"? Well, 9.1 percent would be EVEN WORSE than during the 1930s. Still looking forward to a soft landing or a quick recovery?[63]
Consumer Spending

Consumer spending accounts for the vast majority of the economy in the United States. The figure commonly cited is that consumer spending accounts for 70% of U.S. Gross Domestic Product. [64]. (Consumer spending has been a lower percentage of GDP in most other countries. [65])

But the economic crisis is driving consumer spending downward. Economist David Rosenberg [66] says that consumers have undergone a generational shift in spending habits, and will be frugal for a long time to come.[67]

The head of Collective Brands, Matthew Rubel, states:
Consumer spending as a percentage of GDP has moved down, will probably continue to move down through the end of year, and then normalize as we get into somewhere in early-to-mid next year, from our point of view.[68]

The chief economist of IHS Global Insight, Nariman Behravesh, says consumer spending will decline to 65 percent of GDP:

With individuals more focused on saving than spending, Behravesh said retail consumer spending as a percentage of GDP is likely to fall from 70 percent to 65 percent. “It will take a while, maybe 10 years,” he said. “Correspondingly other countries are going to have to shift in the opposite direction to rely more on their own consumers rather than the U.S. consumers.”[69]

Jason DeSena Trennert, Chief Investment Strategist for Strategas Research Partners, says:

Consumer spending as a percentage of GDP is going to go in one direction for a long time -- lower.[70]

Time points out :

Economist Stephen Roach, chairman of Morgan Stanley Asia, says that "there is good reason to believe the capitulation of the American consumer has only just begun." U.S. consumer spending as a percentage of GDP reached 72% in 2007, well above the pre-bubble norm of 67%. Using that as a gauge, Roach says that only 20% of the potential retrenchment of spending has taken place, even after the dramatic decline at the end of 2008. "The imbalance that contributed to the crisis — overconsumption and excessive savings — cannot continue," says Ajay Chhibber, director of the Asia bureau at the United Nations Development Program in New York City. "The model where you stimulate and [then] go back to the old days is gone."[71]
The Wall Street Journal notes:

"Economists also see an upturn in U.S. household saving as the beginning of a prolonged period of thrift....."[72]

Demographics

Financial analysts who have studied U.S. demographics - like Harry Dent and Claus Vogt - point out that the U.S. population is aging:

United States Population Pyramid for 2010

Predicted age and sex distribution for the year 2010:

United States Population Pyramid for 2020

Predicted age and sex distribution for the year 2020:

United States Population Pyramid for 2050

Predicted age and sex distribution for the year 2050:

[73]

Vogt argues that an aging population within a given nation is correlated with a decline in that country's economy. [74]. Certainly, a population with less working-age people and more dependent elderly people will experience a drag on its economy.

Dent argues that one of the main drivers of a country's economic growth is the number of people in the country who are in their peak spending years.

For example, Dent says that in the U.S., 45-54 year olds are the biggest spenders, because that is when - on average - they are paying for their kids' college, paying mortgage on the biggest house they will own during their life, etc. Dent argues that the American economy will tend to grow when the number of 45-54 year olds grows, and to shrink when it shrinks.

As the charts above show, the number of 45-54 year olds in the U.S. will shrink considerably in the year ahead.

Decline in Manufacturing

As everyone knows, the manufacturing has shrunk in the United States and the service sector has grown. Even in a manufacturing center such as Detroit, manufacturing jobs have been declining for decades:

[75]

Indeed, according to professor of economics Dr. Mark J. Perry, manufacturing jobs have dropped to their lowest level since 1941, and are now below 9% of the workforce for the first time. [76]

Wayne State University's Center for Urban Studies argues:
For each job lost in the manufacturing industry, more spinoff jobs are lost than would be in other sectors. Each manufacturing job helps support a larger number of other jobs than do most other sectors. [77]
That means that the ongoing reduction in manufacturing jobs will adversely affect unemployment for the foreseeable future.

Destruction of Credit

The amount of credit outstanding has been reduced by trillions of dollars in the past year.

For example, the amount of consumer credit outstanding has plummeted:

Banks have become tight-fisted about lending, and this will probably not change any time soon. As the New York Times wrote in an article from October 2008 entitled "Banks Are Likely to Hold Tight to Bailout Money":

"Will lenders deploy their new-found capital quickly, as the Treasury hopes, and unlock the flow of credit through the economy? Or will they hoard the money to protect themselves?

John A. Thain, the chief executive of Merrill Lynch, said on Thursday that banks were unlikely to act swiftly. Executives at other banks privately expressed a similar view.

'We will have the opportunity to redeploy that,' Mr. Thain said of the new capital on a telephone call with analysts. 'But at least for the next quarter, it’s just going to be a cushion.'

***

Lenders have been pulling back on credit lines for businesses, mortgages, home equity loans and credit card offers, and analysts said that trend was unlikely to be reversed by the government’s money.

Roger Freeman, an analyst at Barclays Capital, which acquired parts of the now-bankrupt Lehman Brothers last month [said] 'My expectation is it’s quarters off, not months off, before you see that capital being put to work.' ”[78]

And another New York Times article included the following quote:

“It doesn’t matter how much Hank Paulson gives us,” said an influential senior official at a big bank that received money from the government, “no one is going to lend a nickel until the economy turns.” The official added: “Who are we going to lend money to?” before repeating an old saw about banking: “Only people who don’t need it.”[79]
Reading between the lines, the bank officials are saying that they will not lend freely until the economic crisis is over.

As WLMLab Bank Loan Performance points out, outstanding loans in the United States have dropped $110 billion dollars quarter-over-quarter. [80]

McClatchy notes:

Over the course of 2008, the nation's five largest banks reduced their consumer loans by 79 percent, real estate loans by 66 percent and commercial loans by 19 percent, according to FDIC data. A wide range of credit measures, including recent FDIC data, show that lending remains depressed.[81]
The Telegraph writes:

US credit shrinks at Great Depression rate prompting fears of double-dip recession...

Professor Tim Congdon from International Monetary Research said US bank loans have fallen at an annual pace of almost 14pc in the three months to August (from $7,147bn to $6,886bn).

"There has been nothing like this in the USA since the 1930s," he said. "The rapid destruction of money balances is madness."

The M3 "broad" money supply, watched as an early warning signal for the economy a year or so later, has been falling at a 5pc annual rate.

Similar concerns have been raised by David Rosenberg, chief strategist at Gluskin Sheff, who said that over the four weeks up to August 24, bank credit shrank at an "epic" 9pc annual pace, the M2 money supply shrank at 12.2pc and M1 shrank at 6.5pc...

US banks are cutting lending by around 1pc a month. A similar process is occurring in the eurozone, where private sector credit has been contracting and M3 has been flat for almost a year.
[82]

Indeed, total seasonally adjusted consumer debt fell $21.55 billion, or at a 10.4% annual rate, in July 2009 alone. credit-card debt fell $6.11 billion, or 8.5%, to $905.58 billion. This is the record 11th straight monthly drop in credit card debt. Non-revolving credit, such as auto loans, personal loans and student loans fell a record $15.44 billion or 11.7% to $1.57 trillion [83]

In addition, the securitization market has largely collapsed, which in turn has destroyed a large proportion of the world's credit. As noted in an article in the Washington Times:
“Before last fall’s financial crisis, banks provided only $8 trillion of the roughly $25 trillion in loans outstanding in the United States, while traditional bond markets provided another $7 trillion, according to the Federal Reserve. The largest share of the borrowed funds - $10 trillion - came from securitized loan markets that barely existed two decades ago. . . .

Mr. Regalia [chief economist at the U.S. Chamber of Commerce] said ... 70 percent of the system isn’t there anymore,’ he said.”[84]

The reason that seventy percent of the system "isn’t there anymore" is because the traditional bond markets and securitized loan markets (part of the "shadow banking system") have dried up. As the Washington Times article notes:

“Congress’ demand that banks fill in for collapsed securities markets poses a dilemma for the banks, not only because most do not have the capacity to ramp up to such large-scale lending quickly. The securitized loan markets provided an essential part of the machinery that enabled banks to lend in the first place. By selling most of their portfolios of mortgages, business and consumer loans to investors, banks in the past freed up money to make new loans. . . .

“The market for pooled subprime loans, known as collateralized debt obligations (CDOs), collapsed at the end of 2007 and, by most accounts, will never come back. Because of the surging defaults on subprime and other exotic mortgages, investors have shied away from buying the loans, forcing banks and Wall Street firms to hold them on their books and take the losses.”

Senior economic adviser for UBS Investment Bank, George Magnus, confirms:

The restoration of normal credit creation should not be expected, until the economy has adjusted to the disappearance of shadow bank credit, and until banks have created the capacity to resume lending to creditworthy borrowers. This is still about capital adequacy, where better signs of organic capital creation are welcome. More importantly now though, it is about poor asset quality, especially as defaults and loan losses rise into 2010 from already elevated levels.[85]
And McClatchy writes:

The foundation of U.S. credit expansion for the past 20 years is in ruin. Since the 1980s, banks haven't kept loans on their balance sheets; instead, they sold them into a secondary market, where they were pooled for sale to investors as securities. The process, called securitization, fueled a rapid expansion of credit to consumers and businesses. By passing their loans on to investors, banks were freed to lend more.

Today, securitization is all but dead. Investors have little appetite for risky securities. Few buyers want a security based on pools of mortgages, car loans, student loans and the like.

"The basis of revival of the system along the line of what previously existed doesn't exist. The foundation that was supposed to be there for the revival (of the economy) . . . got washed away," [economist James K.] Galbraith said.

Unless and until securitization rebounds, it will be hard for banks to resume robust lending because they're stuck with loans on their books.[86]

Not only has the supply of credit been destroyed, but the demand for many types of loans - such as commercial real estate loans - is also drying up.[87]

So there is simply much less credit flowing through the economic system than there was prior to 2007.

The New Normal - Lower Economic Activity

As chief economist for the International Monetary Fund, Olivier Blanchard, said:

This recession has been so destructive that "we may not go back to the old growth path ... potential output may be lower than it was before the crisis." [88]

All of the above trends force many economists to conclude that economic activity as a whole will be lower for many, many years. In other words, they say that "The New Normal" will be a much lower level for the economy.

Pimco CEO Mohamed El-Erian says elevated unemployment and record wealth destruction will keep growth at 2 percent or less for years. [89]

As Bloomberg writes:

The New Normal theory predicts that the recession will leave unemployment, forecast to reach 10 percent for the first time since 1983 early next year, higher for years. [90]

Indeed, the "overhang" of inventory [91]- that is, the inventory of unsold goods - in everything from housing [92 and 93] to cars [94] to consumer electronics [95] means that the newly reduced consumer demand is meeting up with very high levels of supply. [96 - Indeed, entire fleets of cargo ships are sitting empty because of slack demand] This is a recipe for unemployment.

Many economists also point out that the length of time people are remaining unemployed is skyrocketing. As the Washington Post notes:

Another disturbing development was that the number of people out of work for 27 weeks or longer reached a record 5 million, accounting for a third of the unemployed. That suggests to some economists that those job losses were caused by structural changes in the economy and that many of those people won't be called back to work once the economy picks up. The longer people are out of work, the harder it becomes for them to find jobs and the more likely they are to exhaust savings or lose their homes to foreclosure. [97]

The following chart from the St. Louis Federal Reserve Bank shows that people are staying unemployed much longer than they have in any previous economic downturn since 1950:






















[98]

As David Rosenberg writes:
The number of people not on temporary layoff surged 220,000 in August and the level continues to reach new highs, now at 8.1 million. This accounts for 53.9% of the unemployed — again a record high — and this is a proxy for permanent job loss, in other words, these jobs are not coming back. Against that backdrop, the number of people who have been looking for a job for at least six months with no success rose a further half-percent in August, to stand at 5 million — the long-term unemployed now represent a record 33% of the total pool of joblessness. [99]
[100: for graphical updates on the state of the economy, see charts from the Cleveland Federal Reserve Bank posted at http://www.clevelandfed.org/research/data/updates/index.cfm?DCS.nav=Local]

Other Theories Regarding the Causes of Unemployment

The main cause of unemployment today is the economic crisis. For example, a report from the the National Industrial Conference Board pointed out in 1922 stated the obvious: depressions increase unemployment. [101]

The report also points out that seasonal variations, "immigration and tariff policies and international relationship" can affect unemployment figures. [102]

In fact, economists from different schools of thought ascribe different causes to unemployment. For example:
Keynesian economics emphasizes unemployment resulting from insufficient effective demand for goods and services in the economy (cyclical unemployment). Others point to structural problems, inefficiencies, inherent in labour markets (structural unemployment). Classical or neoclassical economics tends to reject these explanations, and focuses more on rigidities imposed on the labor market from the outside, such as minimum wage laws, taxes, and other regulations that may discourage the hiring of workers (classical unemployment). Yet others see unemployment as largely due to voluntary choices by the unemployed (frictional unemployment). Alternatively, some blame unemployment on disruptive technologies or Globalisation.
[103 and 104]

For example, many Americans believe that globalization has increased unemployment because "American jobs" have moved abroad. Certainly, the American government has encouraged multinational corporations based in the U.S. to move jobs overseas. But quick fixes may lead to new problems. For example, a new American protectionism could stifle trade, further weakening the American economy.

Similarly, some economists believe that inflation decreases unemployment. However, that is only true where the workers drastically underestimate the extent to which higher prices are decreasing the real value of their wages. Indeed, as the Cato Institute notes:

This reduction in unemployment cannot occur unless workers systematically underestimate the inflation rate. When workers are aware of the inflation rate and, for example, have their pay adjusted according to the cost of living, they will interpret wages properly and not be misled into thinking that a normal wage offer is a relatively high wage offer.

Rather than merely failing to decrease unemployment, inflation may actually increase the unemployment rate. Frequent concomitants of inflation, such as high interest rates and volatility and uncertainty in the financial and product markets, increase the risks inherent in business operations and thereby discourage the expansion of firms and the creation of jobs. [105]

Therefore, many "quick fixes" for unemployment may actually do more harm than good.

Isn't the Government Helping to Reduce Unemployment?

The government has committed to give trillions to the financial industry. President Obama's stimulus bill was $787 billion, which is less than a tenth of the money pledged to the banks and the financial system. [106]

Of the $787 billion, little more than perhaps 10% has been spent as of this writing. [107]

The Government Accountability Office says that the $787 billion stimulus package is not being used for stimulus. [108] Instead, the states are in such dire financial straights that the stimulus money is instead being used to "cushion" state budgets, prevent teacher layoffs, make more Medicaid payments and head off other fiscal problems. So even the money which is actually earmarked to help the states stimulate their economies is not being used for that purpose.

Indeed, much of the $787 billion was earmarked pork [109], not for anything which could actually stimulate the economy. [110]

Mark Zandi - chief economist for Moody's - has calculated which stimulus programs give the most bang for the buck in terms of the economy:

[111]

But very little of the stimulus funds are actually going to high-value stimulus projects.

Indeed, as the Los Angeles Times points out:

Critics say the [stimulus money reaching California] is being used for projects that would have been built anyway, instead of on ways to change how Californians live. Case in point: Army latrines, not high-speed rail.

***
Critics say those aren't the types of projects with lasting effects on the economy.

"Whether it's talking about building a new [military] hospital or bachelor's quarters, there isn't that return on investment that you'd find on something that increases efficiency like a road or transit project," said Ellis of Taxpayers for Common Sense.

Job creation is another question. A recent survey by the Associated General Contractors of America found that slightly more than one-third of the companies awarded stimulus projects planned to hire new employees. But about one-third of the companies that weren't awarded stimulus projects also planned to hire new employees.

"While the construction portion of the stimulus is having an impact, it is far from delivering its full promise and potential," said Stephen E. Sandherr, chief executive of the contractors group.

It's unclear how many jobs will be created through the Defense Department projects. Most of the construction jobs are awarded through multiple award contracts, in which the department guarantees a minimum amount of business to certain contractors, and lets only those contractors bid on projects.

That means many of the contractors working on stimulus projects already have been busy at work on government projects.even the stimulus money which is being spent [112]
David Rosenberg writes:
Our advice to the Obama team would be to create and nurture a fiscal backdrop that tackles this jobs crisis with some permanent solutions rather than recurring populist short-term fiscal goodies that are only inducing households to add to their burdensome debt loads with no long-term multiplier impacts. The problem is not that we have an insufficient number of vehicles on the road or homes on the market; the problem is that we have insufficient labour demand.[113]
Donald W. Riegle Jr. - former chair of the Senate Banking Committee from 1989 to 1994 - wrote (along with the former CEO of AT&T Broadband and the international president of the United Steelworkers union):
It's almost as if the administration is opting for a rose-colored-glasses PR strategy rather than taking a hard-nose look at actual consumer and employment figures and their trends, and modifying its economic policies accordingly.[114]

How Much Unemployment Do We Want?

On the one end of the spectrum, Article 23 of the United Nations' Universal Declaration of Human Rights declares:

Everyone has the right to work, to free choice of employment, to just and favourable conditions of work and to protection against unemployment.[115]

In other words, the U.N. says that there should be essentially no unemployment for those who wish to work.

On the other end of the spectrum, some people - who make a lot of money during periods where the condition lead to high levels of unemployment - are comfortable with unemployment percentages reaching those in the Great Depression.

Societies should decide for themselves what level of unemployment they consider acceptable, and then demand policies which will accomplish that goal to the greatest extent possible. As discussed above, there are many factors which affect employment levels, and so solutions are complicated.

However, without an open and visible public policy debate about the issue, unemployment levels will either remain second order affects of policy choices concerning other elements of the economy, or will be decided behind closed doors by decision-makers who may or may not have the best public interest in mind.

Public Funding

As the above facts show, unemployment is a very serious problem in the United states, and world-wide. The policy responses of the U.S. and other Western governments has not been working. As discussed above, there is no simple solution.

Senator Riegle recommends a 4-part prescription, including:

Ensure that loans and credit facilities are readily available to the nation's small and medium size businesses and manufacturers.

Many of the top economists argue that we need to break up the giant banks which are insolvent in order to save the economy.[116] Fortune[117], BusinessWeek[118] and Federal Reserve governor Daniel K. Tarullo[119] have pointed out that breaking up the largest, insolvent banks would allow more competition from small to mid-size banks, and that such banks may actually make more loans to small businesses. More loans to small businesses would lead to more employment by those many small businesses.

In addition, the U.S. has largely been financing job creation for ten years. Specifically, as the chief economist for BusinessWeek, Michael Mandel, points out, public spending has accounted for virtually all new job creation in the past 1o years:

Private sector job growth was almost non-existent over the past ten years. Take a look at this horrifying chart:

longjobs1.gif

Between May 1999 and May 2009, employment in the private sector sector only rose by 1.1%, by far the lowest 10-year increase in the post-depression period.

It’s impossible to overstate how bad this is. Basically speaking, the private sector job machine has almost completely stalled over the past ten years. Take a look at this chart:

longjobs2.gif

Over the past 10 years, the private sector has generated roughly 1.1 million additional jobs, or about 100K per year. The public sector created about 2.4 million jobs.

But even that gives the private sector too much credit. Remember that the private sector includes health care, social assistance, and education, all areas which receive a lot of government support.

***

Most of the industries which had positive job growth over the past ten years were in the HealthEdGov sector. In fact, financial job growth was nearly nonexistent once we take out the health insurers.

Let me finish with a final chart.

longjobs4.gif

Without a decade of growing government support from rising health and education spending and soaring budget deficits, the labor market would have been flat on its back. [120]

Raw Story argues that the U.S. is building a largely military economy:

The use of the military-industrial complex as a quick, if dubious, way of jump-starting the economy is nothing new, but what is amazing is the divergence between the military economy and the civilian economy, as shown by this New York Times chart.

In the past nine years, non-industrial production in the US has declined by some 19 percent. It took about four years for manufacturing to return to levels seen before the 2001 recession -- and all those gains were wiped out in the current recession.

By contrast, military manufacturing is now 123 percent greater than it was in 2000 -- it has more than doubled while the rest of the manufacturing sector has been shrinking...

It's important to note the trajectory -- the military economy is nearly three times as large, proportionally to the rest of the economy, as it was at the beginning of the Bush administration. And it is the only manufacturing sector showing any growth. Extrapolate that trend, and what do you get?

The change in leadership in Washington does not appear to be abating that trend...[121]
So most of the job creation has been by the public sector. But because the job creation has been financed with loans from China and private banks, trillions in unnecessary interest charges have been incurred by the U.S.

Former Washington Post editor and author of one of the leading books on the Federal Reserve, William Greider, points out that governments actually have the power to create money and credit themselves, instead of borrowing it at interest from private banks:

If Congress chooses to take charge of its constitutional duty, it could similarly use greenback currency created by the Federal Reserve as a legitimate channel for financing important public projects--like sorely needed improvements to the nation's infrastructure. Obviously, this has to be done carefully and responsibly, limited to normal expansion of the money supply and used only for projects that truly benefit the entire nation (lest it lead to inflation)...

This approach speaks to the contradiction House Speaker Pelosi pointed out when she asked why the Fed has limitless money to spend however it sees fit. Instead of borrowing the money to pay for the new rail system, the government financing would draw on the public's money-creation process--just as Lincoln did and Bernanke is now doing.[122]
By creating the credit itself - instead of borrowing from private banks and foreign nations - the American government could finance the creation of new jobs without incurring huge interest charges owed to the private banks and foreign countries which lent America the money. In other words, the U.S. government would itself create the new credit, just as Lincoln did to finance the civil war.

By financing new projects with credit created by the government itself, America might be able to pick itself up by its bootstraps and put its people back to work.

The same may be true for other countries as well.