Foreign capital, go home! Is China going to stop buying USG bonds?

Foreign capital, go home!

POLITICAL ECONOMY | MICHAEL PETTIS | 17 AUGUST 2011 10:30

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By Michael Pettis

Is the PBoC going to stop buying USG bonds? Once again we are hearing very worried noises from various sectors about the possibility of a reduction in Chinese purchases of USG bonds. Here is what an article the South China Morning Post said:

China will press ahead with diversification of its US$3.2 trillion in foreign exchange reserves, the State Administration of Foreign Exchange (SAFE) said on Thursday, adding it does not intentionally pursue large-scale foreign currency holdings. Officials have long pledged to broaden the mix of the country's huge reserves – as much as 70 per cent of which are now in US dollar assets, according to analysts' estimates – but the process has been gradual.

"We will continue to diversify the asset allocation of our reserve assets and continue to optimise the holdings based on market conditions," the foreign exchange regulator said in a statement, responding to questions about its reserve management from the public. It did not mention the US debt debacle. Top Republicans and Democrats worked behind the scenes on Wednesday on a compromise to avert a crippling US default and potential credit rating downgrade.

Xia Bin, an adviser to the central bank, told reporters earlier this month that China should speed up reserve diversification away from dollars to hedge against risks of the US currency's possible long-term decline.

It sounds like this time the PBoC might be pretty serious about diversifying their risk away from USG bonds, right? Let's leave aside the fact that every six months we have heard the same thing for the past several years, and nothing has happened, shouldn't we nonetheless be worried? Won't reduced PBoC purchases be hugely disruptive to the US economy and to the US Treasury markets?
No, they won't. There is so much nonsense still being said about this, even by economist who should know better, that I thought I would try to address what it would mean if the PBoC were actually serious and not simply making noises aimed at domestic political constituents.
First of all, remember that the PBoC does not purchase huge amounts of USG bonds because it has a lot of money lying around and doesn't know what to do with it. Its purchase of USG bonds is simply a function of its trade policy.
You cannot run a current account surplus unless you are also a net exporter of capital, and since the rest of China is actually a net importer of capital, the PBoC must export huge amounts of capital in order to maintain China's trade surplus. In order the keep the RMB from appreciating, the PBoC must be willing to purchase as many dollars as the market offers at the price it sets. It pays for those dollars in RMB.
It is able to do so by borrowing RMB in the domestic markets, or by forcing banks to put up minimum reserves on deposit. What does the PBoC do with the dollars it purchases? Because it is such a large buyer of dollars, it must put them in a market that is large enough to absorb the money and – and this is the crucial point – whose economy is willing and able to run a large enough trade deficit.
Remember that when Country A exports huge amounts of money to Country B, Country A must run a current account surplus and Country B must run the corresponding current account deficit. In practice, only the US fulfills those two requirements – large financial markets, and the ability and willingness to run large trade deficits – which is why the PBoC owns huge amounts of USG bonds.
If the PBoC decides that it no longer wants to hold USG bonds, it must do something pretty drastic. There are only four possible paths that the PBoC can follow if it decides to purchase fewer USG bonds.

1. The PBoC can buy fewer USG bonds and purchase more USD assets.
2. The PBoC can buy fewer USG bonds and purchase more non-US dollar assets, most likely foreign government bonds.
3. The PBoC can buy fewer USG bonds and purchase more hard commodities.
4. The PBoC can buy fewer USG bonds by intervening less in the currency, in which case it does not need to buy anything else.

We can go through each of these scenarios to see what would happen and what the impact might be on China, the US, and the world. To make the explanation easier, let's simply assume that the PBoC sells $100 of USG bonds.
The PBoC can sell $100 of USG bonds and purchase $100 of other USD assets. In this case basically nothing would happen. The pool of US dollar savings available to buy USG bonds would remain unchanged (the seller of USD assets to China would now have $100 which he would have to invest, directly or indirectly, in USG bonds), China's trade surplus would remain unchanged, and the US trade deficit would remain unchanged. The only difference might be that the yields on USG bonds will be higher by a tiny amount while credit spreads on risky assets would be lower by the same amount.
The PBoC can sell $100 of USG bonds and purchase $100 of non-US dollar assets, most likely foreign government bonds. Since in principle the only market big enough is Europe, let's just assume that the only alternative is to buy $100 equivalent of euro bonds issued by European governments.
There are two ways the Europeans can respond to the Chinese switch from USG bonds to European bonds. On the one hand they can turn around and purchase $100 of USD assets. In this case there is no difference to the USG bond market, except that now Europeans instead of Chinese own the bonds. What's more, the US trade deficit will remain unchanged and the Chinese trade surplus also unchanged.
But Europe might be unhappy with this strategy. Since there is no reason for Europeans to buy an additional $100 of US assets simply because China bought euro bonds, the purchase will probably occur through the ECB, in which case Europe will be forced to accept an unwanted $100 increase in its money supply (the ECB must create euros to buy the dollars).
On the other hand, and for this reason, the Europeans might decide not to purchase $100 of US assets. In that case there must be an additional impact. The amount of capital the US is importing must go down by $100 and the amount that Europe is importing must go up.
Will this reduction in US capital imports make it more difficult to fund the US deficit? Not at all. On the contrary – it might make it easier. Why? Because if US capital imports drop by $100, by definition the US current account deficit will also drop by $100, almost certainly because of a $100 contraction in the trade deficit.
A contraction in the US trade deficit is of course expansionary for the economy. Since the purpose of the US fiscal deficit is to create jobs, and a $100 contraction in the trade deficit will create jobs, the US fiscal deficit will contract by $100 for the same level of job creation – perhaps even more if you believe, as most of us do, that increased trade is a more efficient creator of productive jobs than increased government spending.
In other words although there is $100 less demand for USG bonds, there is also $100 less supply (or more) of USG bonds. It is of course possible that the USG ignores the employment impact of the contraction in the trade deficit, and goes ahead and spends the $100 anyway, but in that case unemployment would drop even more than expected.
This is the key point. If foreigners buy fewer USD assets, the US trade deficit must decline. This is almost certainly good for the US economy and for US employment. When analysts worry that China might buy fewer USG bonds, in other words, they are worrying that the US trade deficit might contract. This is something we should welcome, not deplore.
But the story doesn't end there. What about Europe? Since China is still exporting the $100 by buying European government bonds instead of USG bonds, its trade surplus doesn't change, but of course as the US trade deficit declines, the European trade surplus must decline, and even possibly go into deficit. This is because by selling dollars and buying euro, China is forcing the euro to appreciate against the dollar.
This deterioration in the trade account will force Europeans either into raising their fiscal deficits or letting domestic unemployment rise. Under these conditions it is hard to imagine they would tolerate much Chinese purchase of European assets without responding eventually with trade protection.
The PBoC can sell $100 of USG bonds and purchase $100 of hard commodities. This is no different than the above scenario except now that the exporters of those hard commodities must face the choice Europe faced above. Either they can neutralize the trade impact of Chinese purchases by buying US assets or they have to absorb the employment impact of deterioration in their trade account.
This, by the way, is a bad strategy for China but one that it seems nonetheless to be following. Commodity prices are very volatile, and unfortunately this volatility is badly correlated with Chinese needs. Since China is the largest or second largest purchaser of most commodities, stockpiling commodities is a good investment only if it continues growing rapidly, and a bad investment if its growth slows. This is the wrong kind of balance sheet position any county, especially a very poor country like China, should be engineer. It simply exacerbates underlying conditions and increases economic volatility – never a good thing, especially for a poor and undeveloped economy.
The PBoC can sell $100 of USG bonds by intervening less in the currency, in which case it does not need to buy anything else. In this case, which is the simplest of all to explain, China's trade surplus declines by $100 and the US trade deficit declines by $100 as the RMB rises. The net impact on US financing costs is unchanged for the reasons discussed above. Chinese unemployment will rise because of the reduction in its trade surplus unless it increases the fiscal deficit.
It's about trade, not capital
This may sound counterintuitive to all except those who understand the way the global balance of payments work, but countries that export capital are not doing anyone favors unless incomes in the recipient country are so low that savings are impossible or the capital export comes with technology, and countries that import capital might be doing so mainly at the expense of domestic jobs. For this reason it is absurd to worry that China might stop buying USG bonds.
On the contrary, the whole US-China trade dispute is indirectly about China's insistence on purchasing USG bonds and the US insistence that they stop. Because make no mistake, if the Chinese trade surplus declines, and the US trade deficit declines too, by definition China is directly or indirectly buying fewer USG bonds, and this reduction in bond purchases will not cause US interest rate to rise at all. If it did, it would be like saying that the higher a country's trade deficit, the lower its domestic interest rates. This statement is patently untrue.
Inevitably whenever I write about trade and capital exports someone will indignantly point out a devastating flaw in my argument. Since the US makes nothing that it imports from China, they will claim, a reduction in China's capital exports to the US (or a reduction in China's trade surplus) will have no impact on the US trade deficit. It will simply cause someone else's exports to the US to rise with no corresponding change in the US trade balance.
No it won't, unless this other country steps up its capital exports to the US and replaces China – which is pretty unlikely. Aside from the sheer idiocy of the claim that the US does not produce, or is incapable of producing, anything it imports from China, the claim is irrelevant even if it were true. Trade does not settle on a bilateral basis but must settle on a multilateral basis. If the US imports less capital its current account deficit must decline, whether because of bilateral changes in trade or not. I explain this in a blog entry early last year.
The basic point is that if reduced intervention in Chinese capital exports causes a reduction in Chinese exports to the US to be matched dollar for dollar with an increase in, say, Mexican exports to the US, the story doesn't end there. Since Mexico's trade balance is itself decided by the relationship between domestic investment and savings, a rise in Mexican exports will mean a rise in Mexican imports. It may very well be that lower Chinese exports to the US are matched by higher US imports from Mexico, but this will come with higher US exports to Mexico. And if it isn't Mexico, it will be someone else.
This is an abbreviated version of the newsletter that went out two weeks ago. Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me atchinfinpettis@yahoo.com, stating your affiliation, please. Investors who want to buy a subscription should write to me, also at that address.

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Simon Johnson: Su vision de la crisis

A Second Great Depression – Or Could It Become Something Worse?

By Simon Johnson
With the US and European econIs This omies having slowed markedly according to the latest data, and with global growth continuing to disappoint, a reasonable question increasingly arises: Are we in another Great Depression?
The easy answer is "no" – the main features of the Great Depression have not yet manifest themselves and still seem unlikely.  But it is increasingly likely that we will find ourselves in the midst of something nearly as traumatic, a long slump of the kind seen with some regularity in the nineteenth century, particularly if presidential election-year politics continue to head in dangerous direction.
The Great Depression had three main characteristics, seen in the United States and most other countries that were severely affected.  None of these have been part of our collective experience since 2007.
First, output dropped sharply after 1929, by over 25 percent in real terms in the US (using the Bureau of Economic Analysis data, from its website, for real GDP, using chained 1937 dollars).  In contrast, in the U.S. we had a relatively small decline in GDP after the boom peaked.  According to the BEA's latest online data, GDP peaked in the 2^nd quarter of 2008 at 14.4155 trillion and bottomed out in the 2^ndquarter of 2009 at 13.8541 trillion; a decline of about 4 percent.
Second, unemployment rose above 20 percent in the US during the 1930s and stayed there.  We experienced record job losses for the post-war US, with around 8 million jobs lost.  But unemployment only briefly touched 10 percent (in the 4^th quarter of 2009; see the Bureau of Labor Statistics website).  Even if we include the highest estimates – which include people discouraged from looking for a job, thus not registered as unemployed – the jobless rate reached around 16-17 percent.  It's a jobs disaster, to be sure, but not the same scale as the Great Depression.
Third, in the 1930s the credit system shrank dramatically.  In large part this is because banks failed in an uncontrolled manner – largely as a part of panics that led to retail depositors running to take out their funds.  The creation of the Federal Deposit Insurance Corporation (FDIC) put an end to that kind of run and, despite everything, the FDIC has continues to play a calming role.  (Disclosure: I'm on the FDIC's newly created systemic resolution advisory committee, but I don't have anything to do with how they handle small and medium-sized banks.)
But experience at the end of the 19^th century was also quite different from the 1930s – not as dramatic, yet very traumatic for many Americans.  The heavily leveraged sector more than 100 years ago was not housing but rather agriculture – a different play on real estate. 
There were booming new technologies in that day, including the stories we know well around the rapid development of transportation, telephones, electricity, and steel.  But falling agricultural prices kept getting in the way for many Americans.  With large debt burdens, farmers were vulnerable to deflation (a lower price level in general or just for their products).  And prior to the big migration into cities, farmers were a mainstay of consumption.
According to the NBER, falling from peak to trough in each cycle took 11 months in 1945-2009 but twice that amount of time during 1854-1919.  The longest decline on record, according to this methodology, was not during the 1930s but rather during October 1873 to March 1879 – more than 4 years of economic decline. 
In this context, it is quite striking – and deeply alarming – to hear a prominent Republican presidential candidate attack Ben Bernanke for his efforts to prevent deflation.  Specifically, Texas Governor Rick Perry said earlier this week, referring to Mr. Bernanke,

"If this guy prints more money between now and the election, I dunno what y'all would do to him in Iowa but we would treat him pretty ugly down in Texas. Printing more money to play politics at this particular time in American history is almost treasonous in my opinion."

In the nineteenth century the agricultural sector, particularly in the west of the country, favored higher prices and effectively looser monetary policy.  This was the background for William Jennings Bryan's famous "cross of gold" speech in 1896; the "gold" to which he referred was the gold standard, the bastion of hard money – and tendency towards deflation – favored by the east coast financial establishment.
Populism in the nineteenth century was, broadly speaking, from the left.  But now the rising populists are from the right of the political spectrum and they seem intent on intimidating monetary policy makers into inaction.  We see this push both on the campaign trail and on Capitol Hill – for example in interactions between the House Financial Services Committee, where Ron Paul chairs the monetary policy subcommittee, and the Federal Reserve.
The relative decline of agriculture and the rise of industry and services over a century ago was long believed to make the economy more stable – as we moved away from cycles based on the weather and global swings in supply and demand for commodities.  But financial development creates its own vulnerability as more people have access to credit for their personal and business decisions.  Add to that the rise of a financial sector that has proved brilliant at extracting subsidies that protect against downside risk – and hence encourage excessive risk-taking.  The result is an economy that is at least as prone to big boom-bust cycles as what existed at the end of the nineteenth century.
The rise of the tea party has taken fiscal policy off the table as a potential counter-cyclical instrument; the next fiscal moves will be contractionary (probably more spending cuts), irrespective of whether jobs start to come back or not.  In this situation, monetary policy matters a great deal – and Mr. Bernanke's focus on avoiding deflation and hence limiting the problems for debtors does not seem inappropriate (for more on Mr. Bernanke, his motivations and actions, see David Wessel's book, In Fed We Trust).
Mr. Bernanke has his flaws, to be sure.  Under his leadership, the Fed has been reluctant to take on regulatory issues – continuing to see the incentive distortions of "too big to fail" banks as somehow separate from monetary policy, its primary concern.  And his team has consistently pushed for capital requirements that are too low relative to the shocks we now face.
And the Federal Reserve itself is to blame for some of the damage to its reputation – although it did get a major assist from Treasury in 2008-09.  There were too many bailouts rushed over weekends, with terms that were too generous to incumbent management and not sufficiently advantageous to the public purse.
But to accuse Mr. Bernanke of treason for worrying about deflation is worse than dangerous politics.  It risks returning us to the long slump of the late 1870s.
An edited version of this post appeared this morning on the NYT.com's Economix blog; it is used here with permission.  If you would like to reproduce the entire post, please contact the New York Times.

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La quimera de la rentabilidad de las AFP (Chile)

lunes 9 de mayo de 2011

La quimera de la rentabilidad de las AFP (Chile)

Quimera: "aquello que se propone a la imaginación como posible o verdadero, no siéndolo". En relación al artículo publicado en Estrategia el 6 de mayo, donde el Sr. Roberto Fuentes, en representación de la Asociación de AFP (Chile), cuestiona mi columna en la cual se señala la metodología de la Tasa Interna de Retorno (TIR) del cliente para determinar la rentabilidad después de comisiones, y que es ésta la variable relevante a considerar, me gustaría aclarar una serie de profundos errores conceptuales que permanentemente se observan cuando se evalúa el sistema de pensiones:

1) La rentabilidad que calcula la autoridad se refiere al retorno de la cuota. Es una rentabilidad bruta. Publicitarla en forma directa induce a error porque no considera el flujo de caja relevante para el afiliado. Para una mejor comprensión: en marzo 2011 las comisiones promedio del sistema fueron 1,55% del ingreso imponible. Así, por cada $100 que cotizaron los trabajadores, cerca de $13 se destinaron al pago de comisiones netas del seguro y sólo $87 ingresaron efectivamente al fondo de pensiones. Si para efectos de calcular la rentabilidad consideramos sólo los $87 ingresados al fondo, es claro que estaremos sobreestimando la rentabilidad dado que, en la práctica, el aporte efectivo fue $100. Dicho de otro modo, los $87 aportados deben acumular ganancias de $13 para recién comenzar a ser financieramente rentables para el cliente. La rentabilidad de la cuota no considera esto, la TIR sí.

2) Otro error conceptual es que la rentabilidad bruta de 9,2% anual calculada por la autoridad está hecha en base a un promedio simple. Esto implica que, en el caso chileno -que experimentó una baja en su costo financiero y un aumento en los precios de los activos financieros- se sobreestime aún más la rentabilidad. Lo correcto sería un promedio ponderado por el monto administrado. En el caso de la rentabilidad bruta informada, ésta pasaría de 9,2% anual promedio simple a 6,8% anual promedio ponderado.

3) Se plantea que "si se quieren restar las comisiones a la rentabilidad de la cuota que calcula la autoridad, estas comisiones deberían estimarse como promedio anual sobre el fondo administrado". Parece que se olvida que las comisiones son un flujo, mientras que el fondo acumulado es un stock. Nuevamente, la TIR soluciona este problema al considerar tanto las comisiones y el ingreso al fondo de pensiones cada mes (flujo de caja negativo global del cliente), como el stock al final del periodo (un flujo de caja positivo para el cliente, que tiene incorporada la rentabilidad de la cuota). La herramienta existe y es simple de usar. Se llama TIR. ¿Para qué usar una piedra para clavar un clavo si existe el martillo?

4) En relación a la TIR para cada multifondo mostrada en mi columna (período 2002-2011), se plantea que "en el sistema de AFP la comisión por administración se cobra una sola vez, al momento de la cotización, administrándose posteriormente ese aporte sin costo por el resto del período. Al acortarse arbitrariamente el plazo de evaluación, se reduce la TIR. Esa forma de utilizar la TIR es incorrecta, ya que su cálculo es fuertemente dependiente de la cantidad de años que se incorpora en el análisis y no del nivel de comisiones". Se recuerda que en el caso del fondo C se presentó claramente un cálculo para los 30 años, arrojando una TIR de 6,1% anual. ¿Deberíamos esperar 15 años más, y así completar el ciclo de vida de un trabajador, para darnos cuenta de una fantasía que no es tal? ¿Qué pasa con las últimas comisiones, pagadas por una sola vez, cuya rentabilidad incierta de la cuota no alcanza a absorber? Incluso en el cálculo del retorno de los multifondos en el periodo 2002-2011, el argumento de la autoridad es falaz. Los contratos de los cotizantes de AFP son de corto plazo: ellos se pueden cambiar de AFP cuando quieran. Ergo, los costos que el cotizante paga por una sola vez no tienen compensación en el futuro. Si un afiliado decide cambiarse de AFP, ¿quién le va a responder por los costos incurridos los años previos? ¿cuál es el don especial que tiene la nueva AFP para administrar en forma gratuita los fondos de un afiliado nuevo, cuyas comisiones fueron recibidas por la AFP antigua? El argumento cae por su propio peso.

5) Con respecto al 9,2% anual de rentabilidad bruta del sistema (TIR de 6,1% anual para el cliente), es lamentable que no se aclare que dicho 9,2% bruto es aplicable exclusivamente a los cotizantes que entraron al sistema el año 1981 y, en consecuencia, constituye en el mejor de los casos un techo máximo a la rentabilidad que ha obtenido algún cotizante en el sistema. Y lo más grave, nada garantiza que a futuro se logre dicha rentabilidad. En la medida que Chile avance al desarrollo, la TIR marginal de sus inversiones caerá. Por lo tanto, será cada vez más difícil replicar los retornos pasados. Por otra parte, dicha rentabilidad está sujeta a riesgo. Entonces, un X% de rentabilidad promedio del sistema de pensiones proyectada para los próximos años es equivalente a un retorno cierto, libre de riesgo, no muy distinto al que pudieran ofrecer hoy instrumentos de renta fija ¿O Ud. cree que se le puede ganar permanentemente al mercado? El viejo pascuero no existe.

6) Se dice que "publicar la TIR es poco representativo, ya que cada cuenta de los 8,8 millones de afiliados tiene ciertas características que las hace únicas, lo que haría necesario calcular la TIR para cada caso". Sorprende que, 30 años después, y con la tecnología existente hoy, todavía la solución a este problema sea un enigma. Computacionalmente hablando, hay problemas muchos más complejos.

7) Finalmente, se valora el Giro Único del sistema de pensiones. Sistema previsional no es sinónimo de sistema de AFP. ¿Acaso no nos dice nada que la Rentabilidad sobre el Patrimonio (ROE) del sistema de AFP haya sido en promedio 26,6% anual en el período 1997-2010, que es un reflejo de la diferencia entre la rentabilidad de la cuota y la TIR del cliente? ¿Acaso no nos dice nada que de los 4,8 millones de cotizantes en diciembre 2010, hayan sólo 3.244 que lo hagan en forma voluntaria (de un universo de 1,4 millones de trabajadores independientes)? Las cifras hablan por sí solas. Es evidente que se debería avanzar a entregar una mayor libertad a los cotizantes para hacer sus ahorros previsionales en una amplia gama de instituciones e instrumentos, que cumplan todos los requisitos por parte de la autoridad para una posterior fiscalización. Así, la brecha entre la rentabilidad bruta y la TIR del cliente no sería tan abismante.

Después de 30 años no se pueden seguir escondiendo dos hechos indesmentibles, a saber: 1) la variable relevante es la TIR para el cliente, que es significativamente menor que la rentabilidad bruta de la cuota, y 2) dicha rentabilidad está sujeta a riesgo, por lo tanto, su equivalente cierto no debería ser muy distinto a una alternativa de renta fija y, en consecuencia, hay que tener especial cuidado con la rentabilidad proyectada y las promesas a la hora de destacar las bondades del sistema. La magia no existe. La oposición que ha mostrado la autoridad en reconocer estos hechos pudiera traernos a la mente las palabras del filósofo alemán Arthur Schopenhauer: "Toda verdad pasa por tres etapas. Primero, es ridiculizada. Segundo, es violentamente rechazada. Tercero, es aceptada como evidente".
Publicado por Iván Rojas Bravo en 11:55

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The evolution of crisis By George Friedman Classical political economists like

The evolution of crisis
By George Friedman

Classical political economists like Adam Smith or David Ricardo never used the term ''economy'' by itself. They always used the term ''political economy.'' For classical economists, it was impossible to understand politics without economics or economics without politics. The two fields are certainly different but they are also intimately linked.

The use of the term ''economy'' by itself did not begin until the late 19th century. Smith understood that while an efficient market would emerge from individual choices, those choices were framed by the political system in which they were made, just as the political system was shaped by economic realities. For classical economists, the political and economic systems

were intertwined, each dependent on the other for its existence. 


The current economic crisis is best understood as a crisis of political economy. Moreover, it has to be understood as a global crisis enveloping the United States, Europe and China that has different details but one overriding theme: the relationship between the political order and economic life. On a global scale, or at least for most of the world's major economies, there is a crisis of political economy. Let's consider how it evolved. 


Origin of the crisis
As we all know, the origin of the current financial crisis was the subprime mortgage meltdown in the United States. To be more precise, it originated in a financial system generating paper assets whose value depended on the price of housing. It assumed that the price of homes would always rise and, at the very least, if the price fluctuated the value of the paper could still be determined. Neither proved to be true. The price of housing declined and, worse, the value of the paper assets became indeterminate. This placed the entire American financial system in a state of gridlock and the crisis spilled over into Europe, where many financial institutions had purchased the paper as well. 


From the standpoint of economics, this was essentially a financial crisis: who made or lost money and how much. From the standpoint of political economy it raised a different question: the legitimacy of the financial elite. Think of a national system as a series of subsystems - political, economic, military and so on. Then think of the economic system as being divisible into subsystems - various corporate verticals with their own elites, with one of the verticals being the financial system. Obviously, this oversimplifies the situation, but I'm doing that to make a point. 


One of the systems, the financial system, failed, and this failure was due to decisions made by the financial elite. This created a massive political problem centered not so much on confidence in any particular financial instrument but on the competence and honesty of the financial elite itself. A sense emerged that the financial elite was either stupid or dishonest or both. The idea was that the financial elite had violated all principles of fiduciary, social and moral responsibility in seeking its own personal gain at the expense of society as a whole. 


Fair or not, this perception created a massive political crisis. This was the true systemic crisis, compared to which the crisis of the financial institutions was trivial. The question was whether the political system was capable not merely of fixing the crisis but also of holding the perpetrators responsible. Alternatively, if the financial crisis did not involve criminality, how could the political system not have created laws to render such actions criminal? Was the political elite in collusion with the financial elite? 


There was a crisis of confidence in the financial system and a crisis of confidence in the political system. The US government's actions in September 2008 were designed first to deal with the failures of the financial system. Many expected this would be followed by dealing with the failures of the financial elite, but this is perceived not to have happened. Indeed, the perception is that having spent large sums of money to stabilize the financial system, the political elite allowed the financial elite to manage the system to its benefit. 


This generated the second crisis - the crisis of the political elite. The Tea Party movement emerged in part as critics of the political elite, focusing on the measures taken to stabilize the system and arguing that it had created a new financial crisis, this time in excessive sovereign debt. 


The Tea Party's perception was extreme, but the idea was that the political elite had solved the financial problem both by generating massive debt and by accumulating excessive state power. Its argument was that the political elite used the financial crisis to dramatically increase the power of the state (health care reform was the poster child for this) while mismanaging the financial system through excessive sovereign debt. 


The crisis in Europe
The sovereign debt question also created both a financial crisis and then a political crisis in Europe. While the American financial crisis certainly affected Europe, the European political crisis was deepened by the resulting recession. There had long been a minority in Europe who felt that the European Union had been constructed either to support the financial elite at the expense of the broader population or to strengthen Northern Europe, particularly France and Germany, at the expense of the periphery - or both. What had been a minority view was strengthened by the recession. 


The European crisis paralleled the American crisis in that financial institutions were bailed out. But the deeper crisis was that Europe did not act as a single unit to deal with all European banks but instead worked on a national basis, with each nation focused on its own banks and the European Central Bank seeming to favor Northern Europe in general and Germany in particular. This became the theme particularly when the recession generated disproportionate crises in peripheral countries like Greece. 


There are two narratives to the story. One is the German version, which has become the common explanation. It holds that Greece wound up in a sovereign debt crisis because of the irresponsibility of the Greek government in maintaining social welfare programs in excess of what it could fund, and now the Greeks were expecting others, particularly the Germans, to bail them out. 


The Greek narrative, which is less noted, was that the Germans rigged the European Union in their favor. Germany is the world's third-largest exporter, after China and the United States (and closing rapidly on the number two spot). By forming a free trade zone, the Germans created captive markets for their goods. During the prosperity of the first 20 years or so, this was hidden beneath general growth. But once a crisis hit, the inability of Greece to devalue its money - which, as the euro, was controlled by the European Central Bank - and the ability of Germany to continue exporting without any ability of Greece to control those exports exacerbated Greece's recession, leading to a sovereign debt crisis. Moreover, the regulations generated by Brussels so enhanced the German position that Greece was helpless. 


Which narrative is true is not the point. The point is that Europe is facing two political crises generated by economics. One crisis is similar to the American one, which is the belief that Europe's political elite protected the financial elite. The other is a distinctly European one, a regional crisis in which parts of Europe have come to distrust each other rather vocally. This could become an existential crisis for the European Union. 


The crisis in China
The American and European crises struck hard at China, which, as the world's largest export economy, is a hostage to external demand, particularly from the United States and Europe. When the United States and Europe went into recession, the Chinese government faced an unemployment crisis. If factories closed, workers would be unemployed, and unemployment in China could lead to massive social instability. 


The Chinese government had two responses. The first was to keep factories going by encouraging price reductions to the point where profit margins on exports evaporated. The second was to provide unprecedented amounts of credit to enterprises facing default on debts in order to keep them in business. 


The strategy worked, of course, but only at the cost of substantial inflation. This led to a second crisis, where workers faced the contraction of already small incomes. The response was to increase incomes, which in turn increased the cost of goods exported once again, making China's wage rates less competitive, for example, than Mexico's. 


China had previously encouraged entrepreneurs. This was easy when Europe and the United States were booming. Now, the rational move by entrepreneurs was to go offshore or lay off workers, or both. The Chinese government couldn't afford this, so it began to intrude more and more into the economy. The political elite sought to stabilize the situation - and their own positions - by increasing controls on the financial and other corporate elites. 


In different ways, that is what happened in all three places - the United States, Europe and China - at least as first steps. In the United States, the first impulse was to regulate the financial sector, stimulate the economy and increase control over sectors of the economy. In Europe, where there were already substantial controls over the economy, the political elite started to parse how those controls would work and who would benefit more. In China, where the political elite always retained implicit power over the economy, that power was increased. In all three cases, the first impulse was to use political controls. 


In all three, this generated resistance. In the United States, the Tea Party was simply the most active and effective manifestation of that resistance. It went beyond them. In Europe, the resistance came from anti-Europeanists (and anti-immigration forces that blamed the European Union's open border policies for uncontrolled immigration). It also came from political elites of countries like Ireland who were confronting the political elites of other countries. In China, the resistance has come from those being hurt by inflation, both consumers and business interests whose exports are less competitive and profitable. 


Not every significant economy is caught in this crisis. Russia went through this crisis years ago and had already tilted toward the political elite's control over the economy. Brazil and India have not experienced the extremes of China, but then they haven't had the extreme growth rates of China. But when the United States, Europe and China go into a crisis of this sort, it can reasonably be said that the center of gravity of the world's economy and most of its military power is in crisis. It is not a trivial moment. 


Crisis does not mean collapse. The United States has substantial political legitimacy to draw on. Europe has less but its constituent nations are strong. China's Communist Party is a formidable entity but it is no longer dealing with a financial crisis. It is dealing with a political crisis over the manner in which the political elite has managed the financial crisis. It is this political crisis that is most dangerous, because as the political elite weakens it loses the ability to manage and control other elites. 


It is vital to understand that this is not an ideological challenge. Left-wingers opposing globalization and right-wingers opposing immigration are engaged in the same process - challenging the legitimacy of the elites. Nor is it simply a class issue. The challenge emanates from many areas. The challengers are not yet the majority, but they are not so far away from it as to be discounted. The real problem is that, while the challenge to the elites goes on, the profound differences in the challengers make an alternative political elite difficult to imagine. 


The crisis of legitimacy
This, then, is the third crisis that can emerge: that the elites become delegitimized and all that there is to replace them is a deeply divided and hostile force, united in hostility to the elites but without any coherent ideology of its own. In the United States this would lead to paralysis. In Europe it would lead to a devolution to the nation-state. In China it would lead to regional fragmentation and conflict. 


These are all extreme outcomes and there are many arrestors. But we cannot understand what is going on without understanding two things. The first is that the political economic crisis, if not global, is at least widespread, and uprisings elsewhere have their own roots but are linked in some ways to this crisis. The second is that the crisis is an economic problem that has triggered a political problem, which in turn is making the economic problem worse. 


The followers of Adam Smith may believe in an autonomous economic sphere disengaged from politics, but Adam Smith was far more subtle. That's why he called his greatest book the Wealth of Nations. It was about wealth, but it was also about nations. It was a work of political economy that teaches us a great deal about the moment we are in. 


(Published with permission from STRATFOR, a Texas-based geopolitical intelligence company. Copyright 2011 Stratfor.)

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Anticorrida bancaria en USA

Cuando ocurre una corrida bancarios, los  clientes de un banco hacen cola para convertir sus depósitos en moneda estatal , pero  ahora ocurre lo in verso en Estados Unidos porque los bancos de USA no saben que hacer con la enorme cantidad de dinero que reciben de los inversionistas. Aunque no hay nombre para denonomianr al curisos fenómeno, el comenatrista que adjunto lo llama una caorrida banacaria aal reveés, una anti-corrida bancaria. La locura se extiende .....

A Problem for US Banks: A Reverse Run

Published: Thursday, 18 Aug 2011 | 2:30 PM ET

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By: John Carney
Senior Editor, CNBC.com

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Banks in the U.S. are experiencing a very strange problem.

There's a bank run underway...but in reverse.

All the major U.S. banks are seeing an influx of deposits. Reserve levels at the Federal Reserve  are climbing to astronomical levels.

Balance sheets are expanding as never before.

Imagine that this is that scene from "It's A Wonderful Life," but played in rewind. The depositors are rushing in with their money, nearly toppling George Bailey as they try to get their money in the bank.

When the U.S. dollar reserve in the Fed accounts of European banks decline, it necessarily means that the dollar reserves of the U.S. banks are increasing. As a result of various transactions, the Fed is moving money across the digital spreadsheet from European banks to U.S. banks.

This sounds like a good problem to have...but it isn't.

Remember, a deposit at the bank creates a liability for the bank.

Banks must pay the FDIC fees equal to around 10 basis points, or about 0.1 percent, for their total liabilities. So the influx in deposits are costing the banks money. What's more, banks begin to press up against regulatory limits on leverage as the deposits grow.

There isn't much the banks can do with the hot money flowing in. They cannot commit the funds to longer-term loans, because it could come out of the banks as quickly as it can come in. Short-term and safe assets—such as a Treasury bond maturing in one month—pay less than nothing.

Banks can keep the money on reserve at the Fed, where they will earn 25 basis points, or 0.25 percent. They'll earn some money on the 10-point spread, but not much.

Some banks, such as Bank of America [BAC  Loading...      ()   ], have actively been trying to shrink their balance sheets in order to comply with stricter capital and leverage rules. The growth of their deposit base does not help—and may even undermine this effort at the margin.

Some banks are actually doing the running. Bank of New York Mellon [BK Loading...      ()   ] recently began charging customers with large cash deposits.

"It used to be that banks barred the door to prevent a run of cash out. Now they'd love to bar the door to prevent the run of cash in," one banking source told me.

Questions? Comments? Email us at NetNet@cnbc.com

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R

Central Banks added 155 tons Gold reserves in 2011

"Global holdings of gold by governments and official institutions such as the International Monetary Fund stood at 30,684 tons last month, according to the World Gold Council. Central banks added 155 tons valued at about $8.18 billion to reserves in the first five months of the year and will be net buyers next year, according to the council."

Indian Gold Imports May Reach Record 1,000 Tons as Investment Demand Rises

Gold imports by India, the world's biggest consumer, may reach a record this year as investors seek a haven against inflation and volatility in stock markets, a traders' group said.

Imports may be between 950 metric tons and 1,000 tons this year, Prithviraj Kothari, president of the Bombay Bullion Association, told reporters at a gold conference in Kovalam in south India. Consumption in India rose to a record 963.1 tons last year, driving bullion imports to the highest ever at 958 tons, according to the World Gold Council.

Rising Indian imports may help extend a 30 percent rally in gold prices to a record that's made the precious metal the second-best performer on the Thomson Reuters/Jefferies CRB Index of 19 raw materials this year. Bullion is heading for its 11th annual gain as Europe's sovereign-debt crisis and concern that the U.S. economy may be slowing spur demand for a haven.

"The equity market is volatile and property prices are too high, driving people toward gold as an investment," Kothari said. "The rains have been good so far, so we can expect good demand for festival season this year."

Purchases by India, the world's biggest user, surged 60 percent to 267 tons in the three months ended June 30, from 167 tons a year earlier, the producer-funded council said on Aug. 18. Investment demand jumped 78 percent to 108.5 tons, the second-highest quarter on record, it said.

Stocks Tumble

Gold for immediate delivery gained $28.30, or 1.6 percent, to settle at $1,852.10 yesterday, after touching $1,878.15, the highest ever. Prices gained 6 percent last week, the most since January 2009, and 14.4 percent this month.

U.S. stocks tumbled yesterday, sending the Standard & Poor's 500 Index to its biggest four-week loss since March 2009 on concern that the global economy is stalling. Morgan Stanley economists cut forecasts for global growth this year and said the U.S. and Europe are "dangerously close to recession." JPMorgan Chase & Co. said the U.S. economy may expand less than previously projected in the next two quarters as consumer sentiment drops and the housing market fails to gain momentum.

"Gold is the currency of the world at the moment, with the world convinced that the monetary and fiscal authorities are likely to do nothing right and everything wrong when it comes to resolving the world's current fiscal problems," Dennis Gartman, the economist who correctly forecast 2008's commodities slump, said in his daily Gartman Letter yesterday.

Central Banks

Gold may top $2,000 an ounce by the end of this year as central banks' purchases and a stalling economy boosts the appeal of the precious metal as a haven, Kothari said.

"Gold may rise to $2,000 or more by 2011 end if the global economy remains the same," he said. "Central banks are also buying gold, which is positive."

Holdings in exchange-traded products touched a record on Aug. 8, and central banks are adding to their reserves for the first time in a generation. George Soros, the billionaire investor, cut his holdings in the SPDR Gold Trust in the second quarter as prices rallied, while billionaireJohn Paulson maintained the largest stake, according to regulatory filings this week.

Global holdings of gold by governments and official institutions such as the International Monetary Fund stood at 30,684 tons last month, according to the World Gold Council. Central banks added 155 tons valued at about $8.18 billion to reserves in the first five months of the year and will be net buyers next year, according to the council.

The precious metal prices may be headed for a drop to $1,725 an ounce as early as next month, according to Jeffrey Rhodes, chief executive officer at INTL Commodities LLC.

"It is definitely in a bubble territory and I don't think the bubble will burst, but it will deflate a bit," Rhodes told the gold conference. "Trees do not grow to heaven."

To contact the reporter on this story: Swansy Afonso in Mumbai at safonso2@bloomberg.net

To contact the editor responsible for this story: Paul Tighe at ptighe@bloomberg.net

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Fwd: The Recession of 2011? - John Mauldin's Weekly E-Letter

The Recession of 2011? By John Mauldin | August 20, 2011 In this issue: The Recession of 2011? The Streettalk/Mauldin Economic Output Index Is There a Recession in Our Future? The Bright Side of Europe’s Dysfunctionality The “Treasonous” Fed Some Final Thoughts Some Hope and Needed Help, Plus Travels The data this week was just ugly. Even the uptick in the leading economic indicators, seized upon by so many talking heads, must have a large asterisk beside it. This week we look at the increasing probability that we are headed for recession, and the follow-on implications. Then I take a perilous and speculative journey into the realm of the political, commenting on Texas (and my) Governor Rick Perry’s rather interesting comments about the Fed and Ben Bernanke. There is a lot to cover, and lots of charts, so we will jump right in. But please read at the end about two events coming up in the next few months that you might be very interested in attending. The Recession of 2011? It was relatively easy for me to forecast the recessions of 2001 and late 2007 over a year in advance. We had an inverted yield curve for 90 days at levels that have ALWAYS heralded a recession in the US. Plus there were numerous other less accurate (in terms of consistency) indicators that were “flashing red.” (For new readers, an inverted yield curve is where long-term rates go below short-term rates, a [thankfully] rare condition.) And since stocks drop on average more than 40% in a recession, suggesting that you get out of the stock market was not such a challenging call. Although, when Nouriel Roubini and I were on Larry Kudlow’s show in August of 2006, we got beaten up for our bearish views. And you know what? The stock market then proceeded to go up another 20% in the next six months. Ouch. That interview is still on YouTube at http://www.youtube.com/watch?v=9AUoB7x2mxE. Timing can be a real, um, problem. There is no exact way to time markets or recessions. My view then was based on the inverted yield curve (as an article of faith) and, not much later in 2006, my growing alarm as I realized the extent of the folly of the subprime debt debacle and how severe a crisis it would become. I changed my assessment from a mild recession to a serious one in early 2007 as my research revealed more and more fault lines and the damning interconnection of the global banking system (which has NOT been fixed, only made worse since then). I should note that my early views were rather Pollyannaish, as I thought (originally) that losses to US banks would only be in the $400 billion range. I keep telling people that I am an optimist. With the Fed artificially holding down rates on the short end of the curve, we are not going to get an inverted yield curve this time, so we have to look for other indicators to come up with a forecast for the US economy. We grew at less than 1% in the first half of the year. That is close to stall speed. And that was with a full dose of QE2! So now, let’s look at a series of charts that cause me to be very concerned about the near-term health of the economy. Then we turn to Europe and problems compounding there. The Streettalk/Mauldin Economic Output Index Last year I was having a discussion with Lance Roberts of Streettalk Advisors in Houston about how to build an indicator that might give us a clue as to the direction of the economy. Most indicators use one or two data points and thus can be suspect. For instance, the Philly Fed Economic Index went from 3.2 in July to -30.7 in August, helping to tank the market. Almost every subcomponent (new orders, employment, etc.) was not just down but negative. This was truly a shocker. You can see the gory details at http://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0811.cfm. The Empire Index (New York) went from -3.8 to -7.7. The Empire Index suggests that the August ISM manufacturing number will be 49, or in a state of negative growth. The Philly Index suggests a very dismal 42, which if true would suggest we are already in recession. But these are regional indexes. Now, just for fun, let’s look at a combined index that David Rosenberg created from the Philly Index plus the Michigan Consumer Confidence Index. (Those of us old enough can remember Jack Nicholson playing the Joker in Batman back in 1989. When Batman escaped with the help of something from his tool kit, Nicholson said, “Where does he get all those wonderful toys?” When I read Rosie’s newsletter, I have the same reaction. “Where does he get all those wonderful charts?” He swears he makes them himself. I stand in awe.) Notice that with Rosie’s combined index where it is today, we are either at the beginning of a recession or already in one. And the Philly Fed Index is consistent with a 90% chance of a recession. And that is again consistent with the following chart from Rich Yamarone, which I used last month but that bears looking at again. Rich is chief economist at Bloomberg. (By the way, for Conversation subscribers, I just recorded a powerhouse session with Rich, which will be available as soon as we can get it transcribed.) Is There a Recession in Our Future? I previously wrote, in late July: “And the last chart is one I had not seen before, and is interesting. Rich notes that if year-over-year GDP growth dips below 2%, a recession always follows. It is now at 2.3%.” Oops. Last week David Rosenberg updated that chart. This from Rosie: If Rich is right, then the next revisions to second-quarter GDP will be down from an already abysmal 1.3%. And the growth in the second half is not going to be all that good for jobs and consumer spending But these are charts of single data points. You can quibble that the Philly Fed could be influenced by something local or that the 1.6% number might be different this time. So Lance Roberts of Streettalk Advisors (with me looking over his shoulder) created an index that combines a number of economic indexes in an effort to build an index that is not subject to single (or double) indicators. The Streettalk/Mauldin Economic Output Index is composed of a weighted average of the following indexes: Chicago Fed National Activity Index Chicago PMI The Streettalk ISM Composite Index Richmond Fed Manufacturing Survey Philly Fed Survey Dallas Fed Survey Kansas City Fed Survey The National Federation of Independent Business Survey Leading economic indicators Note that there are six regional and national indicators, plus the NFIB survey, which is national. Lance’s index is not driven by one region or index or survey. When the combined indicator falls below 30, it has always indicated either that we are in a recession or about to be in one. The chart is overlaid, below, against GDP and LEI (leading economic indicators) – both tend to have a fairly high correlation to our Economic Output Composite Index. And LEI is currently supported by the yield spread and money supply (more on that below). A few quick notes before the chart. First, note the increases in the index with the onset of QE1 and QE2 and the sharp drops when QE ends. The red at the end of the chart is the recent drop, and it takes us into recession territory. Recessions are indicated by gray bands Note: I will be speaking at the Streettalk conference on October 14 in Houston, and tickets are currently on sale at www.streettalklive.com. David Rosenberg will also be speaking. They put on a very good conference at a reasonable price. Now, a comment on the uptick in the leading economic indicators this week. Even the ECRI noted that it was because two of the financial components added to the positive numbers. One was the sharp rise in M2 money supply. But a lot of that is because people are going to cash, which is not all that positive from a macro viewpoint. The other is the steepness of the yield curve, which is being manipulated at the short end. Without their positive contributions, the index would be down 0.5%, down three of the last four months, and in a pattern that led to a recession in late 2007. Coincidence? One last chart from Batman, I mean Rosie. Here he gives us the latest data from Larry Meyer’s Macroeconomic Advisers, where they track the real GDP index (inflation-adjusted). It is also in recession territory. Housing is terrible. Existing-home sales were bad. The inventory for homes for sale grew, even as mortgage rates are at all-time lows. A 30-year mortgage is at 4.15%. It is possible we could see a 30-year mortgage with a “3” handle if we slip into recession. I could go on and on about the negative data, and may do so in future letters, but I will resist writing another book tonight, as we have a few other topics to cover. The Bright Side of Europe’s Dysfunctionality To say that the government of Europe is dysfunctional is an no-brainer. The bright side is that it makes the US government look slightly better, and that’s not saying a lot. This past week Nicholas Sarkozy asked Angela Merkel out, so they could decide what to do about the euro crisis. What they said was, we need yet another eurozone governing body overseeing fiscal debt and promises by governments not to run large deficits – like that has ever worked. And they unequivocally said “non” and “nein” to the idea of eurobonds, which everyone else says is vital if the euro is to survive. Oh, and we will harmonize our tax structures within five years. As if that solves the crisis today. Note to Nick and Angela: the problem is not tax structures, it is debt that cannot be repaid. Lars Frisell is the chief economist for the Swedish group that regulates that nation’s banking system. Yesterday he was quoted as saying: “It won’t take much for the interbank market to collapse. It’s not that serious at the moment, but it feels like it could very easily become that way and that everything will freeze.” (hat tip, Art Cashin) My friend Porter Stansberry wrote today: “In Europe, the problem is a bit different … and slightly more technical. Most of the debt in Europe is held by the big banks, not the sovereigns. Look at just two French banks, for example. Credit Agricole and BNP Paribas have combined deposits of a little more than 1 trillion euro. But they hold assets of 2.5 trillion euro. Those assets equal France's entire GDP. “And those are only two of France's banks. Right now, the tangible capital ratios of these banks have fallen to levels that suggest they are probably bankrupt – like UniCredit in Italy and Deutsche Bank in Germany. BNP's tangible equity ratio is 2.85%. Credit Agricole's tangible equity ratio is 1.41%. (UniCredit's is 4.42%, and Deutsche Bank's is 1.92%). “These banks have long been instruments of state policy in Europe. They've funded all kinds of government projects and favored industries. Making loans is far more popular with politicians than demanding repayment for loans. As a result, these banks are left with nothing in the kitty to repay their depositors. If there's a run on these banks (and there will be), how will they come up with money that's owed?” I totally agree (although Porter is wrong about US debt). If there is a sovereign debt credit crisis in Europe, it is entirely possible that 80% of Europe’s banks will be technically insolvent, depending on the level of the crisis. Frisell could be eerily prescient. We gave them subprime; they may pay us back with their own crisis and in spades, as Dad used to say. I really need to do a whole letter on Europe again soon. The next real crisis in Europe that is not bought off with yet more debt will push the world into recession. It is that serious. That is why the ECB keeps ignoring its charter and taking on bank debt and buying sovereign debt they know will be marked down. The entire world economy now swings on the German voters and whether they will take on all of Europe’s debt, risking their own AAA status and putting themselves at serious risk. Supposedly, Finland wants collateral from Greece if it contributes its portion of a guarantee. Think every other country will not want some of that action? I simply do not have the space to go into it tonight, but this is VERY serious. Maybe next week. And just as I was getting ready to hit the send button, economy.com sent me an email entitled “Article: Europe's Leaders Know the Way but Lack the Will, by Tu Packard. Summary: The stability facility lacks credibility.” That more than sums it up. Dysfunctional indeed. We now need to turn to Governor Perry, our newest candidate for president. The “Treasonous” Fed I have been asked many times what I think about Governor Perry getting into the presidential race. Over six months ago he told me personally there was no way he would run, and he was serious when he said it. I believed him. But what I think happened in the interim is that he looked at the field of candidates and said, “I can play in that league.” And as long as he can keep from making any more gaffs like he did with his Fed comments, he can indeed play in the current field. He has the charm of being plainspoken and blunt, and that might just play well this year. Whether the country is ready for another Texan is a different question. (Sidebar: my personal bet is that there are at least two and possibly three other potential candidates who would be taken seriously if they got into the race. They, too, have got to be saying, “Is this all I’m up against? I can play in this league. In fact, I might just be the MVP.” The lure of the presidency is a powerful one. My bet is we have not seen the final field of candidates. And it is not impossible that a challenger emerges on the Democratic side as well. Obama’s poll numbers, even among Democrats, are not good. This is a very interesting political year and as wide open as I can remember.) But however injudicious Perry’s actual remarks were, he is right to call into question Fed actions. Why do I as your humble analyst get that right and politicians don’t? Let me be clear. I want a VERY independent Fed. I do not want Congress or the President dictating Fed policy. I do not like Senators holding up Fed nominations for political gain, whether it was Dodd fighting Bush over his nominees or current GOP senators fighting Obama over his. That is simply wrong in every way. But I think Fed actions are fair game for comment and disagreement. And I agree with Perry that QE2 was not helpful. It was not very wise policy – but that is a long way from “treasonous.” Let’s see if the electorate gives him a “mulligan” on that comment. Think about this. The Fed announced this week that it would extend low rates until 2013. They are practically pushing people into higher-risk assets in a search for yield, at PRECISELY the time we may be slipping into recession, which will put those assets at their highest risk. I think this could end in tears and land those who are close to retirement in even worse shape. Note to Governor Perry: If you want to learn how to properly criticize the Fed and the US government, go read the last ten speeches of another Texan, Dallas Fed President Richard Fisher (who should be the next Fed chair!). Let’s take a look at a few paragraphs from his latest speech, this week (again, hat tip Art Cashin). “I have spoken to this many times in public. Those with the capacity to hire American workers―small businesses as well as large, publicly traded or private―are immobilized. Not because they lack entrepreneurial zeal or do not wish to grow; not because they can’t access cheap and available credit. Rather, they simply cannot budget or manage for the uncertainty of fiscal and regulatory policy. In an environment where they are already uncertain of potential growth in demand for their goods and services and have yet to see a significant pickup in top-line revenue, there is palpable angst surrounding the cost of doing business. According to my business contacts, the opera buffa of the debt ceiling negotiations compounded this uncertainty, leaving business decision makers frozen in their tracks. {Mauldin note: Opera buffa (Italian; plural, opere buffe) is a genre of opera. It was first used as an informal description of Italian comic operas variously classified by their authors as ‘commedia in musica.’ Us Texans have our literary abilities.} “I would suggest that unless you were on another planet, no consumer with access to a television, radio or the Internet could have escaped hearing their president, senators and their congressperson telling them the sky was falling. With the leadership of the nation―Republicans and Democrats alike―and every talking head in the media making clear hour after hour, day after day in the run-up to Aug. 2 that a financial disaster was lurking around the corner, it does not take much imagination to envision consumers deciding to forego or delay some discretionary expenditure they had planned. “Instead, they might well be inclined to hunker down to weather the perfect storm they were being warned was rapidly approaching. Watching the drama as it unfolded, I could imagine consumers turning to each other in millions of households, saying: ‘Honey, we need to cancel that trip we were planning and that gizmo or service we wanted to buy. We better save more and spend less.’ Small wonder that, following the somewhat encouraging retail activity reported in July, the Michigan survey measure of consumer sentiment released just recently had a distinctly sour tone. “Importantly, from a business operator’s perspective, nothing was clarified, except that there will be undefined change in taxes, spending and subsidies and other fiscal incentives or disincentives. The message was simply that some combination of revenue enhancement and spending growth cutbacks will take place. The particulars are left to one’s imagination and the outcome of deliberations among 12 members of the Legislature. “Now, put yourself in the shoes of a business operator. On the revenue side, you have yet to see a robust recovery in demand; growing your top-line revenue is vexing. You have been driving profits or just maintaining your margins through cost reduction and achieving maximum operating efficiency. You have money in your pocket or a banker increasingly willing to give you credit if and when you decide to expand. “But you have no idea where the government will be cutting back on spending, what measures will be taken on the taxation front and how all this will affect your cost structure or customer base. Your most likely reaction is to cross your arms, plant your feet and say: ‘Show me. I am not going to hire new workers or build a new plant until I have been shown what will come out of this agreement.’ “Moreover, you might now say to yourself, ‘I understand from the Federal Reserve that I don’t have to worry about the cost of borrowing for another two years. Given that I don’t know how I am going to be hit by whatever new initiatives the Congress will come up with, but I do know that credit will remain cheap through the next election, what incentive do I have to invest and expand now? Why shouldn’t I wait until the sky is clear?’” You can read the whole speech at http://www.dallasfed.org/news/speeches/fisher/2011/fs110817.cfm. In addition to his reasoning for his latest dissent at the Fed, Fisher also goes into detail about the Texas job-growth machine, which is what Perry will be touting. Again from Art Cashin: Bullard, of the St. Louis Fed, said “Policy should be set by the state of the economy, not according to the calendar,” pointing to the Fed’s decision to stand pat until mid-2013. Next came the Philly Fed’s Plosser, who said, “There is a price to be paid” for monetary policy and that the Fed’s decision was “inappropriate policy at an inappropriate time.” Now that, Rick, is how to take the Fed to task. Some Final Thoughts If we are headed into recession, and I think we are, then the stock market has a long way to go to reach its next bottom, as do many risk assets. Income is going to be king, as well as cash (and cash is a position, as I often remind readers). If we go into recession, we’ll know several things. Recessions are by definition deflationary. Yields on bonds will go down, much further than the market thinks today. And while the Fed may decide to invoke QE3 to fight a deflation scare, the problem is not one of liquidity; it is a debt problem. It is not unusual for a recession to last a year, which means it could well take us into next summer and election season. And while the NBER (the people who are the “official” recession scorecard keepers) will tell us when the recession started, about nine months after it has, it is unlikely they will give an all-clear before the election. There is little stomach for more fiscal stimulus. The drive is to cut spending. Fed policy is impotent. Unemployment will rise yet again and tax receipts will fall and expenses related to unemployment benefits will rise, putting further pressure on the deficit. Already, 40 million of our citizens are on food stamps. Wal-Mart notes that shoppers come into their stores late at night on the last day of the month and wait until midnight, when their new allotment of food stamps is activated. It is hard to see at this moment what pulls us out, other than the blood, sweat, and tears of American entrepreneurs. Fisher is right; the US government should create certainty, create policies to foster new business, and get out of the way. So, I guess I am going out on a limb, without any help from an inverted yield curve, and saying that we will be in recession within 12 months, if we are not already in one. This will be unlike any recession we have seen, as there is not much that can be done, other than to just get through it as best we can. Sit down and think about your own situation and prepare. And frankly, for those of us who are entrepreneurs, this will offer some very interesting opportunities. I am not one for digging a hole and crawling in it. Stay aware of what can be done and create your own solutions! Some Hope and Needed Help, Plus Travels I will be the keynote speaker and honoree in Atlanta at the Hedge Funds Care Southeast Benefit on November 9th. The online registration link is http://www.hedgefundscare.org/event.asp?eventID=74. This group raises money for abused children, and their numbers are growing as the economy gets worse. You participation is appreciated. They are doing a special small private lunch with me as well, so take a look. I will also be speaking at the Singularity Summit in New York, October 15-16. Rather than focusing on the bad news, this conference looks at how wonderful and bright our future is. I love these guys and am honored to be included. You can find out more and register at http://www.singularitysummit.com/program. If you are interested at all in the future, you should consider coming. I am home for another 30+ days, and I need it. Starting in late September, my schedule once again gets crazy. Europe (Ireland for four days on a fact-finding trip, as I think Ireland is the true “ground zero” in Europe; but that’s just me) plus Geneva and London. It looks like a quick trip to South Africa (seeing Dubai as a long layover on the way), Houston, New York, New Orleans, San Francisco, some place in Maryland, and then Atlanta. I am enjoying my time in Dallas. One of the twins (Amanda) and her husband moved down last week, so now six of seven kids are near Dad. Just one more to go, and she should graduate in December. Even being home, this has been a very busy week and tough all the way around. It seems that the demands on my personal bandwidth just keep increasing, even as my growing staff takes on more and more of the load. Without them I would crash and burn. I am not complaining, as many in our industry are looking for work. I know I am blessed beyond any reasonable measure. There are 243 emails in my personal inbox. If one of them is yours, I will try and get to it as soon as I can. But I do enjoy hearing from my readers, as it keeps me grounded. I intend to catch up some this weekend, even while making it to the gym. I am taking the time while home to make sure I get into the gym. Have a great week. And remember, we get through this. Time passes faster every year. We will get through this decade and then be set up for the biggest bull market of our lives. Patience, grasshopper. Your wishing he had better news analyst, John Mauldin John@FrontlineThoughts.com Copyright 2011 John Mauldin. All Rights Reserved.