Famous Investor Says Gold Could Reach $5,000

John Paulson, who is known as one of the greatest hedge-fund managers of all time and has been called "The Man Who Made Too Much" after making billions betting against mortgage-backed securities is bullish on gold. Paulson said that gold could rise to $5,000 due to the devaluation of paper currencies. Chris Mayer from Daily Wealth discusses this in the following article.

The U.S. dollar is a sort of monetary brand.

And like any other brand, it can fall out of favor. Even iconic brands can rapidly lose their "must-have" cachet. Sometimes, a brand can disappear entirely, as did Pan American Airways or "Members Only" jackets. But there is always something else waiting to take its place. So it is with the U.S. dollar, a brand making lows in the financial markets.

The dollar has been the "Coca-Cola of monetary brands," says James Grant, editor of Grant's Interest Rate Observer. But even the best of brands can be lousy investments. Grant uses the analogy of the New York Times. It was the greatest name in newspapers. In 2002, the stock sold for $53 per share – an all-time high, as it turned out. Today, the "Gray Lady" fetches only $8 per share.

"What happened?" Grant asked. The World Wide Web happened, he says. "The Times has hundreds of reporters, but this is a story they seem to have missed." As if the lowly stock price was not evidence enough of its decline, the NY Times got another reminder when it borrowed $225 million against its headquarters building.

The cost of such borrowing, Grant reports, was 14%. The august Times today borrows at rates no better than a working-class stiff at a pawnshop. The U.S. Treasury should take note. The government seems as intent on creating dollars as prolifically as bunnies create other bunnies.

Here we get to John Paulson, a presenter at the Grant's Fall Investment Conference and undoubtedly the richest man in the room. Portfolio magazine dubbed him "The Man Who Made Too Much" after he made $3.7 billion by betting against mortgage-backed securities (MBS). He is one of the greatest hedge-fund managers ever.

Gold is his favorite today. As to why, Paulson presented a simple, but compelling case. First, the monetary base has exploded in a way we've never seen before. The monetary base is essentially the Federal Reserve Bank's currency and reserves. The Fed, by buying up securities in this crisis, has pumped a lot of money into the economy.



You've probably seen this chart, or some variation of it. Still, there haven't been noticeable signs of inflation as a result of that big spike – not yet.

As Paulson explained, that's because this base money has not yet been lent out and multiplied throughout the economy. Yet the monetary base and money supply are highly correlated, "almost 1-to-1 between the two," Paulson said.

That means that as the monetary base expands, the money supply surely follows, though there is a lag. (Money supply is a broader measure of money than just the monetary base, as it includes personal deposits and more. The monetary base is like a kind of monetary yeast. It makes money supply rise.)

If money supply grows faster than the economy, that will create inflation, says Paulson. As it is impossible for the economy to grow anywhere near that vertical spike in the monetary base, Paulson contends inflation is coming.

The U.S. is not alone in its money-printing exercise. The supply of most currencies is expanding rapidly – even the normally tame Swiss franc. In the race of paper currencies, they are all dogs. Hence Paulson's interest in gold, which no government can make on a whim.

Therefore, in the content of the exploding monetary base, gold seems relatively cheap. In other words, as the money supply rises, so does the price of gold, eventually. As a result, says Paulson, "gold has been a perfect hedge against inflation."

There is some slippage over time. The gold price can change faster or slower than the money supply. But when the market gets worried about inflation, the gold price usually changes much faster – as happened in the 1970s. In 1973 – to pick a typical year – inflation was 9% and gold rose 67%. That was a pattern common in the 1970s.

The potential for inflation this time around is greater than it was in the 1970s, given that the growth in the monetary base is so much greater than it was in the 1970s. Gold could do much better this time around, reaching "$3,000 or $4,000, or $5,000 per ounce" as Paulson said.

Future historians will look back at the present day and see clearly how this unfolded. They will see the litany of news items that pointed to the dollar losing its top perch: China and Brazil are settling up trade in their own currencies. The Russians and others are openly calling for a new monetary standard. Even mainstream outlets are discussing alternatives to a dollar-based standard, a province once solely occupied by cranks and gold bugs. Not a week goes by without these kinds of stories.

As for a replacement waiting in the wings, Grant offers up gold. Indeed, a kind of "de facto gold standard" seems to be taking shape. The SPDR Gold Trust, the largest gold-backed security in the world, is now the sixth largest holder of the metal in the world. Anybody with a brokerage account can easily buy gold today through the trust, which trades on the NYSE under the ticker GLD.

It's still early. Most people still own no or very little gold. As it becomes clearer what's happening, they will buy more gold, especially as it is now easy to do so.

The gold supply, too, is limited against the vast pool of dollars. As Paulson points out, global money supply is 72 times the value of gold. I'm betting that gap will narrow. It only has to narrow a smidgen and the gold price flies.

As Grant eloquently put it: "Gold is a speculation. But it is a speculation on a certainty: the debasement of the currency." Gold stocks, too, are a speculation. But they are a speculation on an inevitably higher gold price.

This post has been republished from Daily Wealth.

How The Economy Grew By 3.5% In The Third Quarter

There is reason to think that everything might be okay after all, as third quarter GDP numbers revealed the first time the economy has expanded in a year. All areas of consumer spending showed healthy growth, and although there are a number of caveats, this news is no small feat. James Picerno discusses how it unfolded in the following post from The Capital Spectator.

It's official: the U.S. economy expanded by 3.5% in the third quarter, the Bureau of Economic Analysis reports today. Encouraging as that is, it's neither a surprise nor anything near to closure for the financial and economic hurricane of the last year or so. But it is a step in the right direction, albeit a tentative and not-yet fully confirming step that the walk ahead will be equally brisk.

Nonetheless, good news is worthy of celebration at this point, if only for a moment. After four straight quarters of retreat, a gain in GDP is no trivial change. All the more so when we dive into the numbers and learn that the expansion was broad based. All the major categories that factor into the final GDP calculation posted healthy gains in Q3. That is, personal consumption expenditures, gross private domestic investment, exports and government spending were higher during the three months through September. That compares with red ink on those ledgers in past quarters, save for government spending and a mild rise in consumer spending in Q1 2009.

Otherwise, this is the first time in more than a year (or two, depending on your perspective) since the GDP report showed unambiguous growth across the board. If there's a single report that confirms that the economy has dodged a bullet—i.e., avoided a deeper, prolonged contraction—today's update is it. Thanks largely to Bernanke's Fed, the central bank's great mistake in the 1930s—keeping monetary policy too tight after the economic slump—has been avoided this time. GDP's Q3 report tells us so in no uncertain terms.

Indeed, it's no small trick to elevate consumer spending in the wake of the deepest economic recession since the Great Depression. And yet the numbers in our table below show that Joe Sixpack has been pulling out his wallet and spending across the board. This is no free lunch, of course, and so there'll be a price to pay for juicing consumer spending at a time of mounting debts and default. But the bigger risk, albeit temporary risk, was allowing spending generally to seize up. We've avoided that trap, at least for the moment, although we fear that we've traded an large acute problem for a modest chronic one that lingers.



In short, there are caveats lurking behind today's sunny GDP report. Many caveats. For now, we'll simply note one. The jump in durable goods, for instance, was assisted in no small way by the government's cash-for-clunkers stimulus program that boosted (or seemed to boost) auto purchases in recent months. That was a one-shot deal, of course, and it's not clear that the additional spending generated by the plan didn't simply transfer future spending activity into the present. Indeed, a report by Edmunds.com, via The Christian Science Monitor, charges that the cash-for-clunkers program gave money to consumers who would have bought a car regardless of the government's efforts.

The fact that the Fed has been effectively giving money away for much of the past year, combined with various fiscal stimulus efforts, insured that liquidity would be spilling over into every nook and cranny of the economy. Some of this liquidity was destined to show up as new consumption. If you print it, they'll spend it, at least some of it.

Helping the process along has been the snapback effect. Early in 2009, the economy was going to do one of two things: collapse or bounce back. The Fed's efforts helped tip the scale by more than a little to the latter, and we continue to see the effects. Indeed, the clues leading up to today's news of GDP's Q3 rise have been bubbling for some time, as we've been noting for months, including here.

But the snapback effect has limited reach, as do the government's various stimulus efforts. The true judge of the post-apocalyptic world of last autumn can't be judged—shouldn't be judged—by the Q3 GDP report alone. Yes, we've learned the lesson of how to manage monetary affairs in the immediate aftermath of a severe financial crises/recessions. But the lessons, and the solutions, for the period beyond that early post-crash period remain much more of a gray area with less-obvious policy responses, if any.

We're now moving into uncharted territory. Yes, we've arguably laid a foundation to provide the economy with a fighting chance of maintaining stability. Fostering growth, on the other hand, remains a challenge of some magnitude, with no easy answers, as the ongoing slump in the labor market reminds. Part of the problem is that there are so few periods to study in recent history. Japan in the 1990s and the U.S. in the 1930s are the main precedents, and neither offers compelling insights beyond the immediate snapback period.

Regardless, the U.S. economy faces a number of challenges, few of which are of the garden variety, starting with debt. Another is the labor market, which was showing signs of strain well before last year's debacle. As we pointed out earlier this month, the labor market rebound following recessions over the past 25 years has been increasingly mild. Given the context this time around, there's little reason to think the trend will abate. If anything, it seems likely to accelerate.

So, yes, let's cheer today's GDP report. But let's reserve judgment on whether we won the war or merely survived the first battle.

This post has been republished from James Picerno's blog, The Capital Spectator.

New Real Estate Sales Flatline

Sales of new homes hit a wall in September and now sit at an annual rate of 402,000, a record low when adjusted for population. This is hard to swallow for home builders who can't move inventory and see a massive wave of bank-owned homes on the horizon. See the following post from The Mess That Greenspan Made.

"Flatline" appears to be the operative word for the homebuilding industry these days as sales levels remain near historic lows amid fierce competition from banks where the supply of distressed sales coming onto the market continues unabated.



The Census Bureau reported(.pdf) that new home sales unexpectedly declined last month, from a downwardly revised annual rate of 417,000 in August to 402,000 in September.

On a year-over-year basis, sales were down 7.8 percent and, from the peak of the residential construction boom back in mid-2005, sales are down 71.1 percent.

More importantly, current levels of home construction and sales remain near historically low levels, first reached in January of this year, and this bodes ill for a sustainable economic recovery where residential construction normally plays a major role.

Last week's report on housing starts showed a similar trend in recent months.

As noted here many months ago when all-time record lows were first being made, in population-adjusted terms, the current housing downturn is without precedent. The pre-2009 all-time low of 338,000 in September of 1981 works out to a population-adjusted rate of about 460,000 today, meaning that, even after the improvement of recent months, new home sales would have to rise another 15 percent just to get back to the previous record low!

While there has clearly been improvement in new home sales in recent months, recent increases are akin to your favorite 2000 technology stock rising 8 or 10 percent during a few months in 2001 after plunging 80 percent in 2000.

Inventory remained at a 7.5 months supply in September, down significantly from earlier this year but still about 50 percent higher than normal, and the total of 251,000 unsold new homes is the lowest in 27 years, a confirmation of just how low current sales levels are.

It looks to be a long and difficult road to recovery for the homebuilders, particularly in light of the expected waves of foreclosures that are expected to come in the next year.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Can Housing Be Fixed Without Jobs?

An end to the first time home-buyer tax credit could result in a decline in the housing market, experts warn. However, can we expect a sustainable recovery in housing by using temporary measures rather than creating more jobs? See the following post from Expected Returns.

From Bloomberg, U.S. Economy: New home sales drop as end of tax credit looms:

Sales of new U.S. homes unexpectedly fell in September as the end of a tax credit for first-time homebuyers approached, highlighting the importance of government aid to the emerging economic recovery.

Purchases dropped 3.6 percent to a 402,000 annual pace that was lower than the most pessimistic economist’s, according to Commerce Department figures issued today in Washington. Other data showed orders fo climbed 1 percent in September, the fourth gain in the last six months.

The drop in sales “does raise some questions about where the housing market is going to be in six months, arguably without any more support,” said Michael Feroli, an economist at JPMorgan Chase & Co. in New York. “Whatever you think about the economy, it’s not going to be a straight line” toward recovery.

Are people still calling a bottom to this market? This is a sneak peek of what is going to happen once the government removes props from housing. Housing sales are still down year over year, and we're supposed to be in recovery mode. The ultimate driver of housing will be jobs, which we're still shedding, and lower housing prices, which the government won't allow to happen.

Tax Credits + MBS Purchases

“Much of the strength in the economy is due to temporary factors such as fiscal stimulus initiatives like the home- buyers credit,” said Dana Saporta, an economist at Stone & McCarthy Research in Skillman, New Jersey.

Fed policy makers meeting next week are likely to repeat their commitment to keeping interest rates low for an “extended period.” The Fed last month decided to slow purchases of $1.25 trillion in mortgage-backed securities while extending the end-date of the program by three months, to March 31.

Fed policy makers are obviously pushing on a string here when it comes to housing. Low interest rates are immaterial when banks refuse to refinance and people are unemployed. It won't be pretty for housing when there are no more buyers of mortgage-related debt, and foreclosures and distressed sales really start to hit the market.

This post has been republished from Moses Kim's blog, Expected Returns.

Another Round Of Stimulus Anyone?

Although most economists proclaim the recession to be at an end, the expected surge in foreclosure and unemployment rates could precipitate the recurrence of a recession which has some economists calling for more government stimulus. The argument is that another round of effective stimulus could prevent the slowest recovery in modern memory. See the following from Economist's View.

As many of us have been saying for some time now, more stimulus would speed the recovery -- the jobs outlook is particularly worrisome -- but unfortunately, it doesn't appear that more stimulus is politically feasible:

The Case for More Stimulus, Editorial, NY Times: The consensus among economists is that the recession is over, and, technically, the herd is probably right. ... Immense federal stimulus has jolted the economy.

But... The economy is going to need more government support, or it is bound to be very weak for a very long time — and vulnerable to a relapse into recession. Unemployment is expected to worsen well into next year, exceeding 10 percent. Foreclosures are expected to rise, which will push home values down further. Hundreds of small and midsize banks are likely to fail in coming years. State and local governments face budget shortfalls in 2010 that are as bad or worse than this year’s.

Yet Washington is not providing a coherent plan for effective stimulus. The Senate has been hamstrung for nearly a month over the most basic relief-and-recovery boost: an extension of unemployment benefits. ... Lawmakers in both parties fret that large budget deficits preclude more stimulus, lest the burden of debt outweigh the benefit of deficit spending. ... Deficits are a serious issue, but the immediate need for stimulus trumps the longer-term need for deficit reduction. A self-reinforcing stretch of economic weakness would be far costlier than additional stimulus.

The Senate could take a step in the right direction by extending unemployment benefits without further delay. ... Next, Congress and the administration should agree on ways to ease the dire financial condition of the states. Most important is continued aid for state Medicaid programs... As long as the states are suffering, any economic recovery efforts by the federal government are undermined. ...

Without another round of effective stimulus, the worst recession in modern memory will likely become — at best — the weakest recovery in modern memory. Another boost to federal spending that is targeted and timely should not be too much for politicians to deliver.

Recall this recent graph from the San Francisco Fed:



Output is not expected to return to potential until well into 2012.

Now recall the long delay between the end of the last two recessions and the peak in the unemployment rate (or just about any other labor market indicator):



And the recovery for the labor market could be even slower this time.

To be fully effective, plans for additional stimulus should have been in place long ago. However, given how long the recovery is expected to take, it's not too late to do more if we get started right away. But the political climate makes it highly unlikely that labor markets and the economy will get the help that they need.

This post has been republished from Mark Thoma's blog, Economist's View.

Is Gold Overrated?

Is Gold Overrated? Economics Professor Nouriel Roubini says yes, arguing that gold is unlikely to go much higher due to deflationary pressures. However, there are many counterarguments to this such as the falling dollar and the higher demand by the world's central banks. See the following from The Mess That Greenspan Made.

Nouriel Roubini shares some thoughts about gold in this interview with IndexUniverse, drawing the same conclusion that millions of investors have drawn - gold can't go significantly higher without high inflation or Armageddon, neither of which are imminent.

I don’t believe in gold. Gold can go up for only two reasons. [One is] inflation, and we are in a world where there are massive amounts of deflation because of a glut of capacity, and demand is weak, and there’s slack in the labor markets with unemployment peeking above 10 percent in all the advanced economies. So there’s no inflation, and there’s not going to be for the time being.

The only other case in which gold can go higher with deflation is if you have Armageddon, if you have another depression. But we’ve avoided that tail risk as well. So all the gold bugs who say gold is going to go to $1,500, $2,000, they’re just speaking nonsense. Without inflation, or without a depression, there’s nowhere for gold to go. Yeah, it can go above $1,000, but it can’t move up 20-30 percent unless we end up in a world of inflation or another depression. I don’t see either of those being likely for the time being. Maybe three or four years from now, yes. But not anytime soon.

To his personal list of reasons that gold can go up, Nouriel may want to add the one that David Einhorn noted last week - people are increasingly realizing that all paper money is bad.

After what we've seen over the last couple years, $1,200-$1,300 an ounce gold sometime in the next year without either high inflation or a financial catastrophe probably isn't going to shock too many people (aside from those like Roubini).

In fact, if the dollar continues to weaken, that could occur very quickly - just look at the move from $950 to $1,050 over the last couple months and then look at a multi-year chart.

You'll see that the gold price has spent a lot of time in the $800-$1,000 range and is due for another big move up.

Regarding the "lack of inflation" argument, the folks at GATA had a few comments:

If GATA had been part of the interview, we might have asked Roubini to elaborate with a few follow-up questions. For example:

1) What if the monetary inflation already has occurred over decades and has been masked, in regard to gold, by Western central bank gold sales, leasing, and underwriting of bullion bank derivatives, activities meant to mask that inflation and support government currencies and bonds and suppress interest rates?

2) Since it is generally acknowledged that in recent years gold demand has greatly exceeded supply and that the gap has been filled by massive dishoarding of gold by Western central banks, what if, inflation or deflation aside, the day comes when central bank reserves available for dishoarding are simply exhausted? What happens to gold then?

3) Is Roubini aware of the Federal Reserve's recent admission that it has gold swap agreements with foreign banks that the Fed insists on concealing? (For that admission, see http://www.gata.org/files/GATAFedResponse-09-17-2009.pdf.) What does Roubini imagine the purposes of those swap agreements might be? Could those swap agreements indicate the continuation of a long and often surreptitious U.S. government policy of suppressing the gold price, a policy documented extensively by GATA and others? (See http://www.gata.org/node/7894 and http://www.gata.org/node/6242.)

Roubini is a brilliant guy who has identified much that is wrong with the world financial system and who lately has fascinated the financial news media. Imagine the possibilities if someone in his position was to go beyond the financial news media's superficiality in regard to gold, or if the financial news media were to question his own superficiality -- or, for that matter, any other supposed expert's.

The more you think about it, the less meaning there really is in any "gold-inflation" relationship given how central bankers and economists have changed the meaning of the word "inflation" over the years.

We'll probably never have high "consumer price" inflation the way it's currently measured.

As for the GATA arguments about gold price suppression, a few years ago I was starting to worry that I'd never know in my lifetime whether there was anything substantive behind this.

That's much less of a worry these days...

For years, Jim Rogers has poo pooed gold as an under-performing commodity saying that central banks simply have too much of the stuff that they can sell for too long and that this will keep a lid on the price. The sales are ostensibly not because they're suppressing the price, mind you, but because they have no use for the stuff any more.

That seems to have changed rather dramatically in just the last year or so as central banks around the world have been doing more buying than selling.

The gold story is not going to go away anytime soon, though it's not clear whether any economist will ever really understand it.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Costs Of Stimulus Far Outweigh The Benefits

Moses Kim argues that by subsidizing deeply underwater mortgages, the government is unfairly bailing out those who made unwise investments and undermining the free market system. Moreover, the costs of the bailout seem to heavily outweigh any benefits. See the following post from Expected Returns.

The government continues to recklessly waste taxpayer money without any measurable effect to our economy. The post cash-for-clunkers hangover effect on auto sales has now made it clear to most observers that the program was a failure. Housing is also receiving tremendous support from the government with similar dubious results. From the Washington Post, refinancing lifeline fails to reach most 'underwater' homeowners.

A seven-month-old government program to help homeowners with little or no equity refinance their mortgages has so far reached fewer than 3 percent of those targeted, with many struggling borrowers deciding that the benefits of a new loan aren't worth the closing costs.

This lackluster performance reflects the difficulty of helping the growing segment of "underwater" homeowners -- those who owe more than their home is worth.

The program is a key component of the Obama administration's efforts to stabilize the housing market and arrest the nation's growing foreclosure rate. But the initiative has received far less public attention than its companion, a loan modification program that pays lenders to lower the payments of delinquent borrowers who are in imminent danger of losing their homes.

The skewed logic behind subsidizing deeply underwater homeowners is similar to the screwed up logic behind bailing out "too big to fail" companies. A functioning free-market system demands accountability for failed investments- otherwise, the resulting moral hazard guarantees the perpetuation of crises in the future.

Level 1 Economic Thinking Masks Inefficiencies

During a recent conference call with reporters, Treasury Secretary Timothy F. Geithner noted that, with mortgage rates near historic lows, 3 million homeowners had already refinanced this year. That refinancing boom pumped $10 billion in purchasing power into the economy, chimed in Shaun Donovan, secretary of the Department of Housing and Urban Development.

But those benefits have yet to trickle down.

"The government is spending a trillion dollars to drive mortgage rates down, and it's been successful. But who is taking advantage of that? The people with the best credit and best equity. Not the people on the fringes," said Bob Walters, chief economist of online mortgage company Quicken Loans.

You can be sure that the government will focus only on the billions of dollars that have been pumped into the economy and not the costs. However, someone needs to bring up the asymmetric relationship between inputs and outputs here. Even a 2nd grader understands that spending trillions of dollars to bring about billions of dollars in benefits is not good economics.

Frederic Bastiat's parable of the broken window beautifully illustrates the faulty logic behind statists' arguments for government intervention. In short, statists argue that broken windows have a net positive effect on the economy since so many jobs are created to fix the broken window. This is level 1 economic thinking at its finest- just focus on benefits and not costs.

The modern day equivalent of the statists in Bastiat's day are the Keynesian economists that litter the Obama Administration and college campuses across the country. The government, primarily through the manipulation of interest rates, creates malinvestments and imbalances in the economy that always get addressed through shocks to our system. Government intervention has gone a step further through the monetization of debt, which is a move that will bring shocks to the system that will be far greater than anything we've experienced thus far. Someone needs to ask: what are the costs to government intervention? The costs are quite clearly being reflected in the dollar.

The example of the Great Depression makes one thing clear: the more the government intervenes in the economy, the longer recovery will take. As the masses start to realize that "green shoots" are utter nonsense, expect the government to blame it on not enough stimulus. Ironically, the same government and banking clowns that got us in this mess in the first place are going to garner more power.

This post has been republished from Moses Kim's blog, Expected Returns.

Uruguay Real Estate: Why Its The Perfect Location For Expatriates

The picturesque, sleepy Uruguay town of Punta del Este represents a unique opportunity for savvy investors. Boasting affordable real estate, a remarkably high standard of living, and a party season each summer that transforms the town into a prime spot for South America's rich and famous, Punta del Este is primed for a real estate boom. See the following post from Daily Wealth for more on this.

I'm writing to you from a farm in South America...

There are three horses outside my bedroom window. My host, Fitzroy, lets horses roam his property. In the morning, we find them munching grass on the front lawn. And when we're having afternoon tea on the back patio, they'll come wandering slowly past...

In a moment, my wife and I will walk across the garden, past the horses, to the main house, where we'll join Fitzroy's family for breakfast. The housekeeper, Alexandra, is there. She's already set the table, pressed the oranges, and prepared a large plate of organic sausage, ham, and eggs.

After breakfast, we'll saddle the horses and Fitzroy will take us for a trot around his property...

We're in Uruguay, in a town called Punta del Este.

They call Uruguay the "Switzerland" of South America because of its powerful banking secrecy laws. It's also one of the last countries in the world where you can own property anonymously. Finally, there's no tax on foreign earnings. So Europeans and South Americans move here to avoid income taxes.

These laws attract money to Uruguay. Uruguay is the second-richest country in South America, after Chile.

For six weeks every summer, Punta del Este is the most important party town in South America. If you're a celebrity here, this is where you come for your summer vacation. If you're a wealthy aristocrat from Brazil, Argentina, or Columbia, you come here to party with the celebrities.

During this "party month," tables at nightclubs sell for $10,000 a night, rents jump 4,000%, and it takes two hours to move across town because of the traffic.

Luckily, high season doesn't start until January. For now, we're the only tourists in town...

For full-time residents, Punta del Este is a sleepy seaside town. Three-quarters of the houses and apartments are empty. Most of the restaurants are closed. And they disconnect the traffic lights. The standard of living for these folks is extraordinarily high...

Fitzroy, for example, lives in a large country house with wooden floors and big windows. He has a lake, a forest, and a horse paddock on the grounds. On the other side of the lawn, there's a cottage for the housekeepers and another cottage for guests.

He told me his country estate would sell for around $750,000 if it were on the market today. The same property in England or America would cost 10 times as much...

We went on a tour of Punta del Este's real estate market with Fitzroy. We found dozens of seaside cottages and small homes for under $200,000. They come with neat lawns, brightly painted walls, and fruit trees. Most of them even have separate quarters for housekeepers. A full-time housekeeper costs $400 a month. The country club charges $150 a month for offseason membership. And the top private school charges $200 a month per pupil.

The weather is wonderful. It never freezes. In the summer, you rarely need air conditioning. Travel connections are great, too. The international airport is two hours away and offers direct flights to the United States and Europe.

In short, Punta del Este is the perfect location for expatriates. It's cheap, easy to reach, and the quality of life is unbeatable, even in America. Best of all, there's going to be a property boom here as money flees from the bankrupt governments in America and Europe.

If you ever get the chance to visit Punta del Este, I highly recommend it. Just make sure you avoid the party season... unless you like that sort of thing.

This post has been republished from Daily Wealth, Steve Sjuggerud's contrarian investment site.

There's No Magic Formula To Investing

Despite what some self-proclaimed experts might tell you, seeking quick and easy profits with magic formulas or limited information is a recipe for a losing investment strategy. James Picerno argues that successful investment requires constant vigilance, effort, and intuition. See the following post from Capital Spectator.

Twenty-first-century investing is all about predicting. But developing intuition about markets, asset classes and how they interact is too often overlooked if not ignored outright. That's a mistake for strategic-minded investing, albeit a mistake that's understandable in the crowd's rush for quick and easy profits.

It's hard to miss all the self-proclaimed seers running around espousing magic formulas and the three most-important investment gauges that insure big gains. Rarely do you hear of the dark side of these easy rules, such as the possibility that maybe, just possibly they're byproducts of data snooping, survivorship bias and other gremlins that harass seemingly flawless assumptions.

It's no surprise that limitations, blemishes and in some cases blatant fallacies are minimized/ignored in the three-minute talking-head interview or the personal finance column at your favorite financial publication. To be fair, some of this is simply an issue of time. Journalists and investment strategists can't deliver a full accounting of prudent investing practices and concepts every time they opine on the subject du jour. As such, it's easy to get a distorted view of investing by looking at any one post from, say, the CapitalSpectator.com and embracing it in isolation to my broader asset allocation analysis as outlined in my book and in my monthly newsletter.

The point is that investing requires (demands) constant vigilance on the critical issue of maintaining strategic perspective. It's tempting to cherry pick a few tidbits of the analytical pie in the belief that a few simple rules and/or market metrics will dispense triumph. Too often they lead to something less.

Investing, after all, is complicated. Financial economics has uncovered many insights into the inner workings of the black box known as asset pricing, but we're still a long way from fully understanding the process. There are some tantalizing clues, however. But in order to take full advantage of the lessons distilled by way of studying economic cycles, asset class relationships and asset pricing, we need to develop some intuition and context about the capital and commodity markets and how they compare with one another and the larger economy through time.

As a quick example, investors need to develop informed expectations about return and risk for each of the major asset classes, or at the very least domestic stocks, domestic bonds, and the aggregate equivalents for foreign markets. That begins by studying history and incorporating what we know about the behavior of prices relative to risk.

Take a simple dynamic like stock market return relative to stock market volatility. How should we think about this relationship? It's temping to extrapolate a raw reading of history and call this a forecast, but that's naïve. The relationship isn't stable. By looking at, say, three-year snapshots of this relationship, however, we can develop a deeper understanding of risk and return. In turn, this can help us formulate an enlightened view of the future.

But we can't stop there. We should also apply an overlay of current valuation, for instance. Another variable is integrating these signals with the business cycle. And if we're strategically oriented in our investing decisions, we'll apply a similar analysis of other asset classes and combine the insights for designing asset allocation. Even so, this only scratches the surface of the necessary work.

If you're looking for rules of thumb, here's one: Forecasting returns directly is short sighted. A more durable approach is inferring equilibrium-based risk premiums via studying volatility, correlation and other risk parameters and then comparing that with our tactical expectations. This takes time and effort, of course, which is why such topics aren't popular fodder for the three-minute interview.

The bottom line: be wary of easy solutions that purport to offer investment success for little or no effort. If it was really that easy, middling investment results (and worse) wouldn't be so common.

This post has been republished from James Picerno's blog, Capital Spectator.

Government Money Should Not Go To Bondholders

While government bailouts of banks often protect depositors, the argument can be made that it is wasteful to protect bondholders as well. Harvard Professor Lucian Bebchuk discusses why the costs outweigh the benefits of a government safety net for bondholders. See the following post from Economist's View.

Lucian Bebchuk says there's no need for the government to protect bondholders in a financial crisis:

Governments must not bail out bondholders, by Lucian Bebchuk, Commentary, Project Syndicate: A year after the United States government allowed ... Lehman Brothers to fail but then bailed out AIG,... a key question remains: when and how should authorities rescue financial institutions?

It is now widely expected that, when a financial institution is deemed “too big to fail”, governments will intervene if it gets into trouble. But how far should such interventions go? In contrast to the recent rash of bailouts,... the government’s safety net should never be extended to include the bondholders of such institutions.

In the past, government bailouts have typically protected all contributors of capital of a rescued bank other than shareholders. Shareholders were often required to suffer losses or were even wiped out, but bondholders were generally saved by the government’s infusion of cash. ... Bondholders were saved because governments generally chose to infuse cash in exchange for common or preferred shares – which are subordinate to bondholders’ claims – or to improve balance sheets by buying or guaranteeing the value of assets.

A government may wish to bail out a financial institution and provide protection to its creditors for two reasons. First,... a protective government umbrella might be necessary to prevent inefficient “runs” on the institution’s assets that could trigger similar runs at other institutions.

Second, most small creditors are ... unable to monitor and study the financial institution’s situation when agreeing to do business with it. To enable small creditors to use the financial system, it might be efficient for the government to guarantee (explicitly or implicitly) their claims.

But, while these considerations provide a basis for providing full protection to depositors and other depositor-like creditors..., they do not justify extending such protection to bondholders.

Unlike depositors, bondholders generally are not free to withdraw their capital on short notice. They are paid at a contractually specified time, which may be years away. Thus, if a financial firm appears to have difficulties, its bondholders cannot stage a run on its assets and how these bondholders fare cannot be expected to trigger runs by bondholders in other companies.

Moreover, when providing their capital to a financial firm, bondholders can generally be expected to obtain contractual terms that reflect the risks they face. Indeed, the need to compensate bondholders for risks could provide market discipline: when financial firms operate in ways that can be expected to produce increased risks down the road, they should expect to “pay” with, say, higher interest rates or tighter conditions.

But this source of market discipline would cease to work if the government’s protective umbrella were perceived to extend to bondholders... Thus, when a large financial firm runs into problems that require a government bailout, the government should be prepared to provide a safety net to depositors and depositor-like creditors, but ... the government should not provide funds (directly or indirectly) to increase the cushion available to bondholders.

Rather, bonds should be at least partly converted into equity capital, and any infusion of new capital by the government should be in exchange for securities that are senior to those of existing bondholders.

Governments should ... make their commitment to this approach clear in advance. ... This would not only eliminate some of the unnecessary costs of government bailouts, but would also reduce their incidence.

Anything that imposes the costs of the bailout on the people participating in the markets rather than on taxpayers without compromising the ability to protect the financial system (or, as claimed above, even enhancing the protective shield) is ok with me.

This post has been republished from Mark Thoma's blog, Economist's View.

The Case For A Jobless Recovery

Even as some indicators point to an economic upturn, the employment sector has faltered. Without job opportunities to accompany the positive forecasts, intervention may be needed to prevent a long and painful recovery. The following post from Economist's View discusses the mounting evidence that a jobless recovery will take place.
Each year, Tim Duy organizes the Oregon Economic Forum, and this year he invited David Altig of the Atlanta Fed to talk about monetary policy. I'll be discussing fiscal policy, and one of the questions I'll address is whether more stimulus is needed. The poor condition of job markets will be a key part of that discussion, and this post of David's at macroblog provides additional evidence that the odds of a jobless recovery are increasing:

The growing case for a jobless recovery, by David Altig: The Wall Street Journal repeats the unhappy news:

"Companies across the economy are holding off on hiring even as the profit outlook improves, amid economic uncertainty and their own success at raising productivity in rough waters.

"Hiring always lags behind in economic recoveries, but the outlook this time is worse, many economists say. Most forecasters now expect a prolonged period of high unemployment, even though the government is expected to report next week that the economy grew in the third quarter, after four quarters of contraction."

I'd like to be able to contradict what most forecasters expect, but we at the Atlanta Fed have been building the case for a similar outcome on macroblog. Here are few salient points from previous posts.

Job opportunities are scarce. (Oct. 14, 2009)

"At the end of August there were estimated to be fewer than 2.4 million job openings, equal to only 1.8 percent of the total filled and unfilled positions—a new record low."

This development could, of course, turn around as business activity picks up, but there is more than a little evidence that some structural impediments are afoot.

Job losses have been disproportionately concentrated in small businesses. (Oct. 6, 2009)

As Melinda Pitts pointed out a few weeks back, businesses with fewer than 50 employees account for about one third of net employment gains in expansions. They have accounted for about 45 percent of job losses since the beginning of this recession. Given that these are the types of businesses most likely to be dependent on bank lending—and given that bank lending does not appear poised for a rapid return to being robust—the prognosis for an employment recovery in these businesses is a question mark.

The share of workers reporting that they have been involuntarily cut back to part-time is at a recorded high. (Aug. 14, 2009)

"… the increase in people reporting that they are involuntarily working part-time rather than full-time is considerably higher in this recession than in past recessions. Although the increase in these workers has moderated some since the spring of this year, the number of people in the category of working part-time for economic reasons remains at 8.8 million, well above the level of past contractions in both absolute and relative terms."

One potential implication of this fact is that firms probably have the capacity to expand production without hiring new workers (or increasing worker productivity). All these firms have to do is give more hours to existing workers, who have indicated they would be plenty eager to have them. Good for them—and good for GDP growth—but not much help on the employment front.

Here is one additional concern that we have not previously emphasized.

The percentage of employee separations labeled permanent is at a recorded high.

Underneath the usual total unemployment numbers are the reasons an individual is unemployed: You are on temporary layoff; you quit your job; you have reentered the labor market and have yet to find a job; or you are entering the job market for the first time and have yet to find a job. Or, finally, you have been permanently separated from your previous employer, who has no expectation of hiring you back.

The last category is the dominant reason for unemployment at this time. That might not seem surprising, but it actually is. Never, in the six recessions preceding the latest one, did permanent separations account for more than 45 percent of the unemployed. The current percentage stands at 56 percent as of September and appears to be still climbing:




Of course, none of this is proof positive that we are in for a "jobless recovery," but, to me, the odds appear to be increasing.

I wish I would have had the last graph when I made up the slides (pdf) for the presentation.
This post has been republished from Mark Thoma's blog, Economist's View.

Investment Opportunities In Emerging Countries

The potholes, frequent power outages, and various non-connected dots within emerging markets are dismaying and off-putting at first glance to unaccustomed visitors from fully industrialized countries. However, a smart investor can look at that same scenario as a golden investment opportunity. See the following post from Daily Wealth for more on this.

Two weeks ago, I returned from my second visit to the financial capital of India, the city of Mumbai (formerly Bombay).

On the first go-round, I was mainly in tourist mode and visited several other cities, too. This time, I spent a week here just working, meeting businessmen, and talking with investors.

I got a different perspective simply living there on a day-to-day basis. I got a sense for more mundane things like the harrowing daily commute. I got a better feel for how the city works. Mumbai looks and feels chaotic and messy, but for millions, it gets the job done.

Some parts of Mumbai are tough to stomach, such as the widespread and seemingly hopeless poverty. While at a stoplight, little kids came up to our car window begging. One was carrying a little baby, barely clothed, dirty. It was sad to see.

One of the things about India that I always find striking is the contrasts. There is great poverty in this city, but also great wealth. Often, they are side by side. For instance, we visited the oldest gold market in the city. It's part of a larger market that also houses a temple to the goddess Mumbadevi, from whom some think the city got its name. This market was packed with people. Cars, including ours, rolled slowly down the narrow streets, honking their horns at indifferent pedestrians.

Old, dilapidated buildings lined the streets with shops selling everything from linens to pineapples. In the gold market, we saw several blocks of gold merchants selling gold in all its forms. We stopped to visit the largest market maker for gold in the city.

We entered a decrepit building with towering slums around it. We got in a creaky elevator little bigger than a phone booth, with an attendant who opens and shuts the door. The elevator looked about a hundred years old. We got to our floor and went down a filthy hallway so narrow that you had to turn your shoulders to get by other people in the hall. Finally, we got to this gold merchant's office.

When we got inside, we entered a modern looking office – clean, wooden floors; air conditioned; a wall-mounted TV playing the Indian version of CNBC. You'd never know the squalor and chaos that exists just outside the door.

When it comes to India, I also always think of the infrastructure opportunity here. Our other daily trips throughout the city brought home how rough the basic infrastructure is. The roads are often clogged with cars and people and the occasional cart drawn by man or beast. The effects of this poor infrastructure are wide and deep.

India, for instance, actually wastes more fruit and veggies than it consumes, according to The Economic Times, India's largest financial daily. India is the second largest producer of fruits and vegetables in the world, but 30%-40% never make it to their destination.

As the Times reports: "Gaps such as poor infrastructure, insufficient cold storage capacity, unavailability of cold storage in close proximity to farms and poor transportation infrastructure all are contributing factors."

There are also routine brownouts and blackouts throughout India, often lasting for seven hours or more, which lead to food spoilage. It may seem hard to believe, but after being here for a week, I believe it.

Somehow, so far, India has managed to overcome many of these obstacles. The economy is still growing more than 6% annually. We saw more evidence of this, too, when we spent some time going over a cross section of midcap and small-cap Indian stocks. Many are growing 30%-40% per year, and have done so for 15 or 20 years.

One of the people we met on this trip was Jayesh "Jimmy" Seth, who runs KC Securities, a large brokerage firm in Mumbai. We also met his son, Harsh, a 22-year-old Northwestern graduate who returned home to make it in Mumbai.

Over lunch one day, Jimmy told us the advice he gave Harsh: "When you are in America, take note of all the daily conveniences you enjoy. Write them all down. Then, when you come back to Mumbai, check that list again. Whatever's missing, start a business around that."

It's a good piece of advice, as India has lots of gaps to fill, such as those basics of infrastructure. I think it's a brilliant strategy for all emerging markets. Look for the gaps in these emerging markets. Find what they don't have but want or need. Invest in the companies that fill those gaps.

For U.S. investors, you can play this idea with shares of water, agriculture, and energy producers. The huge and growing countries of India and China simply don't have enough of these resources to grow. They must buy them.

For instance, my readers have made good money on Nalco Industries (NLC), one of the world leaders in water filtration equipment and services. We've also made great returns in Potash, the world's largest agricultural fertilizer company.

I'm also bullish on smaller, local India plays. More will become available to U.S. investors as India grows. These ideas – and the resource investments I just mentioned – are the road map to making a fortune in emerging markets.

This post has been republished from Daily Wealth.

How Can We Encourage Reduction Of Global Trade Imbalances?

Ben Bernanke voiced concerns over the global macroeconomic imbalances creating conditions for another global crisis, but reducing the imbalances could require a herculean effort. The challenge is creating an incentive for countries to cooperate in lowering imbalances. In the following post from Economist's View, Eswar Prasad explains a creative idea to encourage this cooperation.

Ben Bernanke recently expressed worries that continued large global imbalances could create the conditions for another crisis. Eswar Prasad has a proposal to reduce the danger. The idea is to have individual countries commit to particular objectives with regard to policies that could contribute to global imbalances, and then pay a price if they fail to meet those commitments. The argument is that this would "shift the discussion from contentious arguments about current policies to a focus on outcomes":

Global macroeconomic imbalances: G20 leaders must back up their rhetoric with deeds, by Eswar Prasad, Commentary, Financial Times: The financial crisis has taught us a painful lesson that global macroeconomic imbalances can wreak enormous damage on the world economy. Indeed, the centerpiece of the recent G20 Summit in Pittsburgh was agreement on a framework for balanced and sustainable growth to forestall a resurgence of imbalances as the economic recovery gets underway. ...G20 leaders gave the IMF a mandate to manage this framework by providing hard-nosed evaluations of their countries’ macroeconomic policies.

Experience suggests that grand promises to implement policies that are in the collective global interest can’t be taken seriously without an effective enforcement mechanism. ... The IMF has no real levers when it comes to the leading G20 economies, especially since they are the major shareholders in the institution. Moral suasion and name-to-shame approaches don’t work well as the large economies tend to simply brush off external criticism of their policies.

There is a simple approach that has real consequences, would be straightforward to implement and allows G20 countries to make enforceable policy commitments. It involves Special Drawing Rights, essentially an artificial currency created at the IMF and distributed to countries in rough proportion to their economic size. The total stock of SDRs is now close to $300bn, a sizable chunk of money.

The scheme would work as follows. The G20, in consultation with the IMF, develops a simple and transparent set of rules for governments on policies that could contribute to global imbalances - for instance, that government budget deficits and current account balances (deficits or surpluses) should be kept below 3 per cent of national GDP. Each country posts a commitment bond amounting to a minimum of 25 per cent of its SDR holdings to back up its commitments to those objectives.

Since it is not easy, even with the best of policies, to turn around the factors underlying imbalances within a short period, commitments to policy objectives would be made over a five year horizon. ... Failure to meet the targets would mean a forfeiture of the bond... The actual cost would not be large. China, for instance, now has an allocation of 7bn SDRs and 25 per cent of that would amount to less than $3bn. Still, the symbolic effect of being levied an SDR penalty for running bad economic policies would be huge. ...

This approach would shift the discussion from contentious arguments about current policies to a focus on outcomes. For instance, China has consistently maintained that its current account surplus reflects structural problems in its economy and has nothing to do with its exchange rate policy. Who could quibble with methods so long as China commits to reducing its current account surplus and succeeds in putting its economy on a trajectory to get it below 3 per cent of GDP in the next 5 years...?

What happens to SDRs that get docked if countries don’t hit their targets? These SDRs would be distributed among low income countries. To get incentives right, only those low-income countries that meet minimum standards in terms of their macro policies would be eligible for this redistribution. This way, the IMF could finally offer carrots to poor countries for good policies rather than just sticks for bad policies. Any SDR redistributions to small poor economies ... would be morally justified - instability caused by bad policies in the larger and richer economies tends to hurt these vulnerable and innocent bystanders disproportionately.

The G20 commitment to tackling global macroeconomic imbalances is laudable. G20 leaders must now be ... ready to pay the price for breaking their commitments.

Five years seems too short of a time period given the large adjustment some countries would have to make to get to a 3% target, but I can't imagine this being implemented in any case. They'd never get past the contentious, endless discussions over what the targets should be, how they should be defined, the acceptable range in each case, and so on.

I suppose we could think of this as a tax on excessive contributions to global imbalances (solving an externality problem that is present when individual countries do not consider the effect of their policies might have on other countries except to the extent that it feeds back on them). Maybe we could try a cap-and-trade system instead. Cap global imbalances at some level, and then have countries buy and sell permits in order to deviate from their allotment of the total (the initial permits could be distributed by auction with the proceeds distributed among countries in some way, or simply given away). Yeah, that'll work.

This post has been republished from Mark Thoma's blog, Economist's View.

The Relationship Between Gold and Interest Rates

Former economics professor John Doody argues that $1,000 is the new floor for gold based on a simple historical relationship between gold and interest rates. As interest rates remain low and inflation rises, this information can help you profit from gold. See the explanation in the following post from Daily Wealth.

Using basic economic principles (the gold to interest rate ratio), a former economics professor explains why gold is not a safe investment but rather the only safe investment.

"$1,000 an ounce is thought by some to be gold's ceiling..." John Doody wrote last week to his subscribers. "We see it as now the FLOOR."

When John Doody talks about gold, I listen...

This year, his Top Ten List of gold stocks is up over 100%. John says his Top Ten list has averaged a 30% annual return since the start of his newsletter, Gold Stock Analyst. John has been writing Gold Stock Analyst for about 15 years.

One thing I like about this former economics professor is that it's all about the numbers to him... It's not about conspiracy theories like it is with so many gold bugs. For example, John will actually tell you when gold stocks are overpriced according to his model – imagine that with dyed-in-the-wool gold bugs!

So why does John think gold will keep going up now, when many others say it's bumping up against its ceiling? I asked John that yesterday...

It's simple, he said, if you just compare the price of gold to interest rates.

In short, when interest rates are high, then gold (which pays no interest) falls. And when interest rates are low (like they are now), gold rises. To keep it apples to apples over time, John subtracts inflation from interest rates.

In the 1980s and 1990s, you earned high rates of interest on your cash. So gold was flat for those two decades. Plain as day.

But for much of this decade and the decade of the 1970s, you typically earned NEGATIVE interest on your cash (after you subtracted inflation). So gold has soared.

John sees those negative real interest rates continuing. So gold will keep rising. Simple as that.

For the specifics, currently, the consensus inflation rate forecast for the first half of 2010 is around 2%. But banks basically pay you no interest. So you have a choice: Own gold, which pays no interest. Or hold cash, which pays you NEGATIVE interest, when you take inflation into account.

Yesterday, John explained that since the Federal Reserve will likely keep interest rates very low for a very long period of time, gold can keep going higher.

I asked John if gold had become too popular these days. He said absolutely not...

"Look, hedge funds are just starting to get into gold. Retail investors haven't bought. CNBC calls gold a bad inflation hedge. Central banks haven't bought. If gold was popular, I'd have a hundred thousand subscribers, not a couple thousand. We've got a long way to go. $1,000 isn't the ceiling... it's the new floor."

John ran the numbers, and in a sneak preview of his upcoming issue, he proves how the price of gold has "beaten" inflation fivefold since it first started freely trading 40 years ago.

"CNBC says that gold has only gone from a peak of $850 in 1980 to $1,050 today – for a $200 gain," he said. "So CNBC's conclusion is that gold is not a good inflation hedge... That's just plain wrong, but the people believe it."

To be brutally honest, if you plan to be a serious investor in gold stocks – and you're willing to do your homework – you're foolish if you don't read John's newsletter. John updates his unique valuation numbers every month for the 75 precious metals companies he follows. Plus, he writes up a detailed analysis about once a quarter on each company.

It is the best starting point in the business. It's the first place I go to find out how much gold each company has in the ground and what its cash flows are.

If you agree with John – that $1,000 gold is the new floor, not the ceiling – chances are, you're buying gold stocks. And if you're buying gold stocks in size, you ought to do it with John's help.

This post has been republished from Daily Wealth.

Homebuilders Show No Confidence In Housing Market

The lack of growth in new construction by homebuilders is not a good sign for the struggling real estate market. The cautious behavior may be attributed to the excess inventory and uncertainty over the possible extension of the homebuyers tax credit. See the following post from The Mess That Greenspan Made.

It appears there was good reason for yesterday's dimming confidence by homebuilders - according to today's report(.pdf) from the Commerce Department, housing starts and permits for new construction have flattened out at severely depressed levels.



Housing starts increased modestly, from an annual rate of 587,000 in August to 590,000 in September, however, the gain would not have occurred if not for a downward revision to the August data from 598,000.

In a way, this is reminiscent of a few years ago when there were huge downward revisions to prior data and, each month, gains would be reported when comparing new unrevised data to previous data that had been revised, all part of a clear and persistent downward trend.

The good news today is that, as shown clearly in the chart above, there's not much room to move down from current levels of home building that are still about 75 percent below the 2005-2006 peak, remaining near all-time lows. From year-ago levels, housing starts are down 28.2 percent.

Permits for new construction fell 1.2 percent in September, from an annual rate of 580,000 to 573,000 and as is the case for housing starts, have clearly flatlined over the last five months, a point that should be quite clear to see in the enhanced image to the right from the larger graphic above.

While this is not necessarily bad news for the housing market in general since, if there's one thing that we don't need right now it's more housing inventory coming onto the market, it is certainly not an indication of a resumption to more normal levels of residential construction that would create a few jobs and boost economic growth.

The downward revisions to previous data and the fact that permits - a leading indicator for new home construction - appear to be weaker than housing starts do not bode well for a sustainable rebound in this sector.

It's no wonder that home builders are clamoring for an extension and expansion of the home buyers' tax credit that, according to news this morning, has had more than its share of fraud.

Somehow, just throwing money at the bursting housing bubble doesn't seem to be fixing it...

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Gold Still Far Below 1980 Inflation Adjusted Peak

If adjusted for inflation, then gold is not near the 1980 peak, which would be over $2000 in today's dollars. With the Federal Reserve still unable to raise interest rates to fight the risk of inflation, gold's current upward cycle could continue. See the following post from Expected Returns for more on this.

From Bloomberg, Gold at $2,000 becomes inflation-adjusted bullseye for '80 high:

Gold’s rally to a record means prices are still 53 percent below the 1980 inflation adjusted peak.

While gold rose 19 percent this year to $1,072 an ounce on Oct. 14, consumer prices almost tripled in the past three decades, eroding the metal’s value. Bullion hasn’t kept pace with the cost of bread, fuel or medical care. In 1980, gold hit a then-record $873 an ounce. In today’s dollars, that would be $2,287, according to the U.S. Labor Department’s inflation calculator.

When speaking in terms of real, inflation-adjusted dollars, it's easier to understand the argument that gold is still cheap. Note that these inflation adjustments are based on government statistics of inflation, which are understated.

Gold Bears

“If you bought gold in the 1980s, you’re still losing money today,” said Zeman, a metals trader.

Gold prices in New York languished for two decades after declining from the 1980 record, dropping to a 20-year low of $253.20 on July 20, 1999. While bulls say gold is cheap, the inflation-adjusted price is 15 percent above its 30-year average, Bloomberg data show.

The Federal Reserve may limit gains by raising interest rates before inflation balloons, analysts said. Fed Chairman Ben S. Bernanke said on Oct. 8 that policy makers will need to raise interest rates “at some point” to control inflation

This is the argument you hear most often from gold bears. Of course if you bought gold at its absolute bubble peak in 1980, you wouldn't be doing well. Most people assume that "gold bugs" are always bullish on the yellow metal. In fact, the smart money in gold knows that gold, like any other asset, moves in cycles. We just happen to be in a powerful upward cycle for gold.

Concerning interest rates, the Fed has its back against the wall. Our economy has become so dependent on artificially low interest rates and government stimulus that raising interest rates anytime soon would be disastrous for our economy. Any talks of raising rates to contain inflation must be viewed as mere jawboning. Historically, inflation has always been the means by which governments attempt to escape the burdens of debt.

This article was republished from Moses Kim's blog, Expected Returns.

Bernanke Blames Asia For Financial Crisis

Federal Reserve chairman Ben Bernanke places much of the blame for the global economic crisis on global trade imbalances and warns that without changes in the saving and consumption habits for US and other countries that the global economy is in danger of future crises. While economist Paul Krugman agrees with Bernanke to some extent, he adds that it is important to consider strengthening US financial regulatory defenses to protect the US economy from future shocks. Economist Mark Thoma discusses this in the post below from Economist's View.

Ben Bernanke:

Fed Chief Cites Trade Imbalances’ Role in Crisis, by Edmund Andrews, NY Times: Ben S. Bernanke, the chairman of the Federal Reserve, said on Monday that global trade imbalances played a central role in the global economic crisis and warned that the both the United States and fast-growing Asian nations needed to do more to prevent them from recurring.

“We were smug,” Mr. Bernanke said of the United States, saying the American financial regulatory system was “inadequate” at managing the immense inflows of cheap money from China and other countries that had huge trade surpluses.

Though the Fed chairman acknowledged that trade imbalances have declined sharply as a result of the crisis, mainly because trade itself plunged, he warned that American foreign indebtedness will aggravate the imbalances once again unless the United States reduces its soaring federal budget deficit.

“The United States must increase its national saving rate,” he said. “The most effective way to accomplish this goal is by establishing a sustainable fiscal trajectory, anchored by a clear commitment to substantially reduce federal deficits over time.” ...

By the same token, he said, Asian countries needed to rely less on exports and more on their consumption at home for their economic growth. One way to increase Asian household consumption, he said, would be for countries like China to increase social insurance programs and reduced the uncertainty that currently hangs over many consumers. ...

With the Asian economy expanding at an annualized rate of 9 percent in the second quarter of this year, and China’s economy expanding at rates of more than 10 percent, Mr. Bernanke said, “Asia appears to be leading the global recovery.”

But the Fed chairman warned that the United States-led crisis was fueled in large part by huge inflows of cheap money to the United States from countries like China that were trying to recycle dollars from their huge trade surpluses.

The Fed chairman noted that global trade and financial imbalances have narrowed considerably since the crisis began... But he cautioned that the imbalances could widen out again as economic growth revives. While the United States has to tighten its belt by saving more and consuming less, China and other Asian countries need to increase their consumer spending in order to promote faster domestic economic growth.

Mr. Bernanke avoided what was in many ways the elephant in the room: the value of the United States dollar. The dollar has dropped sharply in recent weeks against the euro and the Japanese yen, which has helped increase American exports by making them cheaper in some foreign markets. But the dollar has not budged in more than a year against China’s renmimbi...

There were three important factors in the crisis, global imbalances (Bernanke's savings glut), low interest rate policy by the Fed, and the failure of markets and regulators to provide the checks and balances necessary to prevent the crisis from occurring. The global imbalances combined with the Fed's low interest rate policy led to the massive build up of global liquidity looking for a safe, high return home, and the market and regulatory failures allowed the extra liquidity and the false promise of high, safe returns to concentrate risk in the mortgage markets.

Bernanke focuses on two of these causes of the crisis, global imbalances and regulatory problems (market failures get less attention), but he does not focus on the Fed's role in the crisis at all. So let me say that I hope the Fed is more willing to consider popping bubbles as they inflate than it has been in the past. But that is not the main point I want to make.

The crisis, according to Bernanke, occurred when the excess global liquidity overwhelmed financial markets -- it was too much for either regulators and markets to handle. Think of a hurricane hitting a city that is so strong and powerful that it overwhelms levees and other flood/damage control mechanisms. That's essentially Bernanke's explanation, the shock was too big for the mechanisms we had in place to control the damage. One solution to the hurricane problem is to hope that such large shocks don't happen again and simply rebuild the same defenses as before, and another response is to recognize that such shocks will occur every so often and to build the stronger defensive measures needed to get ready.

Bernanke acknowledges that the defenses, i.e. the regulation of financial markets, need to be strengthened, but he seems to place a lot of emphasis on reducing the size of future shocks (reduce the budget deficit, have Asian countries consume more to reduce imbalances, etc.). I think that is fine, we should reduce the danger as much as we can, but we need to accept that global imbalances are possible, that a shock of this magnitude could and probably will happen again at some point in the future, and we need to make sure that markets don't fail like they did this time (i.e. we need to fix the bad incentives in these markets). But more importantly, we need to strengthen our regulatory defenses in anticipation of the next big shock. If it's fair to blame the government for not having levees, etc. ready for Katrina, if we insist that the defenses need to be strengthened going forward, then the same argument can be made in financial markets. Despite our best efforts to reduce the chances that a large shock will occur through deficit reduction and higher domestic saving rates, we should expect that global imbalances will rear their head again at some point, and the system cannot be overwhelmed again like it was this time.

For that reason, I'm a bit disappointed in Bernanke's willingness to point fingers at external causes and say other countries must change their consumption habits, or to blame budget deficits, at a time when financial regulation is coming onto the legislative agenda (though he didn't say anything about the exchange rate). Those are important problems and I don't mean to dismiss them, but right now financial regulation is being considered by congress, and it's essential that we get the regulations in place that can withstand the next big shock. Blaming external forces for the crisis will make it easier for opponents of regulation to blame China and other countries, and that gives legislators an excuse to give in to pressure (e.g. campaign contributions) from the financial industry to go soft on regulatory changes.

Update: Paul Krugman comments on Bernanke's remarks: America’s Chinese disease (not quite what you think).

This post has been republished from Mark Thoma's blog, Economist's View.

America's Desire To Save Money Getting Stronger

As Americans continue to reduce their consumer debt by billions of dollars and with personal savings rates rising to the highest levels since 1998, Tom Dyson says that cash may be the best investment opportunity in the U.S. right now. By the end of 2010, it is estimated that Americans will have paid off approximately 13% of their outstanding credit card debt. See the following article from Daily Wealth for more on this.

"We've never seen this aggressive paying down of debt before," said a banker in the Financial Times last week. "Once you slap households in the face... it sticks."

Each month, the Federal Reserve calculates and reports the total amount of consumer credit outstanding in America. This is the money Americans have borrowed to pay for cars, vacations, education, and refrigerator-freezers at Wal-Mart.

When this number rises, it means credit is easy and Americans are in consumption mode. They're buying SUVs, houses, flat-screen TVs, granite countertops, and stainless-steel appliances. And they're borrowing money to make these purchases – often using credit cards – so they're not worried about finances.

When this number falls, Americans are in thrift mode. They prefer saving money and paying off debt to shopping at the mall and going on vacation.

Despite the improvement in the economy and the bounce in the stock market, the American desire to save money seems to be getting stronger...

In the last year, American consumers have reduced their outstanding debt by more than $100 billion, according to the Federal Reserve's data.

In July, Americans reduced their consumer debt by $21 billion... the sixth monthly decline in a row and the largest monthly drop in borrowing ever recorded.

The report for August came out earlier this month. It showed American consumers paid back another $12 billion of their outstanding credit, the seventh monthly decline in a row. At this rate, Americans will have paid off 13% of their outstanding credit-card balances by this time next year.

Not only are Americans paying off debt, but they're saving more money...

Each month, the St. Louis Fed publishes America's savings rate. This is the percentage of disposable income Americans choose not to spend.

In 2005, the personal savings rate fell to less than 1%. This year, it has averaged 4.1%. The last time it averaged more than 4% for the year was in 1998.

Here's the thing: While demand for cash in America soars, investors have been dumping it from their portfolios as if it were venom...

This year, cash has fallen...

60% in terms of Russian stocks
55% in terms of lead
53% in terms of coal
50% in terms of copper
40% in terms of Internet stocks
33% in terms of sugar
17% in terms of gold
16% in terms of the S&P
13% in terms of cotton

The terrible sentiment and Americans' new attitude toward saving make cash the most contrarian investment opportunity in America right now.

In tomorrow's essay, I'll show you one of my favorite ways to invest in cash...

This post has been republished from Daily Wealth, an investment analysis site.

Obama's Report Card On The Economy

After only nine months in office, some may question whether President Obama’s administration has achieved much in changing the lives of Americans. NY Times commentator Alan Blinder believes that while any substantial achievements have yet to be seen, President Obama has been instrumental in pushing forward several macroeconomic and banking policies that may well create positive long-term changes in the future. See the following post from Economist's View.

Alan Blinder grades the administration's accomplishments on macroeconomic and banking issues:

Comedy Aside, an Obama Report Card, by Alan Blinder, Commentary, NY Times: First, “Saturday Night Live” parodies President Obama’s “achievements.” Then Mr. Obama wins the Nobel Peace Prize, bringing yet more head-scratching. Clearly, the nation’s attention is focused squarely on a question few presidents want to answer just nine months into their term: What has your administration accomplished?

I’ll leave foreign and military affairs to the Oslo Five and concentrate on domestic economics. ...

Stopping the Slide Let’s remember that the new president was dealt a dreadful hand on Inauguration Day — including a shattered financial system and a national economy teetering on the brink of disaster. The administration’s chief accomplishment to date surely is devising and executing — with huge assists from the Federal Reserve — a comprehensive program to pull us back from the abyss. ... Thus Job No. 1 — stopping the train wreck — appears to have been done rather well.

Enacting the Stimulus Package The much-maligned fiscal stimulus has been criticized from both the left (as too small) and from the right (as too big, especially the spending parts). My own judgment is that both its magnitude and composition were reasonable, though not perfect. But ... speed of enactment merits substantial weight in the overall grade. By that standard, the stimulus package scores well — especially considering that Republican obstructionism... Give it a B or B+.

Rescuing Banks ...[T]he Treasury secretary ... wisely resisted the siren songs coming from both the left (“nationalize the banks”) and the right (“let ’em fail”), opting instead for the high-risk “stress tests” of 19 big financial institutions. Today, all 19 are alive and breathing. None have been nationalized. ... Most are not just showing a pulse but also actually have pink in their cheeks. ... (In fairness, the Fed and other regulators deserve great credit for executing this delicate task so skillfully.)

So give the bank rescue plan an A–. The minus comes from being too soft on many banks and bankers, who failed us and then benefited from public largess.

Reducing Foreclosures Mr. Obama’s efforts to mitigate foreclosures have been more modest — and less successful. ... Give them a C.

Trying for Regulatory Reform While it is still only a set of proposals,... the Treasury worked at breakneck speed ... to produce an intelligent and comprehensive set of financial regulatory reforms after just five months in office. The ... proposals ... are not perfect. ... And I continue to be distressed that the president, having overloaded his plate, has been unable to devote enough time and effort to pushing the proposals through Congress — leaving the lobbyists far too much running room.

At this point, we can’t even guess what may pass. So give this policy an “incomplete,” noting, however, that the first draft shows promise.

Etc. In addition to these efforts on the macroeconomic and financial fronts, the president appears to be making some headway on health care reform... By contrast, the betting is against getting through Congress a cap-and-trade system for reducing carbon emissions.

On balance, then, this assessment leads to a Nobel-like verdict in the areas of financial regulation, health care and energy: the ideas have great merit, but any real achievements are hopes for the future. They don’t award prizes for that in Washington, even if they do so in Oslo.

Yet on the crucial macroeconomic and banking issues,... Mr. Obama’s accomplishments in just nine months are palpable and were very much needed. ...

Let me add one more category, how the benefits from the stimulus package and the bank bailout package have been distributed. With so many of the benefits of the financial bailout accruing to the same people and institutions that helped to cause the problems, with employment still lagging, and with social insurance programs to help those who cannot find employment coming under increased budgetary pressures, particularly at the state and local levels, it seems evident that the distribution could have been much better without compromising (and perhaps even enhancing) the speed of recovery.

This post has been republished from Mark Thoma's blog, Economist's View. Photo courtesy of Wikipedia Commons.

The Shrinking Purchasing Power Of Dollar Vs Gold

Since the U.S. closed the dollar-for-gold convertibility standard in 1971, the value of the U.S. dollar has consistently eroded, while the purchasing price of gold has increased over the past three decades. With government borrowing at an all time high and the purchasing power of the U.S. dollar expected to decline significantly, investors would be wise to consider investing in the enduring value of gold. Jeff Clark writing for Daily Wealth discusses this below.

In August, the U.S. dollar celebrated its 38th anniversary as a fiat currency.

When Roosevelt issued his infamous 1933 presidential diktat, forcing delivery (confiscation) of gold owned by private citizens to the government in exchange for compensation, gold was $20.67 per ounce. In January 1934, the price was raised to $35 per ounce. The U.S. government pocketed the difference – and essentially devalued the dollar by 69%.

Yet the dollar remained convertible, and foreign central banks could redeem their dollar reserves for gold. This presented no problem when the U.S. was running trade surpluses and foreigners didn't have many dollars to exchange for gold. But in 1965, France's President Charles de Gaulle started aggressively exchanging his country's dollars for gold and loudly encouraged other countries to do likewise. That year, U.S. gold holdings fell to a 26-year low.

Several schemes were tried to stop the drain on the U.S.'s hoard, including lifting the price to $42 per ounce early in 1971, but nothing worked. The run on the dollar did not abate.

With the U.S. unable to eliminate its trade deficit, Nixon was faced with the stark reality of another dollar devaluation. He opted instead to close the gold window on August 15, 1971, ending dollar-for-gold convertibility. The dollar was suddenly off the gold standard, and half of U.S. gold holdings had disappeared. The greenback began to "float," meaning it wasn't tied to any standard and could be printed at will.

So how's it done since then?

The following chart tracks what has happened to the purchasing power of the dollar and gold since the gold standard ended in 1971. After adjusting for inflation, you can plainly see the erosion of a dollar bill, now able to purchase only 18 cents of what it did in 1971, vs. an ounce of gold, which has not only stood up but increased in purchasing power.



Purchasing Power of Gold vs Dollar

There are two overriding conclusions from this chart:

• The dollar has consistently lost value since coming off the gold standard.

• While gold's price has fluctuated, its purchasing power has endured. This fact will not change and is the reason you should own physical gold. It's what I call the four Ps: your Personal Purchasing Power Protection.

At Casey Research, we believe the dollar must go lower over the coming years. Since the end of August 2008, the past year, the U.S. monetary base (coins, paper money, and central bank reserves) has swelled from about $800 billion to $1.7 trillion. This is the largest expansion in history and a staggering devaluation of the dollar.

And as you already know, we're also taking on unprecedented amounts of debt. Year-to-date government spending is $2.9 trillion, while tax revenue is only $1.6 trillion. But that's nothing compared to the massive unfunded liabilities (meaning, they are not covered by an asset of equal or greater value) of Medicare, Medicaid, Social Security, and prescription drugs. Liabilities from this trio total $105.7 trillion.

Taking on debt is like getting a tattoo: It doesn't go away, and it's pretty painful to get rid of. The only way the U.S. government can get rid of its tattoos is by paying them off with greatly diluted dollars.

There are a lot of uncertainties about how this situation will play out. But the future purchasing power of gold is not one of them.

This post has been republished from Daily Wealth.

Los Angeles Commercial Real Estate Struggling

Although the Los Angeles residential real estate market may be starting to show some preliminary signs of life, economic experts say that the commercial real estate market continues to remain stagnant. Despite the innovative tactics that commercial landlords are employing to retain existing tenants and attract new tenants, experts predict that Los Angeles will remain a “tenants’ market” until the job market and business climate begin to show more significant signs of improvement. See the following from The Mess That Greenspan Made for more.

It looks like the "fog a mirror" metaphor in the greater Los Angeles area has made a complete transition from its 2005 usage, reflecting the requirements for getting a home loan, to the absence of fog today to describe the lifelessness in commercial real estate.

At least according to Jack Kyser, of the Kyser Center for Economic Research at the Los Angeles County Economic Development Corp., who, in this LA Times story noted:

It looks like residential may be starting to breathe again, but when you put a mirror under the nose of commercial, there is no sign of life.

Rents for office space are falling in Southern California and Riverside and San Bernardino, ground zero for the residential housing bust, seem to be hardest hit.

Reports of lower rents along with concessions and perks are widespread as the average vacancy rate rose above 17 percent during the third quarter, up from 13 percent a year ago.

Some of the things that landlords are doing to keep tenants are quite interesting:

Loath to set lower rent benchmarks because they reduce a building's value, landlords look for other ways to cut tenants' costs and perhaps stroke their egos.

Want us to wrap the building in a giant nylon "supergraphic" announcing your arrival for a few months? We'll make it happen, some landlords say. Want us to promise we'll never put an advertising supergraphic on the building because you think they're tacky? Glad to, other landlords respond.

Most landlords and tenants agree not to talk about the terms of their leases to preserve their financial secrets, but tenant broker Jonathan Larsen of Transwestern confirmed that he recently negotiated a promotional supergraphic for a new tenant in the South Bay.

Larsen has also been exploring new fronts for what might be called "naming rights," similar to university facilities named after donors or parts of entertainment venues named after paying sponsors, such as Club Nokia at LA Live.

Putting the largest tenant's name at the top of a building has long been an established practice for landlords who want to fill large blocks of space. The former Library Tower in downtown Los Angeles, the tallest building in the West at 72 stories, has been renamed twice, first as First Interstate World Center and now as US Bank Tower.

Larsen is taking a further step for smaller tenants that don't rate building-top signage by asking for other parts of the property to be named after the tenants. An outdoor garden area might get a sign proclaiming it the Acme Insurance Courtyard, for instance. Larsen is negotiating such a deal now, he said, but can't reveal the names of the parties yet.

Another LA Times story details the same situation from the perspective of the renter.

The exodus from office buildings that started in late 2007 accelerated during the third quarter as the anemic business climate took its toll on the real estate rental industry, according to the Cushman & Wakefield real estate brokerage. "These vacancies are a direct reflection on unemployment," said Joe Vargas, an executive vice president at Cushman & Wakefield. "Companies continue to reduce their workforce, or they are not hiring."

Troubled business owners facing expiring leases often choose to downsize these days and take less office space, even though rents are falling, he said.

Real estate rentals are a lagging indicator of the economy, so the shrinking-space trend is expected to persist well into next year even if the nation's financial outlook continues to improve.
...
Cushman & Wakefield's Vargas predicts Southern California will remain a tenant's market through mid-2010 and perhaps longer if employment doesn't start picking up.

"This is certainly the worst downturn we've seen," Vargas said. "We're not going to see real improvement until job growth occurs."

Any word on residential rents in Southern California?

They've got to be dropping too, at least in areas that were way overbuilt during the boom.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

High-End Homes Contributing More To Foreclosures

Persistent economic weakness and a slow and uncertain stock market recovery are creating pressure on the higher end US residential real estate markets. With nearly 10 percent of jumbo prime mortgages in delinquency and available credit scarce, some experts believe that a second wave of the housing crash is threatening. See the following post from Expected Returns for more.

For people who have become convinced that housing has bottomed, the coming 2nd wave down will come as a surprise. The odds favor more downside when unemployment is still rising and credit is contracting. Even with mortgage rates under 5% and first time homebuyer tax credits, there is little that can be done to pump up the housing market. Now comes news that the higher end markets are coming under pressure. From Reuters, for many U.S. wealthy, housing crisis still a squeeze:

Despite some signs that the worst of the U.S. residential housing crisis may be over, many wealthy homeowners are still being squeezed by the combination of weak home prices and the stock market crash.

"I think for wealthy homeowners it will get worse before it gets better," said Dennis Hedlund, founder of iEmergent, a forecaster for mortgage and real estate

Just wait until the stock market starts heading back down once again. A whole generation of wealthy individuals have become accustomed to high stock valuations and the fallacy that stocks always go up in the "long run". This illusion of wealth allowed Americans to consume beyond their means. After stocks go down 30-50%, and remain at those levels for a decade, expect frugality to become an entrenched mindset across the American population. This means no more housing bubbles, and housing valuations below multi-generational trendlines.

Massive Supply to Hit the Market

More unwanted supply of U.S. homes at the high end may also come from foreclosures. According to data from research firm First American CoreLogic, the rate at which wealthy homeowners are falling behind on their mortgage payments is increasing.

It says 9.4 percent of those with jumbo prime mortgages -- those over $417,000 -- are 90 days or more behind on their payments. This pales next to the 33.8 percent of subprime loans that are delinquent 90 days or more. But the rate is rising.

While the subprime delinquency rate is 1.3 times higher than a year ago, the jumbo prime delinquency rate is 2.6 times higher, suggesting that wealthy homeowners overstretched themselves financially much as their poorer counterparts did.

The point that I've been trying to make the past couple of months is that there is more pain to come in the higher end markets. Higher net worth individuals can weather any economic storm better than low income individuals, since they tend to have more savings and assets to liquidate to raise cash. But, persistent economic weakness eventually results in capitulation. Have we reached the point of capitulation for wealthy individuals? Apparently, we're getting close.

This post has been republished from Moses Kim's blog, Expected Returns.

Job Growth Held Back By Weak Consumer Spending

While the U.S. job market continues to be challenging, declining initial jobless claim filings offer hope that the worst of the recession is over. Investors should continue to be cautious with regards to the long-term outlook since sustained job growth will rely heavily on increases in consumer spending levels. See the following post from Capital Spectator for more.

The trend remains our friend in the land of initial jobless claims. The absolute level is still reflecting pain in the labor market, but there's no denying that the general ebb and flow of new filings for unemployment benefits is favorable.

As our chart below shows, new filings dropped again last week, falling to a seasonally adjusted 514,000, below the previous week's 524,000, the Labor Department reports. That puts the latest number at the lowest level since the week ended January 3, 2009.



Confirming the trend is the decline in continuing claims, which dropped below the six-million mark in the week through October 3 for the first time since March.

All of which is encouraging and lends more support to our earlier calls that the recession is technically over. But that invites our standard caveat: sustained growth in the labor market is still far from imminent. Even the optimists don't expect much good news on this front until next year. “We will probably have more sustained growth in the labor market starting in early 2010," Maxwell Clarke, chief U.S. economist at IDEAglobal in New York, tells Bloomberg News. "From there we will find a peak in the unemployment rate and ultimately create jobs.”

Part of the problem is that consumption may revive in fits and starts. For an economy that relies heavily on consumer spending, that challenge threatens to remain a thorn in the recovery's side for the foreseeable future. Indeed, yesterday's update on retail sales offers little reason to think otherwise. The Commerce Department reports that retail sales last month slid 1.5% on a seasonally adjusted basis. Of course, if we exclude auto purchases, which were artificially boosted in recent months by the government's cash-for-clunkers program, retail sales inched higher in September by 0.5%. That encourages some observers, including Bruce Shalett of Wynston Hill Capital in New York, who tells Reuters: "While the consumer may be more prudent in the way they spend money, the data would indicate they are certainly spending money. The consumer is participating in the recovery."

The stock market seems to be buying into that outlook, or so the rally of late suggests: The media's obsession with reporting that the Dow Jones Industrials closing above 10,000 for the first time in more than a year being the obvious example.

But until the labor market starts showing stronger signs of revival, we remain wary of declaring that consumption is set to return to the golden days of yore.



Inflation, meanwhile, still doesn't seem to be a problem, which bodes well for keeping interest rates just above zero. The liquidity-injection train rolls on! But let's also recognize that the deflationary scare is now history, or so it appears. The last time CPI dipped on a monthly basis was March. Last month's inflation report is hardly worrisome—CPI rose just 0.2% in September. But the future will struggle with the question of how long the Fed can/should continue to pump money into the economy as if the world was coming to an end? Finding the sweet spot between juicing the labor market, consumer spending and at the same time keeping a lid on future inflationary pressures promises is the new new thing in central banking.

What does all this imply for investing? For our money, we're increasingly cautious...again. Asset allocation decisions are tougher these days compared with early in 2009, when the price of risk looked unusually attractive. That doesn't mean it's time to run for cover. But for the moment, we're of a mind to consider our Global Market Index's passive weights as a guide for structuring portfolios. Until more convincing signals (or valuations) arrive, we're inclined to settle for a neutral asset allocation. Or, to borrow Warren Buffett's metaphor, we're not tempted to swing at every pitch these days.

This post has been republished from James Picerno's blog, Capital Spectator.

Too Much Competition For Job Openings

The economy continues to destroy jobs at a much faster pace than it is creating jobs. The ratio of unemployed workers to job openings has skyrocketed by over 200% since 2007, which means greater competition for fewer jobs and longer periods of unemployment. See the following post from Economist's View.

The ratio of the number of unemployed to the number of job openings suggests that the current weakness in labor markets is likely to persist:

A look at another job market number, Macroblog: ...At the end of August there were estimated to be fewer than 2.4 million job openings, equal to only 1.8 percent of the total filled and unfilled positions—a new record low. This is an especially significant issue given the large number of people who are looking for work. The ratio of the number of unemployed to the number of job openings was greater than 6 in August. In contrast, that ratio was under 1.5 in 2007 and previously peaked at 2.8 in mid-2003, suggesting that finding a job right now is extremely difficult...



The quit rate moved back down to its record low of 1.3 percent, as relatively few people want to leave a job voluntarily in the face of such a weak labor market. At the same time, the rate of involuntary separations moved up from 1.6 percent to 1.8 percent, not far below the peak of 1.9 percent in April.

The low probability of finding a job has also caused the average amount of time spent unemployed to rise substantially. ...

Labor markets need more help. This article has been republished from Mark Thoma's blog, Economist's View.

The Growing Risk Of The Dollar

The unsustainable growth of the national debt that has risen to about $120,000 per household is a significant threat to the value of the US dollar. Porter Stansberry from Daily Wealth argues that the debt could grow to $20 trillion in the next 8 years, which will lead to high inflation and destroy an unprecedented amount of wealth held in dollars.

At the end of last year, I began writing about what I saw happening as the Federal Reserve started assuming the liabilities of the investment banks and the federal government began deficit spending at an unprecedented pace.

I've been calling these changes the "End of America" because I believe the fiscal policies of the U.S. will result in a massive devaluation of the dollar and the end of the U.S. dollar as the world's reserve currency.

To get an idea of why I'm concerned, have a look at a chart James Bullard, president of the Federal Reserve Bank of St. Louis, included in a recent presentation to the National Association for Business Economics.

What you see here is Bullard's estimate of the future growth of Federal Reserve assets.

A lot of people seem to have forgotten something that is very much on Bullard's mind: The growth of the Fed's balance sheet isn't nearly finished. In fact, the Fed has only completed purchasing about half of the $1.75 trillion worth of assets it has promised to buy. The assets are mostly mortgages and mortgage-related securities.

Even though these direct purchases are unprecedented, that's only about 10% of the story. Since the beginning of the crisis, the Fed has lent, spent, or guaranteed $11.6 trillion.

That includes providing a backstop on the entire system of mortgage finance in the United States, a system that currently shows nearly a $1 trillion loss.

Since the expansion of its balance sheet got started in earnest last fall, the trade-weighed value of the dollar has fallen 15%. Keep in mind, the Fed's assets form the base of our monetary system. The more it grows, the more money and credit become available to the banking system. And the faster the money supply grows, the more likely the value of the dollar will continue to fall.

As Bullard points out, a doubling of the monetary base won't necessarily cause an immediate doubling of inflation... But suppose it takes 10 years? The average inflation rate would still be 7% a year. If inflation does grow to this average level, at least a few of those years will see inflation running at or near double digits.

Nothing in our financial markets is prepared for this kind of inflation. Inflation at these rates would cause the average multiple of earnings for equities to fall by at least 50%. Likewise, we would see high-yield corporate bonds yielding at least 20% – double what they are now. And U.S. Treasuries would probably see their yields triple. The destruction of wealth in the bond markets would be unprecedented in modern finance.

It's going to happen. I guarantee it.

My forecast only assumes the Fed's actions don't continue past what's been announced so far. My bigger concern is what happens if Congress decides the Fed did such a good job fixing the housing bubble that perhaps it should lend a hand on health care or the entitlement time bomb? Although a small handful of people have been writing about the enormous fiscal challenges that all the Western democracies face over the next decade, I'm sure most of today's equity investors don't really understand what lies ahead.

Consider these numbers: Right now, today, without counting any of the unfunded liabilities of our government (which are very real obligations, by the way), our national debt is $12 trillion. There are roughly 100 million American households. So that's a national debt of roughly $120,000 per family. That's more than the average American owes on his mortgage.

Think about what this means in terms of interest payments. Even with interest rates at all-time lows around the world, the U.S. will spend almost $400 billion on interest to service our existing national debt – that's a 3.3% interest rate. Currently, the U.S. takes in roughly $2 trillion in taxes, half of which come from income taxes. So the interest on our debt is already consuming 20% of all tax receipts, or 40% of all income taxes.

It seems obvious to me this money will never be repaid – could never be repaid. The only real question is how much of a "haircut" our creditors are willing to accept in terms of the loss of purchasing power of the U.S. dollar. So far, inflation remains relatively benign. Our creditors don't seem to be losing very much. But we know this will change and could change rapidly, as the Fed continues to expand its balance sheet with less and less creditworthy assets. At what point will our creditors finally decide they can't finance any more of our deficit spending because we're simply not worth the risk?

No one in Washington realizes you can't borrow money endlessly. By the time Barack Obama leaves office (assuming he is reelected), the national debt will likely exceed $20 trillion. What will our creditors charge us to finance this debt? How will our debts compare to the value of our economy? It is impossible to know what will happen. But here's the one thing that seems most obvious: Our borrowing costs will go up, a lot.

At some point in the next few years, our creditors are going to stop believing in our ability to pay our debts in honest money. I don't know what will break first, but we can't go on printing money to prop up our banks and spending money we don't have to prop up our culture of entitlement.

And I don't believe there's any way to avoid it – certainly not with the political system we have in place right now. To protect yourself, you'll have to be very good at managing your assets. You also need to make sure to take the advice we've been issuing for years: Buy and hold plenty of real, honest money that cannot be debased by the government. Buy and hold plenty of gold and silver.

This post has been republished from Steve Sjuggerud's blog, Daily Wealth.

Fed Can't Be Blamed For Financial Crisis

David Altig argues that alleged errors by the Fed in setting the federal funds rate are not responsible for the financial crisis. He points out that the Fed was following the same model for setting rates that had proven successful in the 80's and 90's. See the following post from Economist's View for more on this.

David Altig says "it is yet far from clear that the financial crisis can be explained by a misstep in the setting of the federal funds rate" due to a failure to base monetary policy rules on models that include a well developed credit channel:

Reviewing the recession: Was monetary policy to blame?, by David Altig: In a recent speech given at the University of South Alabama, Federal Reserve Bank of Atlanta President Dennis Lockhart added his voice to what is now the general consensus: "I agree with all who are declaring that a technical recovery is under way."

There is still much work to be done, of course, not least the continuing examination of just what led to the recession and how a repeat performance can be avoided. One theme of this examination appeared in last week's Financial Times:

"It is certainly true that the most recent bubble, its bursting and the Fed's actions in the aftermath have inspired existing critics and recruited new ones. The first charge is that interest rates under Alan Greenspan, [current Fed Chairman Ben] Bernanke's predecessor, were kept too low for too long, contributing to a bubble of easy credit."

Here is an exercise that that I find intriguing. Suppose we try to estimate, as closely as we can, the actual interest rate decisions of the Federal Open Market Committee (FOMC) over the period spanning the beginning of Greenspan's tenure to the present. It turns out that by using an approach based not only on measures of inflation and actual output relative to potential but also on the lagged fed funds rate, you can actually get pretty darn close to statistically describing what the FOMC did:



I'm going to resist the temptation to call this approach a "Taylor rule." The estimating "rule" used here does in fact include realizations of inflation and a measure of the output gap (that is, a measure of how different gross domestic product is from its potential). These are the essential ingredients of the Taylor rule, but not the source of the close fit evident in the chart above. Over the period covered by the chart, you could have done a pretty good job mimicking the actual federal funds rate outcomes in any given month using knowledge of the previous month's rate. (If you are interested in the details of the estimating rule, you can find them here.)

The interpretation of the tendency for today's federal funds rate to generally follow yesterday's rate—sometimes referred to as interest rate smoothing—is controversial. Glenn Rudebusch (from the Federal Reserve Bank of San Francisco) explains:

"Many interpret estimated monetary policy rules as suggesting that central banks conduct very sluggish partial adjustment of short-term policy interest rates. In contrast, others argue that this appearance of policy inertia is an illusion and simply reflects the spurious omission of important persistent influences on the actual setting of policy."

Rudebusch is decidedly in the second camp, but for our purposes here the exact interpretation may not be that important. Though I am glossing over some not insignificant caveats—such as the difference between final data and the information the FOMC had to react to in real time—the chart above suggests that whatever the underlying structure of policy decisions, after the fact the FOMC appears to have behaved in an extraordinarily consistent way over the period extending from the late 1980s. This observation, in turn, suggests to me that there was nothing all that unusual about monetary policy in 2003 once you account for the state of the economy.

Which leads me to my main point on the chart above: If you are of the opinion that interest rate policy was good through the late 1980s and 1990s, then there seems to be a good case the FOMC was just sticking with "proven" success as it set interest rates through the dawning of the new millennium.

There is, of course, the possibility that the pattern of the funds rate depicted in the chart above was incomplete all along in the sense that whatever variables are explicit and implicit in the estimated rule, they did not include information to which the FOMC should have responded. In calmer times, the story would go, not including potentially pertinent information was not much of a problem. Eventually the missing-data chickens could come home to roost. The prime omitted variable suspect would, of course, be some sort of asset prices.

Scratch any gathering of macroeconomists these days and out will bleed a steady stream directed at incorporating credit and financial market activity into thinking about the aggregate economy. The necessity of proceeding with that work was emphasized by no less an authority than Don Kohn, vice chairman of the Federal Reserve Board of Governors, speaking at just such a gathering of macroeconomists last week:

"It is fair to say, however, that the core macroeconomic modeling framework used at the Federal Reserve and other central banks around the world has included, at best, only a limited role for the balance sheets of households and firms, credit provision, and financial intermediation. The features suggested by the literature on the role of credit in the transmission of policy have not yet become prominent ingredients in models used at central banks or in much academic research."

I will admit that economists were not exactly ahead of the curve with this agenda, but prior to 2007 it was not at all clear that detailed descriptions of how funds moved from lenders to borrowers or how short-term interest rates are transmitted to longer-term interest rates and capital accumulation decisions were crucial to getting monetary policy right. Models without such detail tended to deliver policy decisions not far from the sort depicted above, and, as I noted, they seemed to be working quite well in terms of macroeconomic outcomes.

Thus far, one of the lessons from models in which financial intermediation is taken seriously is that interest rate spreads or stock prices or other asset prices do become part of the policy rate recipe. Your response might well be something along the lines of "duh." You are entitled to that opinion, and I won't push back too hard. But it is yet far from clear that the financial crisis can be explained by a misstep in the setting of the federal funds rate caused by the failure to make whatever adjustments might have been indicated by the inclusion of pertinent financial variables in implicit rate-setting rules of thumb. Furthermore, early versions of research I have seen that combines capital regulation policy and interest rate policy suggest that the macroeconomic consequences of getting the former wrong may be much greater than the consequences of getting the latter wrong. To me, that conclusion has the ring of truth.

I have advocated targeting a price index that includes asset prices as part of the policy rule, but I share the view that this likely would not have been enough by itself to stop the crisis from occurring. Targeting a broader price index might have tempered the downturn some, or even quite a bit -- it sounds like I am more optimistic than David along about how well this might work -- but changes in regulation must be an essential component of reform if we are going to prevent problems from reoccurring in the future.

However, I think that not having models with detailed descriptions of the credit transmission mechanism was costly. The New Keynesian model that is used to inform monetary policy decisions relies upon wage and price rigidities to explain how changes in monetary policy and/or financial market conditions are transmitted to the broader economy. Thus, the price/wage rigidity transmission channels must serve as a proxy for the effects that work through credit (or other) channels, and it is not evident to me that they are adequate proxies for this task (e.g. what would a government spending multiplier look like within a model that had a richer set of connections between financial markets and the real economy?). Whether or not having such models would have prevented the crisis is an open question, and I won't push back too hard against David's view of this, but not having such models once this crisis hit did, I think, make it more difficult for us to evaluate the appropriate policy response. Not having the models we needed led to uncertainty from policymakers that showed up in the seemingly, if not actual ad hoc and trial and error nature of many of the policy responses.

This post has been republished from Mark Thoma's blog, Economist's View.

Big Banks Are Still Getting Bigger

Although too large to fail financial institutions cost the US billions in bailouts, we are now seeing these troubled institutions actually getting bigger. This can be good in the sense that they are healthier and able to lend money to businesses and people, but it is still troubling since they could fall over night. See the following post from The Street for more on this.

Whether you credit the taxpayer bailout or believe that top banks never needed one, this exclusive analysis by TheStreet shows that the biggest U.S. banks are more profitable now than last year.

As we head into the third-quarter earnings season, with high expectations for company profits, this review of the second-quarter financials sets the stage:

JPMorgan(jpm Quote) produced $2.7 billion in earnings in the last quarter compared with $2 billion the year before.

Citigroup (C Quote) nearly doubled earnings in the second quarter to $4.3 billion from $2.3 billion a year earlier.

Goldman Sachs' (GS Quote) second-quarter profit jumped to $3.4 billion from $2.1 billion in the same period of 2008.

The only laggard is Bank of America (BAC Quote), whose profit slipped to $3.2 billion in the second quarter from $3.4 billion the year before.

In one of those great historical ironies, trading has emerged as an outsize component of bank earnings after the wreckage in the markets caused in no small measure by the big banks themselves.

Meanwhile, smaller banks are struggling.

Regional banks listed in the S&P 500 are expected to post a cumulative net loss of $1.23 billion for the third quarter vs. an equivalent profit of $1.45 billion in the year-earlier period, according to Thomson Reuters.

The index holds the largest regional banks including Comerica(CMA Quote), Fifth Third Bancorp (FITB Quote) and KeyCorp (KEY Quote), among others.

If President Obama is serious about shifting power away from big banks to prevent a repeat of the past year, then he better get busy.

This post has been republished from The Street, an investment news and analysis site.

Consequences Of Stimulating Employment

Mark Thoma discusses how a hiring incentive given to businesses can have negative consequences by distorting the optimal allocation of labor during a period of economic change. This helping hand could be like helping a butterfly out a cocoon, which reduces the struggle, but prevents the necessary development needed to complete the metamorphosis. Continue reading to learn more.

There has been a bit of a pushback, both implicit and explicit, to calls to implement policies to accelerate hiring. For example, Jim Hamilton recently noted an old theory of his where some types of unemployment cannot be overcome through standard stimulative policies (this was in response to a question about whether Arnold Kling's recalculation model can explain asymmetric adjustment, but I am focusing on the technological and physical constraints present in both Hamilton and Kling's model, not whether the asymmetries can be explained):

Will stimulating nominal aggregate demand solve our problems?, by Jim Hamilton: ...[I]n 1988 ... I presented a model in which unemployment arises from a drop in the demand for the output of a particular sector. The unemployed workers could consider trying to retrain or relocate, or might instead decide to wait it out in hopes that the demand for their specialized skills will come back. ...[T]he key kind of unemployment that I think this sort of model describes-- waiting for an opening in the particular area in which you've specialized-- is caused by drops in demand...

Insofar as the frictions in that model are of a physical, technological nature, increasing the money supply would simply cause inflation and not do anything to get people back to work. I should emphasize that I built that monetary neutrality into the model not because I think it is the best description of reality, but in order to illustrate more clearly that there is a type of cyclical unemployment that stimulating nominal aggregate nominal demand is useless for preventing.

My personal view is that real-world unemployment arises from the interaction of sectoral imbalances with frictions in the wage and price structure of the sort documented by Truman Bewley and Alan Blinder. The key empirical test, in my opinion, is at what point inflationary pressures begin to pick up. If Krugman is correct, we could have much bigger monetary and fiscal stimulus without seeing any increase in inflation. If the sectoral imbalances story is correct, it would be possible for inflation to accelerate even while unemployment remains quite high. ...

Thus, according to this view, some part of the sectoral imbalances in of a "physical, technological nature," and standard demand side policy does not help. Policy may be able to induce people to stop sticking around for jobs that will never materialize and move on, but those typically aren't the kinds of policies typically associated with stimulating employment, e.g. tax credits to encourage hiring.

A new colleague of mine, Nick Sly, emails that it is not always optimal, from a long-run economic growth point of view, to provide incentives for firms to hire workers, how those incentives are structured is crucial:

There is a paper on my website called Intraindustry Trade and the Composition of Labor Market Turnover. (It is a heavily revised version with more of a trade focus.) The highlights of the paper are:

1. Because of constant turnover in labor markets, hiring costs are persistent for all firms.

2. Turnover and Hiring occur both because firms update their workforce (job creation costs) and to replace workers who leave for reasons unrelated to the firm (worker hiring costs). These phenomena are distinct 3. (KEY) I show (theoretically and confirm empirically) that each source of turnover has the opposite effect on the incentives of firms to adopt state-of-the-art production techniques. As a consequence industries with different compositions of labor mobility have varying degrees of engagement of foreign markets.

The relevance:

The act of hiring workers could be the result of demand side (firms creating new jobs) or supply side (workers need to be replaced) incentives. We may not want to jump too quickly to put people back to work if it means employing less productive production methods. The short term gains can be lost as poor matching of workers and adoption of weak production methods alter the recovery path.

I believe that the timing of the hiring tax credits, and the sort of hiring it promotes (i.e. creating new vacancies versus filling previously existing positions), will determine the long-run consequences of such a policy.

Let me try to express the main point a different way. When firms hire workers, as they are constantly doing, they have a choice between using old or new technology, and the way in which hiring incentives are structured can affect this choice. As we think about putting programs to induce firms to hire workers in place, we need to be sure that we are not giving firms the incentive to use old rather than new technology so that economic growth is maximized, and we also need to be sure that we don't distort the choice firms make toward labor intensive rather than growth maximizing change.

Our economy faces lots of adjustments as it recovers from the recession, far more than in some past recessions when we could return, pretty much, to what we were doing before the shock hit. But not this time. We have adjustments in the auto, finance, and housing sectors just for openers, and there are other underlying adjustments that are in progress as well (e.g. in the manufacturing sector). As these adjustments occur, it's important that we don't impede the necessary change, or induce firms to make suboptimal choices as we attempt to induce them to hire more workers.

But if we give firms the time they need to make the changes that are needed, there will be excess labor during these adjustment periods, both from sectoral reallocations and from technological change. The question is what we are going to do to help people who lose their jobs or are otherwise negatively affected by these transitions.

One choice is to induce firms to house the excess labor during this time period through tax or other inducements, but the danger is that in doing so you distort the choices of firms away from the optimal trajectory. Another choice is for the public sector to absorb much of the burden by providing jobs to the unemployed and providing the aid needed to carry workers through the adjustment period (and we can also provide incentives for workers to relocate in areas where they have a better chance of finding employment).

Even better, though, is to structure the incentives so that the technological change is encouraged by the hiring of new workers. For example, Nick Sly suggests that the hiring credit be only for "new" jobs offered by firms, somehow defined, because this gives firms an incentive to both hire new workers and to employ the latest technology. Thus, the best choice of all is to provide incentives to employ workers that have, as a byproduct, and inducement to maximize technology and economic growth, and then use public employment (e.g. infrastructure) or aid to help those who remain unemployed.

No matter what we do, however, there will be those who cannot find employment during these time periods, and we need to do a better job than we do in helping those who, through no fault of their own, are caught up in the tumultuous change that sometimes occurs in modern economies.

This post has been republished from Mark Thoma's blog, Economist's View.

What Australia's Interest Rate Hike Means For Investors

Australia has opened the door for other nations to start raising interest rates, which could start a trend of rates rising around the world. This has significant implications for investors, especially in currency trading and gold investment. Tom Dyson from Daily Wealth, discusses this below.

The Reserve Bank of Australia hiked its interest rate this week...

This was a big piece of financial news. Central banks around the world have been cutting rates for two years, and interest rates are as low now as they've ever been.

When a company raises its dividend, its stock becomes more attractive to investors. Its share price rises. When a bank raises interest rates on its savings accounts, people deposit more money in the bank. It's the same way in the currency markets. Rising interest rates make a currency more attractive and it rises against other currencies with stable interest rates...

The governor of Australia's central bank hinted there would be more interest rate rises on the way. This could be the start of a new trend of rising interest rates around the world. Analysts say Canada, New Zealand, South Korea, and Norway are likely candidates to follow Australia's lead.

If this is the start of a new trend of rising world interest rates, you can expect big new trends in the currency exchange markets, too. That's because interest rates are the single most important driver of exchange rates in the currency markets.

Australia's currency has risen this week as investors celebrate the higher interest rates they'll receive for owning it.

On the other hand, the dollar has fallen 15% in the last seven months. Newspapers will say it's because the Saudis want to price oil in euros or because the Fed prints too much money. This is garbage. The real reason is, it has the lowest interest rate of any major currency in the world except Japan, and speculators expect these low rates to remain indefinitely.

So how do you make money from a new global trend of rising interest rates?

While other central banks are considering raising rates, the Fed has so far refused to join the party. The dollar is the worst-performing major currency in the world this year as a result.

Two weeks ago, the Bureau of Labor released its monthly unemployment report. The report showed that somewhere close to 6 million jobs have vanished from the American economy in the last 18 months. As I write, jobs are still disappearing, albeit at a slower pace.

The employment situation hasn't been this bad since World War II ended and defense contractors eliminated 4.3 million jobs no longer needed for the war effort. With the ongoing unemployment bloodbath, rate hikes in America are unlikely until next year.

First, this gives you a great opportunity to buy the dollar right now, while it's cheap and no one is anticipating rate hikes from the Fed. For regular investors, UUP is the best way of profiting if the dollar rises. It's a fund that replicates the performance of the dollar against a basket of the euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc. By the time Bernanke announces his first rate hike next year, the dollar will have already rallied 10% or more.

Second, a trend of rising interest rates on currencies is great for people looking to buy gold at lower prices. Gold has no interest rate. So when interest rates rise on world currencies, they become more attractive – and they rise – relative to gold. This is especially true with the dollar. It's the world's reserve currency and gold is incredibly sensitive to movements in its interest and exchange rates.

As long as unemployment keeps rising, there's no way the Fed raises interest rates and gold prices will stay high. But next year is a different story. The first hint of rate increases by the Fed will send shockwaves into the gold market. If you're looking to buy gold, wait until Bernanke starts raising interest rates. By then the market will have already discounted the rate hikes and gold will be forming a low point.

This post has been republished from Steve Sjuggerud's blog, Daily Wealth.

Why Oil Is Much More Plentiful Than "Peak Oil" Advocates Claim

"Peak oil" advocates would like you to believe that we are running out of oil, but Matthew Badiali explains at Daily Wealth why extractable oil is much more plentiful than they claim. If his argument is correct, it could mean strong profits for those who can take advantage of this window of opportunity in oil. See the following post to learn more.

Mexico's colossal Cantarell field was once the second-largest oilfield in the world...

Cantarell funds 40% of Mexico's annual budget. Those petro-dollars paid for universities, built a $12 million sports stadium in Chihuahua, erected a giant flagpole in Nuevo Leon, remodeled churches in Yucatan, and constructed swanky government offices in Oaxaca.

But according to a recent Wall Street Journal article, oil production from Cantarell peaked in 2005 and has fallen 75% since then. The golden goose is a dead duck... and its decline cost the government $14 billion this year.

The same thing is happening in Indonesia, Iran, and Venezuela. Indonesia went from a proud member of OPEC to a net oil importer. Venezuelan production peaked in 1997 and is down 27% since then. Iran's production peaked in 2005, but has only fallen 2% so far... The worst is yet to come there.

A lot of factors contributed to the undoing of these great oilfields – bureaucratic mismanagement and socialist daydreaming are key culprits – but behind it all is a simple, unavoidable fact of geo-engineering. That fact is going to make a few energy investors rich... Here's why:

Oil recovery comes in three stages: primary, secondary, and tertiary. The early part of oil production flows under the natural pressure of the field – the iconic gusher of the oil industry. Oil escapes into the well, where it can be pumped to the surface. That's easy work. But primary production will only get about 10% of the oil in the field to the surface.

Eventually, production exhausts the field's natural pressure. Then the engineers begin to replace the natural pressure by pumping water or natural gas into the field. That allows the companies to recover 20% to 40% of the oil left in the field. But it also means 60% to 80% of that oil remains trapped underground in so-called "depleted" fields.

Tertiary recovery, or enhanced oil recovery (EOR), employs more sophisticated techniques to recover another 25% of the original oil in place. That means companies can recover 50% to 100% as much oil as the field originally produced.

When you consider the U.S. has pumped 75 billion barrels of oil since 1977... that means, conservatively, we could recover another 35 billion barrels of oil from known fields.

A lot of the big oil companies scrapped their EOR plans in the '80s, when the price of a barrel of oil wallowed in the teens. Now that oil is back up around $70, EOR is viable again... and it represents a huge "new" source of oil.

EOR companies in the U.S. spend between $20 and $25 per barrel to produce light, sweet crude oil. That's in line with the industry's average cost to find and develop each barrel of oil. And it's well below the cost of developing fields offshore or in tar-sand deposits.

Right now is a terrific time to buy these kinds of oil plays. On average, the market values oil companies at about $14 per barrel of reserves. But you can buy EOR companies for half that – about $7 per barrel of reserves.

You see, most oil companies are valued on their "proven" reserves, meaning these oil holdings have been scrutinized and can be "economically and legally produced under existing economic and operating conditions." That's the SEC's standard: that the reserves can be produced today.

But by definition, most of the oil reserves held by EOR firms can't be produced today... That's why these companies are using unconventional techniques. EOR companies have to describe them to investors as "probable" reserves. And the market doesn't pay for "probable" – certainly not nearly as much as it does for proven.

The market distinction between proven and probable reserves suggests probable reserves are more risky, that maybe there isn't as much oil as the company says. But the fact is, this isn't speculative drilling in virgin territory. Domestic EOR companies are working in 100-year-old oilfields that have been measured, assessed, assayed, developed, and produced over and over. Everyone knows the oil is there.

As soon as the rigs start pumping out petroleum, the SEC's bureaucrats can no longer ignore those reserves. The EOR companies can shift them to the "proven" category, and the market will respond by bidding up the value of those barrels.

Oilfield reclamation technology is actually the future of the entire U.S. oil industry. It's safe, inexpensive, and will get cheaper over time. According to a 2006 study for the Department of Energy, the U.S. has about 210 billion barrels of oil that it can recover using EOR techniques. That's nearly 10 times today's proven reserves.

This article has been republished from Steve Sjuggerud's blog, Daily Wealth.

One Economist's Argument For The Coming Great Depression

The mood on Wall Street and at the Fed are pretty optimistic that a recovery is ready to take place. However, Economist Thomas Palley argues that the massive deleveraging by consumers and government will soon lead to a double-dip recession which could possibly spiral into the Great Depression II. See the following post from Economist's View to learn more.

Let's hope Thomas Palley, who says "a second Great Depression remains a real possibility," is wrong. My best guess is that he is (though I don't expect a quick recovery, particularly for labor). But I suppose I "should never underestimate the destructive power of bad ideas":

A second Great Depression is still possible, by Thomas Palley, Commentary, Economists' Forum: Over the past year the global economy has experienced a massive contraction, the deepest since the Great Depression of the 1930s. But this spring, economists started talking of “green shoots” of recovery and that optimistic assessment quickly spread to Wall Street. More recently, on the anniversary of the Lehman Brothers crash, Ben Bernanke, Federal Reserve chairman, officially blessed this consensus by declaring the recession is “very likely over”.

The future is fundamentally uncertain, which always makes prediction a rash enterprise. That said there is a good chance the new consensus is wrong. Instead, there are solid grounds for believing the US economy will experience a second dip followed by extended stagnation that will qualify as the second Great Depression. ...

There is a simple logic to why the economy will experience a second dip. That logic rests on the economics of deleveraging which inevitably produces a two-step correction. The first step has been worked through, and it triggered a financial crisis that caused the worst recession since the Great Depression. The second step has only just begun.

Deleveraging can be understood through a metaphor in which a car symbolises the economy. Borrowing is like stepping on the gas and accelerates economic activity. When borrowing stops, the foot comes off the pedal and the car slows down. ...

With deleveraging, households increase saving and re-pay debt. This is the second step and it is like stepping on the brake, which causes the economy to slow further, in a motion akin to a double dip. Rapid deleveraging, as is happening now, is the equivalent of hitting the brakes hard. ...

The US economy has hit a debt iceberg. The resulting gash threatens to flood the economy’s stabilising mechanisms, which the economist Hyman Minsky termed “thwarting institutions”.

Unemployment insurance is not up to the scale of the problem and is expiring for many workers. That promises to further reduce spending and aggravate the foreclosure problem.

States are bound by balanced budget requirements and they are cutting spending and jobs. Consequently, the public sector is joining the private sector in contraction.

The destruction of household wealth means many households have near-zero or even negative net worth. That increases pressure to save and blocks access to borrowing that might jump-start a recovery. Moreover, both the household and business sector face extensive bankruptcies that amplify the downward multiplier shock and also limit future economic activity by destroying credit histories and access to credit.

Lastly, the US continues to bleed through the triple hemorrhage of the trade deficit that drains spending via imports, off-shoring of jobs, and off-shoring of new investment. This hemorrhage was evident in the cash-for-clunkers program in which eight of the top ten vehicles sold had foreign brands. Consequently, even enormous fiscal stimulus will be of diminished effect.

The financial crisis created an adverse feedback loop in financial markets. Unparalleled deleveraging and the multiplier process have created an adverse feedback loop in the real economy. That is a loop which is far harder to reverse, which is why a second Great Depression remains a real possibility.

This post has been republished from Mark Thoma's blog, Economist's View.

Riding The Gold Bull To Profit

Moses Kim of Expected Returns lays out a solid case for why gold will continue to appreciate to new highs in the future. One compelling reason is the growing debt that can only be repaid by printing more dollars, a recipe for disaster if you know about the history of fiat currencies. See the following post for more on this.

My projections for gold have remained the same throughout this whole bull market: $2,000, $3,000, and then $5,000. Skeptical? Think gold is "expensive"? Good. I'll keep on buying on every single dip.

I have already given a fairly comprehensive explanation of why I think gold will go to at least $2,000 an ounce. Our monetary system virtually guarantees that gold will appreciate against the dollar. Dollars are debt instruments whose interest can only be repaid through the creation of even more dollars. Every single dollar that enters the system debases currently existing dollars. Imagine an inverted pyramid scheme that must collapse. Don't understand this process? Good, I'll keep buying gold.

Do you think the Fed will let asset prices fall? Cash for clunkers + stimulus + bailouts + first time homebuyer tax credits = dollar debasement. Do you think politicians will risk reelection by restructuring Social Security, and thereby anger the single largest voting bloc- the Baby Boomers? Fat chance. Therefore, the unfunded liabilities of our government will be funded through the printing press.

Gold in inflation adjusted dollars is still trading well below its all-time highs. Sure gold is $200 more expensive than its nominal all-time high seen in 1980. But what has happened to health care prices during that timespan? What about higher education costs? What about real estate and stock prices? Thinking in purely nominal terms means you are thinking at a 3rd grade level.

What is a fiat currency? Fiat currency is money that derives its value purely from government fiat. There is no intrinsic value in fiat currencies. Now, if you study history, you know that fiat currencies have a 100% failure rate. Why? Governments from the beginning of time have funded their profligate spending and wars through debasement of their currency. Look at what our government is doing now. There is nothing materially different from what our government is doing and what Roman, Greek, and Chinese governments in the past did to hyperinflate their currencies. Believe this time will be different? Good, I'll take the other side of the bet and buy gold with both hands.

I could go on for pages, but people who don't want to believe are never going to believe. $2,000 gold is coming. The masses will not jump on board this clear bull market until then.

This post has been republished from Moses Kim's blog Expected Returns.

Leaked Document Shows Fed Preparing For Next Mortgage Crisis

The rising defaults on commercial loans could lead to another banking crisis, although the Fed doesn't seem to be ready to admit the problem. The significant risk is held by financial companies with large commercial loan portfolios and insufficient reserves. In the following post, Glenn Hall from The Street writes that the Fed should be dealing more openly with the threat.

Here we go again with all the regulatory silence and wishful thinking by banks that preceded the first mortgage meltdown. Meltdown part II could be in the making as defaults rise in the commercial real estate sector.

Behind closed doors, U.S. banking regulators appear to be "girding for a rerun" of the mortgage losses that nearly crippled the financial markets last year, according to a report in the Wall Street Journal citing an unpublished Federal Reserve report.

The Fed report concludes that U.S. banks are slow to take losses on their commercial real estate loans , the Journal reports, adding that the documents it obtained do not represent the Fed's formal position. The point is ratified by a review of regulatory filings by the Journal, which found that banks with heavy exposure to commercial property loans set aside only 38 cents in reserves for every $1 in bad loans in the second quarter.

I don't know what's worse, the banks skimping on reserves and holding off on reporting losses in hope of a revival or the Fed for knowing about the problem and trying to keep it a secret. Someone at the Fed must feel the same way because the report somehow found its way to the media.

To illustrate the risk, Capmark Financial is singled out by the Journal as having only 11 cents in reserves for every $1 in bad loans in the second quarter. Capmark, you may recall, was previously part of General Motors' GMAC lending arm before being taken over by an investor group that includes Kohlberg Kravis Roberts and Goldman Sachs (GS Quote).

Last month, Capmark acknowledged that it is teetering on bankruptcy and accepted a rescue deal from a group led by Warren Buffett. Capmark is a pretty good a barometer of the commercial property mortgage industry since it is among the top servicers of U.S. commercial real estate loans and the biggest for property in the rest of the world, according to the Mortgage Bankers Association.

The top servicer of commercial mortgages in the U.S. is Wells Fargo (WFC Quote), which was already in the top 5 before buying Wachovia, which is the biggest master and primary servicer of commercial bank and savings institution loans, according to the MBA. Wachovia also ranks at the top for warehouse facility mortgages.

GEMSA is the top credit company, pension funds, REITs, and investment funds servicer, PNC (PNC Quote) is the leading FHA and Ginnie Mae servicer and Capmark is first for other investor type loans, according to the MBA..

If you're concerned about international exposure to commercial property loans, the leaders are Hatfield Philips, Deutsche Bank (DB Quote) and GEMSA, according to the MBA.

And those are just the servicers. Banks and thrifts hold roughly half of outstanding commercial property loans, representing $1.6 trillion of debt, according to Commercial Property Executive, which concluded that the highest default risk is for loans originated in 2006-2007 boom , when "commercial properties were valued far too highly in those days, and are now underwater."

In case you're wondering whether the commercial real estate sector is really at risk, consider that defaults on loans to the sector rose to 2.88% in the third quarter from 2.25% in the second quarter, which was already the highest level since 1994, according to an analysis of FDIC data by Real Estate Econometrics.

Real Estate Econometrics projects that the default rate will swell to 4.2% by the end of this year and peak in 2011 and the group warns that the largest losses will occur at regional and community banks.

All things considered, it seems like something the Fed should be talking about more openly and that banks should be addressing more quickly.

Nobody wants a rerun of the mortgage meltdown.

This post has been republished from The Street.

Global Trade Decline Worse Than Great Depression

According to Princeton economist Paul Krugman, global trade has fallen greater than during the Great Depression suggesting that the world economies are more intertwined than ever before. With consumer spending down, exports down, and government spending unsustainable, it may fall on business investment to grow the economy (using the Mundell-Fleming model Y = C + I + G + NX ). See the following post from Economist's View for more on this.

Paul Krugman notes the collapse

in world trade:

Paul Krugman: In Trade, ‘It’s Not the Great Depression — It’s Worse’, Real Time Economics: ...Paul Krugman .... offered a few comments about ... world trade. And the picture he painted was not a pretty one.

“When it comes to international trade, actually it’s not the Great Depression, it’s worse,” he said, presenting charts showing the decline in global trade activity falling much more steeply in the current downturn than during the Depression.

“The scale of the collapse of world trade has been so large that it has produced a degree of international linkage that surpasses what even the pessimists imagined,” he said. “World trade acted as a transmission mechanism,” spreading economic distress “even to those countries that had relatively healthy financial systems,” such as Germany.

“We really are one world economy in a way that has never been true before,” he said.

Despite the collapse in trade, Krugman downplayed concerns about protectionism. ...

Felix Salmon adds that:

[Krugman] also had a good line about economic forecasters, who have us returning to full employment in about five years just because all forecasts tend to bake in a return to “normal” in five years. Krugman’s more pessimistic than that, however: “We almost certainly have a long, long haul before we’re fully recovered,” he said. A good part of the reason for that is what has happened to international trade — it “has fallen through the floor in a way that it literally never has before, including in the Great Depression”. And building it back up is going to be very hard indeed.

This goes back to something I should have emphasized in Robert Solow's comments yesterday. Using Y = C + I + G + NX as a reference point, if growth in C falls, as we expect, if G cannot grow much more and if NX cannot take up the slack, also as we expect, then can I grow fast enough to make up the difference? Solow believes:

We have to expect consumer spending to be weak..., not just for six months, but for the next few years. It will not be as strong a driving force as it has been the past several years. Something has to take its place. Government spending can't, since government will have a hard time financing the inevitable deficits and is not in a position to aggressively increase its deficit spending.

We need business investment to support the economy. We have every reason to want to divert our resources toward secure and renewable sources of energy, new materials and environmental improvement. ... I also think it's the job of the federal government to shift incentives, from incentives to consume more to incentives to invest more. Obama ran on this kind of platform, and if he can put some money behind that fundamentally correct view, he might generate something. It's going to take more than that to replace 5 percent of GDP, but that would be a neat place to start.

There must be a way to bring the Republicans on board with plans to increase business investment? Will a focus on "secure and renewable sources of energy, new materials and environmental improvement" spoil whatever cooperation might have existed among Republicans for measures to enhance business investment? In any case, we need to do our best to maintain G, and another round of stimulus measures would help, while we give I the time (and the incentives) it needs to grow robustly.

This post has been republished from Mark Thoma's blog, Economist's View.

Is Deflation Back On The Radar?

According to Bloomberg: "Economists surveyed in the past month expect U.S. consumer prices to fall 0.5 percent this year, the first drop in five decades." In terms of assets like real estate and stocks, your money buys more today than it did a year ago. But instead of worrying about deflation or inflation, Chris Weber explains how you can hedge against both in the following post from Daily Wealth.

One year ago, in the October 1, 2008 issue of the Weber Global Opportunities Report, I used as a title "The Immediate Danger is Deflation."

My view was, to put it briefly, that the world's central banks can try to inflate as much as they can, by creating money and supplying it to banks. But if banks are afraid to lend it out, or are rebuilding their capital base, and if businesses and consumers are afraid to borrow – and rebuilding their own balance sheets, meaning saving more and spending less – then there is not much that central banks can do.

One year later, I am sorry to see no real evidence that things have changed. If anything, consumers are even more afraid to borrow and spend now than they were a year ago. The heightened threat of becoming jobless may have a lot to do with this. Those who borrowed madly in the past are now in a kind of hangover. They are now trying to save more.

The markets themselves are bearing witness to this. If they feared inflation, interest rates would be much higher than they were a year ago. Instead, they are lower. A year ago, the US 10 year T-note yielded almost 4%. Today it yields just 3.17%.

The Commodities Index, CRB, has fallen from 325 to 259 in the same year. Though the Dow Jones has risen sharply since last March, remember that last October 1 it was close to 11,000, not the 9,700 area it is now. London's FTSE is up a bit: from 5,000 to 5,100. But that's just 2%. Japan has fallen from over 11,000 to 9,800.

Nearly every piece of real estate can be purchased for less money today than was the case one year ago. In other words, cash has been king this past year. And that is another way of saying that deflation dangers have still not gone away.

But one area has done better than the rest. Let's turn to precious metals.

One year ago, gold was $860. Now it is $1,042. Silver was $12.30 last September 30. Today it is $17.43.

For my readers who have been with me for years, I know I have been repeating the same mantra for all that time: Have the core of your net worth in a mix of cash and precious metals.

For my new readers, I repeat this, and point out that this approach has saved a lot of money that would otherwise have been lost. Both cash and precious metals buy more than they did one year ago, two years ago, and even farther back. I meant it as a cautious method to conserve money in perilous times, but it has turned out to be pretty much the best approach one could have.

There are those who are absolutely certain that the future will be high and even hyperinflation. There are others equally certain that deflation will be our eventual outcome. To me, it seems like nothing has changed in the 35-plus years I've been in this business. Back when I started out, there were the same arguments, the same certainty on both sides. Only the names of the combatants have changed.

For me, let's just say I'm not smart enough to know what the outcome will be. The only thing on earth that I am absolutely certain of is that I will die; that indeed everyone alive today will one day die. Speaking only for myself, I may die tonight or I may live 50 more years.

Beyond that, I am reasonably certain that history shows that paper money not backed by gold or silver loses value over time. One million dollars 50 years ago was a lot of money. It was even more money 100 years ago. Today, well, it's not chicken feed, but let's say it doesn't buy what it did 50 years ago, or even 20 years ago.

But in terms of assets like stock and property, one million dollars (or euros, etc.) buys more than it did one year ago.

This may just be a temporary development; it may be the start of a new trend. I am not going to bet everything I have on either one or the other. Instead, I've been protecting myself from both. And that's why I have been owning and building cash right along with the precious metals I own.

I have cash in case I am wrong about inflation vaulting the price of gold and silver higher. I have gold and silver in case I am wrong about the value of holding cash. I have tried to protect myself against both inflation and deflation. I own some real estate in case that goes up. It would make sense for me to own some general stocks that would do well if the world economy does well too.

In other words, my watchword has been to protect yourself in case you are wrong: to protect yourself against being hurt by any eventuality. This was my view one year ago, and it remains my view today.

To me, the future is unclear right now. We stand on a kind of knife edge. On one side lies deflation, and on the other inflation. I have tried to hedge myself against both, and yet not be hurt if either happens. The recommended combination of cash and precious metals has not only done well in the past year. It has done well since 2000.

And while I am watching developments every day, I see no reason to change my approach, which has worked so well. Of course, it has worked in the sense that it has given me more money in my net worth than a decade ago. But more important, it has enabled me to sleep well during all that time – a decade which has been very turbulent and disappointing for many if not most. And to me, this gift is priceless.

This post has been republished from Steve Sjuggerud's blog, Daily Wealth.

Jobs Tax Credit Making A Comeback

Unemployment reared its ugly head last month as job losses accelerated, renewing support for a job stimulus. As the fourth quarter begins, we could see many companies looking to reduce costs in order to reach fourth quarter targets. However, the idea of a tax credit for employers is gaining support and might actually work, as the following post from Economist's View explains.

Would a tax credit for businesses that create new jobs be enough to turn the employment picture around?:

Support Builds for Tax Credit to Encourage Hiring, by Catherine Rampell, Ny Times: The idea of a tax credit for companies that create new jobs, something the federal government has not tried since the 1970s, is gaining support among economists and ... has some bipartisan appeal...

One version of the approach, to be unveiled next week by the Economic Policy Institute,... would give employers a two-year tax credit if they increased the size of their work force or added significant hours of work (for example, making a part-time worker full time). ...

“It’s beautiful if it can be timed at a dire moment like this, when unemployment is way too high and appears to be going somewhat higher,” said Mr. Phelps, an economics professor at Columbia, lamenting that the president dropped it from the $787 billion stimulus plan approved in February. “But it’s a pity that this wasn’t done a year ago.” ...

The federal government last tried this measure in 1977-78. During that period, employment — which had been soft from the 1973-75 recession — climbed at a record pace. The creation of one out of three jobs that was awarded the credit then was attributed directly to the policy. But the permanence of those jobs was less clear, and some dispute how many of those positions would have been created eventually anyway. ...

Timothy J. Bartik, a senior economist at the Upjohn Institute for Employment Research who is working on the draft with John H. Bishop of Cornell, estimates that it would cost about $20,000 for each job created. ... The authors estimate their proposal could create more than two million jobs in the first year. ...

An American Economic Review study has suggested that the 1970s policy was responsible for adding about 700,000 of the 2.1 million jobs that were awarded the credit. This may sound modest, but if accurate, economists say it would make this proposal a successful and relatively cheap way of creating jobs.

Advocates argue that such incentives would be more effective this time around not only because of design, but also because of timing. In 1977, hiring was already on the upswing, whereas economists expect today’s job market to decline a bit more and then stagnate for months.

“Now is a better time than ’77 was because we’re closer to the bottom of a recession,” said Daniel S. Hamermesh, an economics professor at the University of Texas, Austin, who helped create the 1970s plan. “This could help an uptick proceed more rapidly.”

But critics of the idea argue that businesses hire based on actual demand for their products, and a minor subsidy for adding an employee will not make up for the collapse in demand across the broader economy. ...

Barack Obama ... proposed a job creation tax credit during his presidential campaign, and then in discussions for the stimulus package. The proposal was eventually killed because of concerns that employers would exploit the tax credit. For example, companies might close and reopen, claiming credit for all their “new” employees.

Even advocates acknowledge that, as with any tax incentive, employers and their accountants will take advantage of loopholes. But they argue that with strong rules ... the proposal could minimize such abuse. ...

It's worth a try, but just because both sides might agree doesn't mean it will be enough on its own to solve the employment problem. To have a chance of doing that, I think a policy like this needs to be combined with demand-side policies that create the need for more workers, the tax credit alone won't be enough. So yes, let's try this, but let's use it in addition to rather than a substitute for additional stimulus measures (which are being called other things for political reasons) that directly increase the demand for workers.

This post has been republished from Mark Thoma's blog, Economist's View.

How Reliable Are Unemployment Figures? Not Very.

Whenever we hear that unemployment is at 9.8%, we should take it with a grain of salt because we do not know how accurate the government's numbers are. According to the following post from Expected Returns, the labor department actually adds an arbitrary number into the calculation to account for new jobs created by newly formed companies that they think have started. See the following post for more on this.

From the New York Post, labor department comes clean about fake jobs:

In 11 of the 12 months, the government adds massive numbers of jobs -- sometimes more than 100,000 -- that it thinks, but can't prove, exist.

This is because the Labor Department uses something called the birth/death model, which assumes that no matter how bad the economy is, there are itty-bitty, newly-formed companies -- which can't be reached by government surveyors -- that are creating jobs.

Not only is the public fooled by this practice, but policymakers are being led astray. So the Labor Department, essentially, lied again when it reported last Friday that only 263,000 jobs disappeared from the economy during September.

For more on the bogus birth/death model, see this post. The birth/death model is one of the government's primary tools of obfuscation. Without questionable birth/death adjustments, we would be seeing unemployment well north of 10%.

Overstatement of Jobs Likely

Right after Friday's report came out, Bloomberg News called Chris Manning, the national benchmark branch chief at the Labor Department's Bureau of Labor Statistics, and asked about the 34,000 probably non-existent jobs.

"In this period of steep job losses, the birth/death model didn't work as well as it usually does," Manning told Bloomberg. "To the extent that there was an overstatement in the birth/death model, that is likely to still be there."

The Labor Department is not only still using this model, but it nearly doubled the number of phantom jobs for this September compared with the same month last year.

We are living in a time when reality is being replaced by propaganda. Anyone who has been laid off knows the real state of the economy and the job market. Month after month, initial jobless projections are revised downward by the government to little fanfare. Instead of properly addressing the unemployment catastrophe through jobs programs, our government is going the route of statistical games to cover up the fact that there is no recovery.

This post has been republished from Moses Kim's blog, Expected Returns.

Are Insurance Exchanges The Answer For Health Care Reform?

A much less hyped idea for health care reform that may have a good shot of passing is that of health insurance exchanges. Individuals could join a pool to purchase insurance as a group to get competitive rates and avoid individual scrutiny for pre-existing conditions. The larger the pool, the greater the potential for economies of scale. For more on this, see the following post from Economist's View that discusses insurance exchanges in detail.

Most of the health care reform proposals being considered by congress include some form of health insurance exchanges. What are they and why are they needed?

...The idea of an insurance exchange is relatively straightforward. If you work for a big company or, say, the federal government, every year you choose from among a set of insurance plans--all of them conforming to some minimal standard, all of them available to you regardless of pre-existing medical condition. They've been chosen by your human resources or benefit department, who--ideally--have some clue about what they're doing, more at least than you do.

If, by contrast, you work on your own or in a small company, then you may have just one choice--or no choice at all. Affordable coverage probably won't be available to you if you have existing medical problems; even if you're healthy, the coverage you get could have major gaps or be otherwise unreliable. It'd be good to know which policies work and which ones don't. But unless you happen to be an actuary or insurance broker yourself, chances are you're clueless when it comes to navigating this complex world.

It's you, the individual or small businessperson trying to buy insurance, for whom the exchanges are being created. They're basically regulated marketplaces, where you get to choose from among insurance plans more or less the same way folks in large companies do. Your premiums should be more affordable, since now you're part of a large bargaining group. You should be able to get coverage regardless of preexisting conditions, since insurers can't pick and choose which exchange customers to cover. And you should have the peace of mind that the coverage is good, since you know it's been screened by the exchange.

Do we have any experience with exchanges?

The concept has been around for a while... And ... one state, Massachusetts, managed to create such an institution three years ago, when--as part of a more comprehensive health reform plan--it started a pair of insurance pools for small businesses and individuals who couldn't get coverage through employers.

The results, so far, are encouraging. People once unable to penetrate the private insurance market because of income or medical condition can now go online and select from a menu of insurance options--all of them covering essential services and providing solid financial protection, for rates not previously available. And although overall medical costs in Massachusetts have continued to rise,... premiums for ... the insurance option that the exchange manages most closely ... have risen at a far slower rate.

There are both weak and strong forms of exchanges:

The strong version is national, or at least regional. It's open to everyone: The unemployed, the self-employed and any business, no matter the size, that wants to buy in. There's risk adjustment to reduce the incentive for cherry-picking. The huge pool of users gives the exchange tremendous advantages in scale, simplicity and standardization (experts say that you need at least 20 million to fully achieve these benefits -- easy in a national exchange but harder in a regional or state-based one). With so many potential customers, insurers are eager to participate, and they will bid aggressively to ensure they're included in the market and compete aggressively to make sure they're successful within it. Over time, the combination of increased efficiencies and greater competition drive down costs, which will lead more employers to use the exchange, which will in turn give it more scale and bargaining power. You could easily see this exchange slowly emerge as the de facto American health-care system. And not through government fiat. Through consumer choice.

The weak version is state-based. It's open to only the unemployed, the self-employed and small businesses. Risk adjustment, if it exists at all, is crude. With such a limited pool of applicants, insurers aren't driven to compete, and the efficiencies of scale and competition are minimal. It never really grows, and instead exists as a marginal policy to mop up those who aren't covered by employers. Sort of an outlet shopping model for health-care, accessible only to the few able to get there.

Which version are we likely to get?

The bills moving through Congress all set up exchanges modeled more or less on what Massachusetts has done. But there are a few critical differences ... in how the exchanges would select which plans to offer...

In the bills that passed three House committees and the Senate Health, Education, Labor, and Pensions (HELP) Committee, the exchange would be a "prudent purchaser." In other words, it would have a staff that bargained with insurers to bring down premiums--and that made sure all plans lived up to strict guidelines for coverage and customer service. In effect, any insurer that wants to offer coverage through the exchanges has to get the equivalent of a "Good Housekeeping Seal of Approval" from the administrators. This is precisely how it works in Massachusetts.

By contrast, the Senate Finance bill envisions much weaker exchanges. Instead of choosing which plans to make available, the exchange administrators would, by law, have to accept any plan that meets a relatively minimal set of standards.

Jon Kingsdale, who runs the Massachusetts exchange, calls that a recipe for "policy disaster," as consumers faced a dizzying array of more expensive, less regulated choices. "It would be like telling your grocery store they have to offer every single kind of bread baked by every single bakery. ... The exchanges would be nothing more than an automated Yellow Pages." ...

Massachusetts senator, Kerry,... proposed to fix it by giving the exchanges the same powers envisioned in the House and HELP bills. But when Kerry introduced his plan last week, he couldn't get the votes to pass it. The reason, several sources on Capitol Hill say, was opposition from Olympia Snowe, the Maine Republican... Snowe seems to be concerned that a more aggressive exchange would amount to more government--which, in fact, it would be. But, as Massachusetts has shown, sometimes more government is exactly what health care needs.

Here's a bit more:

...Congress must also decide whether the exchanges would have any authority to decide which plans are offered and at what price, said Paul Fronstin, a policy analyst with the Employee Benefit Research Institute... “The exchange can have a more active role if it negotiate rates,” he said, “but it is not clear what is going to happen.”

In Massachusetts, for example, the state’s exchange, called the Connector, negotiates directly with the state’s private insurance companies in offering a small number of state-subsidized plans — similar to what an employer does when it screens the policies offered to its work force. ...

Jon Kingsdale, the executive director of the Commonwealth Health Insurance Connector Authority ... said the agency’s ability to negotiate on behalf of 180,000 customers who required state subsidies was a reason it achieved a 6 percent reduction in the cost of premiums this year.

But the Connector would be less effective if it had no say over which plans were offered on the exchange, said Mr. Kingsdale, who criticized the Senate Finance committee’s proposal, for example, as potentially creating little more than “an automated yellow pages.”

Because formulating an effective exchange is so difficult, some policy analysts are still arguing that only a new government-run competitor could create a powerful enough force in many parts of the country to offset the home-court advantage many insurers already wield. ...

And finally:

Chances are reasonably good that Kerry's vision of reform will prevail... But it's not a sure thing, which is why this seemingly narrow question deserves a lot more attention. Exchange design doesn't get the attention of controversies like the public option, abortion, or supposed death panels. In the long run, though, it could be far more decisive in whether reform works.

What is the bottom line to all of this? If exchanges are the way we are going to go, then how they are designed is essential. If we let lobbyists and misguided fears about government intervention stop us from giving the exchanges the breadth and authority they need, then they won't be effective.

This post has been republished from Mark Thoma's blog, Economist's View.

Unemployment In Much Worse Than It Looks

While the 9.8% unemployment number looks bad, if you consider those who are underemployed or those unable to work a full 40 hours, the labor picture looks much more frightening. John Lounsbury argues in the following article from The Street, that a more accurate picture of unemployment would take into account the additional variations of unemployment.

The latest employment report from the U.S. Department of Labor shows further degradation of the employment picture. Here's the short list of bad news items:

* The civilian labor force declined by a whopping 571,000 to September from August.
* Employment declined even more, by 785,000.
* Unemployment increased by 214,000.
* Total nonfarm payroll jobs lost increased by 62,000 to 263,000.
* The number of people of employment age not in the labor force increased by 807,000.
* The official unemployment rate, or U-3, increased to 9.8% from 9.7%.
* The average private work week declined to tie a record low of 33 hours in September, equaling June.

Are there any exceptions to the bad news? Here are a couple of positives:

* Average weekly earnings were essentially unchanged to September from August and up slightly (up 0.5%) from the average for May, June and July.
* Total nonfarm payrolls declined by only 37,000 from the July level and 60,000 from the average for May, June and July -- a second derivative improvement.

Shrinking Labor Force

Just two weeks ago, I reviewed the shrinking labor force in an article for TheStreet.com. The size of the problem has doubled the recent previous decline, with a September loss in the civilian labor force of more than half a million. This is an historic decline, reflected in the following graph, with more than 1 million people disappearing from the labor force in just four months.
Civilian Labor Force Change (Y-over-Y)


Source: U.S. Dept. of Labor
Alternative Measurements of Unemployment

I proposed that employment and unemployment should be measured against full-time employment being a 40-hour work week. Thus, if someone is working 32 hours a week, he should be counted as 80% employed; a 20-hour week would constitute 50% employment. An exception in this methodology is that anyone working part-time by choice will be counted as one employed person. The Labor Department counts all of these as one employed person, which overstates the size of the employment market.

The Labor Department reports several measurements of unemployment, the most common being the U-3 metric. Many also look at the so-called "underemployment" number, or U-6, which attempts to include some of the discouraged without work who aren't currently counted in the labor force, as well as some effects of part-time employment. The unemployment number I proposed corresponding to U-3 has been labeled U-7, and corresponding to U-6 has been called U-9. These numbers are summarized in the following table.

The serious degradation in employment is emphasized by the more rapid unemployment increases in the measurements based on a 40-hour week (U-7 and U-9) compared with Labor's "body count" measurements (U-3 and U-6).

Alarming News
Stock and bond market action following the announcement of the monthly employment data indicated a rather sanguine reaction from investors. Stocks closed fractionally lower, while bonds sold off marginally. These historically large negative developments in the labor market are apparently just not that big a deal for investors.

For my part, this is alarming news and strengthens my conviction that the rally from March 9 is over. Only a reversal of the contractions in the number of people employed and those that are available for work -- the labor force -- can provide a basis for economic improvement. These things are needed for an increase in consumption, a bottom in the housing market and to avoid further corporate cost-cutting. Reducing costs is primarily management-speak for cutting employment. This is a self-reinforcing spiral that must be broken.

This post has been republished from The Street, an investment news and analysis site.

Finding Shelter From Unrestrained Money Printing

There is an outcry of investors who worry about the consequences of unimpeded printing of dollars, as it increases the danger of hyperinflation. Can our unbacked fiat money system survive the aggressive monetary policies of the central bank? If the history of fiat money is any indication, gold investment is as attractive as ever. For more on this, see the following post from The Prudent Investor.

Neither CNBC, the Bull Street Journal or the Debt Times have covered the latest earth-shaking news reported in the new media concerning gold price suppression by governments and central banks. Let me first send respectful hat tips to Zerohedge, EconomicPolicyJournal.com and GATA who all came out in the last 2 weeks with official documents that prove that especially the USA has a most vital interest to keep the price of gold as low as possible. Please check out all three sources to find links to countless official declassified documents that deal with the hot issue of gold manipulation.

Looking at the 10-year chart shows that all multi-billion operations by central banks in the gold market have led to nothing else than the current near-to-record prices although these institutions can short gold unlimited via futures markets.

The fear of a gold price that would correctly mirror the uncountable money printing excesses which show us that central banks are no more than one-trick-ponies. Take away their privateering privileges of creating money out of thin air and it becomes understandable that tireless Congressman Ron Paul wants nothing less than abolishing the Fed.

While Ron Paul has still many hurdles in front of him he at least nurses a strongly growing community supporting him.

Happy USA - it has at least a few million citizens who understand the biggest ponzi scheme in history, AKA Federal Reserve Notes (FRN) created by the trillions nowadays, and who begin to fight this scheme that led to the impoverishment of every generation in the last 3 centuries.

The Situation in Europe is Sad at Best
The situation in Europe is sad at best. I presume that the number of Europeans understanding the diabolic actions of central banks which always ended in hyperinflation would not fill more than a small town concert hall.

While Fed Chairman Ben Bernanke encounters a more and more aggressive environment on his trips to Congress and Senate, ECB President Jean-Claude Trichet can still get away with such blatant disinformation in the European Parliament (EP) like the following 5 bullet points presented to EU politicians on September 28:

1. First, we have fully accommodated banks’ liquidity needs at fixed interest rates.
2. Second, we have further expanded the list of assets eligible as collateral.
3. Third, we have further lengthened the maturities of our refinancing operations.
4. Fourth, we have provided liquidity in foreign currencies, notably the US dollar, to address the need of euro area banks to fund their dollar assets.
5. Fifth, and finally, we have launched a direct covered bonds purchase programme to support financial markets.

You don't have to be an expert to get angry on the nonsense Trichet tells a generally disinterested EP with no second-guessing of his elaborate speeches that hide the simple process of creating unbacked fiat money by the shipload below a couple of technical terms that work like Quaalude on the EP members.

Trusting that my readership knows about the undeniable fact that so far all experiments with unbacked money ended in hyperinflation I nevertheless want to point out that the abolition of metal standards - gold and/or silver - had at least one positive fact: All kingdoms and empires collapsed, beginning with the revolution in France in 1789 that became the first democratic republic and set a precedent for the rest of the world. Monarchic rulers have only survived on a representative level and they are certainly a proper looking circle for ribbon-cutting ceremonies of all kinds.

Allow me to point you again to the 3 sources in the first paragraph of this post (and save me from uploading PDFs when they can be found there easily) that show us that the real power has moved from policymakers to central banks since the USA abandoned the gold standard in 1971 under a pardoned criminal by the name of Richard Nixon.

The gold standard is most uncomfortable for politicians as it would limit their spending. After almost 4 decades where the public was talked out of gold with the main argument that gold is the relic of a past of un-sophisticated finance, gold is stronger than ever.

Gold has Never Lost its Value in 6,000 Years
Gold has never lost its value as all fiat currencies did and it is the last measure we have to calculate real inflation. If you were told that a bag of potatoes cost 3 guilders or 6 florins or 1 mark some decades ago you would not be able to get down to the real price. But if you are parsing historical price statistics and you find out that one troy ounce bought you 100 bags of potatoes it becomes pretty easy to compare it with current prices.

But this probably the last thing those in charge of the financial world want. Inflation can fool people for a long time as every history of a fiat currency begins with the soothing effect that everybody feels richer.

But there is also another undisputed pattern in the history of unbacked money. The trust about its purchasing power took always only a few months, e.g. Germany's hyperinflation, that collapsed in less than 2 years and set the ground for the rise of Adolf Hitler which then led to the demolition of Europe.

In my opinion it is astonishing that in the presently running ruination of the Western world because of unbacked paper money any discussion dogmatically avoids a return to metal backed money. While China's central bank governor favored a commodity based currency last March in a most interesting article I cannot agree to use a commodity basket as backing for a new international monetary system. All commodities are too volatile and can be manipulated in many ways. Just imagine Russia/China/India announcing that their grain stocks have been erased because of bacterial contamination.

There is only one solution to arrive at a stable monetary system: The paper money must be backed by gold and/or silver as they are a value in itself. This worked well for 5,700 years. It would be better for the world to return to this old fashion instead of wasting more time discussing how to repair the monetary system with the same built in weaknesses that have disowned every generation since 1720.

This post has been republished from Toni Straka's blog The Prudent Investor.

Investors Should Run From The US Dollar

The risk of inflation taking a bite out of your portfolio can be averted by diversifying your dollars into other currencies or gold. David Galland from Casey Research discusses why it can be dangerous to have all your eggs in the dollar basket, and what currencies have the best fundamentals. See the following post from Daily Wealth for more.

Last month, I faced a difficult question: "What are the best foreign currencies we can park cash in?"

At Casey Research, we strongly believe no foreign currency is worth much more than the intrinsic value of the paper it's printed on.

Most governments have followed the lead of the U.S. when it abandoned the gold standard. All of these governments like the flexibility of being able to print money freely and use inflation as a hidden tax on their citizens.

Even conservative Switzerland has progressively uncoupled its currency from the gold that used to back it up (up until 2000, the Swiss central bank had a legal requirement to hold gold reserves equal to 40% of its currency).

That said, in a world where one needs to have access to cash quickly, it makes sense to park one's cash in a basket of currencies as opposed to having it all in U.S. dollars.

While one may speculate on specific currencies, it is very important to remember that short-term volatility is all but impossible to predict.

In the short run, exchange rates are more likely to be affected by government policies than by fundamentals. To anticipate these is a fool's game we would not want to play. And in the long term, the only form of money we want to hold is gold (and silver).

Our recommendation for those who want to diversify their cash holdings is to park a higher percentage of their cash in currencies that have stronger fundamentals than the U.S. dollar, the British pound, or the euro.

We generally like the Canadian dollar and the Australian dollar, as both countries have had relatively more conservative monetary policies than the U.S., the EU, or the UK.

In addition, their economies are strongly dependent on natural resources, which we see as the best hedge against inflation. Canada, for instance, is the United States' largest foreign oil supplier. Australia is full of gold, copper, uranium, and natural gas... all of it easily transportable to China. Over the coming years, these "commodity currencies" will hold up much better than the dollar. So consider these when looking for a dollar alternative.

Another choice would be the Swiss franc, as that country is still conservative and still apparently committed to hold 20% of the value of its paper currency in gold. Over the past three decades, the Swiss franc has held more of its value than most other major currencies in the world; no future guarantees, but a good track record.

Another prudent strategy could be to hedge against short-term volatility and to build a portfolio of currencies that would spread across all major denominations.

The million-dollar question is "Where can I park my cash?" The answer is, "Park it in several different places."

Make sure to keep a good portion of your savings in gold and silver. How much you hold really depends on who you are and what your tolerance for risk is. At this point, almost everybody should have 15% of their money in gold, up to as much as 30%. Importantly, don't chase the price. Inflation won't make itself known for some time, but there will be a lot of volatility in the financial markets, periodically pushing gold back. So, buy on the dips. But buy.

And consider getting diversified into the currencies listed above.

Those are the strategies we recommend. For tactics, Casey Research has found an easy way to park our money in a broad basket of foreign currencies – while retaining maximum flexibility and minimizing transaction costs – is to open World Currency Deposit Accounts or CDs such as those offered by our friends at EverBank.* It's the easiest, most hassle-free way to take the steps I've just outlined.

This post has been republished from Steve Sjuggerud's blog, Daily Wealth.

* David Galland was a founder and former partner of EverBank and still owns an inconsequential amount of stock in the company.

Do We Need Another Stimulus?

The technical end of the recession may have arrived, but there is still a lot of healing that has to take place before we should proclaim an end to the economic crisis. The loss of economic productivity from 2010-2013 could add up to trillions of dollars, which is one reason Paul Krugman argues that we can't afford to not have another stimulus. See the following from Economist's View for more.

If we don't do more to promote recovery, the human and economic costs will be large:

Mission Not Accomplished, by Paul Krugman, Commentary, NY Times: Stocks are up. Ben Bernanke says that the recession is over. And I sense a growing willingness among movers and shakers to declare “Mission Accomplished” when it comes to fighting the slump. It’s time, I keep hearing, to shift our focus from economic stimulus to the budget deficit.

No, it isn’t. ... Yes, the Federal Reserve and the Obama administration have pulled us “back from the brink” — the title of a new paper by Christina Romer, who ... argues convincingly that expansionary policy saved us from a possible replay of the Great Depression.

But while not having another depression is a good thing, all indications are that unless the government does much more than is currently planned..., the job market ... will remain terrible for years to come. Indeed, the administration’s own economic projection ... is that the unemployment rate ... will average 9.8 percent in 2010, 8.6 percent in 2011, and 7.7 percent in 2012.

This should not be considered an acceptable outlook. For one thing, it implies an enormous amount of suffering over the next few years. ... John Irons of the Economic Policy Institute ... points out that sustained unemployment on the scale now being predicted would lead to a huge rise in child poverty — and that there’s overwhelming evidence that children who grow up in poverty are alarmingly likely to lead blighted lives.

These human costs should be our main concern, but the dollars and cents implications are also dire. Projections by the Congressional Budget Office, for example, imply that over the period from 2010 to 2013 — that is, not counting the losses we’ve already suffered — the ... difference between the amount the economy could have produced and the amount it actually produces, will be more than $2 trillion. That’s trillions of dollars of productive potential going to waste.

Wait. It gets worse. 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 same report, however, suggests that ... a temporary increase in government spending — “is significantly associated with smaller medium-term output losses.”

So we should be doing much more than we are to promote economic recovery, not just because it would reduce our current pain, but also because it would improve our long-run prospects.

But can we afford to do more...? Yes, we can.

The conventional wisdom is that trying to help the economy now produces short-term gain at the expense of long-term pain. But as I’ve just pointed out,... that’s not at all how it works. The slump is doing long-term damage to our economy and society, and mitigating that slump will lead to a better future.

What is true is that spending more on recovery ... would worsen the government’s own fiscal position. But even there, conventional wisdom greatly overstates the case. The true fiscal costs of supporting the economy are surprisingly small.

You see, spending money now means a stronger economy, both in the short run and in the long run. And a stronger economy means more revenues... Back-of-the-envelope calculations suggest that the offset falls short of 100 percent, so that fiscal stimulus isn’t a complete free lunch. But it costs far less than you’d think from listening to what passes for informed discussion.

Look, I know more stimulus is a hard sell politically. But it’s urgently needed. The question shouldn’t be whether we can afford to do more to promote recovery. It should be whether we can afford not to. And the answer is no.

This post has been republished from Mark Thoma's blog, Economist's View.

Why We Need More Government Debt

Robert Reich argues that government could be spending more to put Americans back to work to recharge the economy, even if that means digging a deeper national debt. He explains that we shouldn't worry about the debt when 1 in 6 Americans are unemployed or underemployed because the lack of jobs could prolong the downturn for years. See the following for more on this.

Robert Reich joins the call for the government to do more to promote recovery:

The Truth About Jobs That No One Wants To Tell You, by Robert Reich: Unemployment will almost certainly in double-digits next year -- and may remain there for some time. And for every person who shows up as unemployed in the Bureau of Labor Statistics' household survey, you can bet there's another either too discouraged to look for work or working part time who'd rather have a full-time job or else taking home less pay than before... And there's yet another person who's more fearful that he or she will be next to lose a job.

In other words, ten percent unemployment really means twenty percent underemployment or anxious employment. All of which translates directly into late payments on mortgages, credit cards, auto and student loans, and loss of health insurance. It also means sleeplessness for tens of millions of Americans. And, of course, fewer purchases...

Which brings us to the obvious question: Who’s going to buy the stuff we make or the services we provide, and therefore bring jobs back? There’s only one buyer left: The government.

Let me say this as clearly and forcefully as I can: The federal government should be spending even more than it already is on roads and bridges and schools and parks and everything else we need. It should make up for cutbacks at the state level, and then some. This is the only way to put Americans back to work. We did it during the Depression. It was called the WPA.

Yes, I know. Our government is already deep in debt. But let me tell you something: When one out of six Americans is unemployed or underemployed, this is no time to worry about the debt.

When I was a small boy my father told me that I and my kids and my grand-kids would be paying down the debt created by Franklin D. Roosevelt during the Depression and World War II. ... My father was right about a lot of things, but he was wrong about this. America paid down FDR’s debt in the 1950s, when Americans went back to work, when the economy was growing again... We paid taxes, and in a few years that FDR debt had shrunk to almost nothing.

You see? The most important thing right now is getting the jobs back, and getting the economy growing again.

People who now obsess about government debt have it backwards. The problem isn’t the debt. The problem is just the opposite. It’s that at a time like this, when consumers and businesses and exports can’t do it, government has to spend more to get Americans back to work and recharge the economy. Then – after people are working and the economy is growing – we can pay down that debt.

But if government doesn’t spend more right now and get Americans back to work, we could be out of work for years. And the debt will be with us even longer. And politics could get much uglier.

This post has been republished from Mark Thoma's blog, Economist's View.

Expect Several More Months Of Job Losses

The unemployment market will be a economic headwind as job losses are expected to continue for several more months according to Joel Prakken, chairman of Macroeconomic Advisers. The worst episode of job destruction since the Great Depression will require a massive cleanup before the economy can reach full speed again. See the following post from Capital Spectator.

It's all about employment now. More of it would be better, although we may have to settle for losing it a slower pace for a bit longer.

The U.S. Labor Department will dispatch the official update for September nonfarm payrolls on Friday. Meantime, dismal scientists, pundits and fans of macabre labor stats are making estimates and crunching the numbers on hand.

Wanted Technologies, an employment analytics firm, expects that nonfarm payrolls will fade by 167,000 in September. If so, that would be an improvement over August's loss of 216,000 jobs, albeit a relative improvement.

Absolute improvement, unfortunately, doesn't look imminent. The ADP employment report released this morning advises that the employment rolls shed 254,000 in September. That's better than the 277,000 loss in August, as per ADP, but we're still stuck in the land of relative progress and the odds of returning to Kansas quickly still look slim.

Julia Coronado, senior U.S. economist at BNP Paribas in New York, states the obvious when she tells Bloomberg News that “the state of the labor market is still very weak” and job destruction is “weighing on wages and income,” which remains a "headwind to growth.”

Joel Prakken, chairman of Macroeconomic Advisers, says bluntly that the crowd should be prepared for more losses for the foreseeable future. Although the rate of loss has been diminishing, "employment, which usually trails overall economic activity, is likely to decline for at least several more months, with losses continuing to diminish," he says via MarketWatch.com.

If September's payrolls give ground once more, as seems likely, that'll mark the 21st consecutive month of job destruction for the U.S.—a record string of retreats since the Great Depression. The pain will end soon, but not yet. Then comes cleaning up the mess.

As we've been discussing for some time, the real challenge still awaits. Ending the job loss is critical, of course, but pulling the labor market out of its hole by way of net employment growth on a national basis is a much bigger hurdle. Alas, as Friday's numbers are likely to show, that all-important task is still premature in terms of topical issues du jour.

This post has been republished from James Picerno's blog, The Capital Spectator.

Did The Lehman Failure Really Matter?

Economist Mark Thoma discusses whether Lehman's failure significantly worsened the economic condition at the time. While some would argue that it would have been better to have let the troubled financial institutions fail, they often have trouble supporting this claim with data, as the following from Economist's View explains.

There's a lot of revisionism going on over the consequences of the Lehman's collapse. The standard view is that allowing Lehman to fail was a mistake, and hence government intervention could have lessened the severity of the crisis. Government intervention wouldn't have avoided problems altogether, but the problems wouldn't have been as bad as what we experienced.

However, a few people are now pushing the idea that the failure of Lehman wasn't a primary contributor to the problems that financial markets and the economy experienced. According to the revisionist view, government intervention would not have made any difference, the problems would have been just as bad either way. The notion that government intervention would not have helped is, of course, the main point that this group wishes to emphasize. However, the revisionist view does not hold up to closer examination:

Why the Lehman failure did change everything, by Richard Robb, Economists' Forum: For anyone who was engaged in the financial markets during the week of September 15, 2008, Lehman changed everything. It was obvious. So what could be more tempting to finance professors than to overturn this conventional wisdom? Descartes described the man of letters who takes more pride in his speculations “the more they are removed from common sense,” and so showing that the Lehman collapse was inconsequential has spawned a minor literature.

The latest contribution by John Cochrane and Luigi Zingales, like others before them, rests partly on misunderstanding of the data. The authors deduce that Lehman wasn’t the main cause of last autumn’s turmoil by inspecting the daily movements in the spread between Overnight Interest Rate Swaps and three-month Libor, which they define as “the rate at which banks can borrow unsecured for three months.”

But a better definition of Libor under the circumstances was “the rate at which banks said they can borrow”. Libor is the result of a survey, not a measure of actual transactions. In the week of September 15 last year, big banks refused to settle foreign exchange with each other. They were not lending interbank for three month terms, so Libor during that week tells us little.

We could say the same thing for OIS. Volume was light to nonexistent in the week of September 15 last year. What we do know is that three-month T-bills traded at 0.04 per cent on September 17, down from 1.47 per cent on Friday September 12. These are real data that ought to impress the professors that the market was breaking down as fast as it knows how.

John Taylor, the father of the Lehman-was-no-big-deal thesis, wrote in a Wall Street Journal op-ed last year that spreads between T-bills and Libor “remained in that range [of the previous year] through the rest of the week” after Lehman’s demise. In fact, in the year prior to Lehman’s collapse, the peak spread was 2.05 per cent; on September 17, 2009 it reached 3.00 per cent. (Of course, any conclusions based on Libor that week are equally unreliable.)

The other principal mistake of the Lehman deniers is their assumption that the incident unfolded entirely on September 15, 2008 and any effect had to be observable by that morning. But during the final two weeks of September, the market still had to absorb the news that the Securities and Exchange Commission had no plan for an orderly transfer of client assets in the US, while Lehman Brothers International Europe would be handed over to an administration process designed for liquidating grocery stores. ...

There is plenty of room to debate the larger counterfactual: if the government had never bailed out Bear Stearns and other too-big-to-fail firms that followed, would Lehman have mattered? If the government had never bailed out anyone at all, would we be better off? But given the bailouts that preceded the Lehman failure, the Lehman failure did in fact change everything. Sometimes things that are obvious turn out to be true.

This post has been republished from Mark Thoma's blog, Economist's View.