Marching Towards Another Depression

A fascinating article at New Deal 2.0 details the steps we are taking towards a likely second Great Depression. At a time when economies are teetering on the edge of recovery and a second recession, governments are starting to make noises, particularly in Europe, about reducing deficits as a model for responsible financial health. Unfortunately, this is the exact opposite response governments should be taking as reducing a governmental deficit will naturally result in deflationary pressures on the private sector because the two are necessarily related.

Governments have two main ways to reduce deficits, increase taxes and reduce spending, both of which are deflationary. Doing either at a time when unemployment runs at 10% in most First world countries would result in huge burdens on the private sector. Governments are currently running large deficits because we just came out of one of the worst recessions the world has ever seen. Unfortunately, the bigger problem is that a huge portion of the government spending during those recessions actually resulted not in job creation but in an amazingly brazen transfer of wealth from the middle class to the wealthy through paying bondholders at par value and keeping the oligarchs in the big banks solvent.

Bailing out the banks instead of the common people was a monstrous mistake but not one that needs to be compounded now by cutting spending which will necessarily affect the very same classes of people negatively that the bank bailouts did through reduction of public services and increased unemployment. The fact that our elites are even considering this shows how little they understand of the situation. Or playing more cynical, how little concern they have for the plight of the middle and lower class.

What we need are statesmen and leaders who can clearly explain why the current budgets deficits are necessary and then begin to formulate plans to redirect stimulus not to the oligarchs in power but to the people most affected by the economic disaster. Instead, we have captured men and cronies in power who will continue to rape the middle class until they no longer can, either because there is no middle class left or because they have been deposed. Until the system is reformed and our political leaders once again serve the interests of the many instead of the power of the few, I don’t see how we aren’t in for dark days ahead.

Can Civilization’s Birthplace Become Its Funeral Pyre?

Overreaching headlines aside, the Eurozone is a bit of trouble. Greece has been bailed out in an attempt to avoid a sovereign default. Those in the know think the Greeks are unlikely to be the last country in the Eurozone to require a bailout and the conditions the IMF are expecting Greece to conform with are likely to have unintended far-reaching consequences that we can’t possibly understand at this point. A lot of people I talk to seem to be of the opinion that the Greeks got themselves into this mess and that bailing them out serves little purpose. This is probably true though for reasons far more complicated than that.

A guest post over at Naked Capitalism outlines 11 points supporting the idea that the Eurozone will likely break down over the Greece bailout. One of the key points revolves around a basic accounting principle: if one entity has a deficit, some other entity must have a surplus. Fiscal accounting is essentially a zero sum game and this is very important in the Greek case. When thinking about this, it’s important to realize that Greece, being a member of the EU, does not control its own sovereign currency. Thus, for Greece to run a deficit, there had to have been complicity from within the EU, specifically from Germany. It’s the fiscally conservative Germans benefiting from their strong export driven economy who provide the opportunity for the Greek government to run a deficit.

This part about sovereign currency is important. Historically, countries that control their own currency have been able to inflate their way out of debt, at least to some degree. In Greece’s case, the country is unable to do this because their currency is the euro and is outside their control. Therefore, they essentially have two options: default or bailout and accept the draconian retrenchment terms the IMF is demanding. As the article above mentions, it is unlikely that these terms are created with the considerations necessary regarding the simple accounting fact above, e.g. if Greece successfully imposes financial austerity measures on its people (a HUGE if at this point, one that isn’t getting enough attention), this necessarily means that the export societies of Germany and other Eurozone countries will retract due to the cutbacks in spending in Greece and others.

On top of that, these austerity measures will likely have a deflationary effect on the Eurozone. The bailout of Greece is aimed at government debt and the austerity measures are aimed in the same direction. Based on the same simple accounting concept I talked about above, if Greek government debt obligations are reduced through austerity measures, the Greek private sector will see their debt obligations grow leading to more private defaults and less growth in the Greek economy. Shortsightedly demanding to lower government debt with no consideration of the interconnectedness of the government and private sector spending will lead to further pullbacks and lack of growth in Greece.

In the end, the issues that we are seeing with Greece and the like illustrates several problems with the Eurozone as it is currently existing. If the Eurozone collapses, as the article seems to think possible, the ramifications will spread out over a much bigger area than just Europe. My crystal ball is cloudy when it comes to the results of a Eurozone collapse but I can’t help but think it will be highly detrimental to our country as well. We should watch carefully how things play out in Europe since it’s quite possible we may have to deal with similar circumstances in the near future here at home as profligate states like California begin to encounter the same issues the Greeks are running into.

Inflation and the Fed

During the current economic crisis, the Federal Reserve has increased its balance sheet significantly in order to increase the monetary liquidity in the economy. Many people assume they have done this by “printing money” which in theory increases the money supply held by the public and over the long term is inflationary. However, because the Fed did not want to increase the actual money supply held by the public, they went about increasing the liquidity of the system in a different manner, one that they are convinced will allow them to avoid unsustainable inflation in the future. Theoretically, this is true. However, in reality, it’s likely to be false for a reason I’ll get to in a minute.

First, we need to understand exactly how the Fed increased economic liquidity without increasing the money supply in public hands. James Hamilton gives us a very thorough explanation. I highly suggest you read the whole thing which is liable to lead you down a very deep rabbit hole but I’ll try to summarise to the best of my abilities. Normally, if the Fed wanted to increase liquidity, it doesn’t physically print money and start handing it out to the people on the front steps. Most large banks have an account with the Fed. To get money into the system, the Fed normally just adds an entry in one of these accounts as a sort of deposit. The bank now has more money than it did before. It can then use that money to pay off debt, to loan out to other banks or customers or ask for actual money. Typically they do the one of the first two and not the other. This may go on for several steps but eventually, someone wants the actual money and the original entry gets converted to cold hard cash.

That of course would increase the money supply held by the public. The Fed did two different things to increase the liquidity without increasing the money supply. First, it asked the Treasury to borrow a bunch of money by selling T-Bills to banks. Those banks paid for the T-Bills by asking the Fed to transfer money from the accounts at the Fed to accounts at the Treasury. The Treasury then just sits on the money and you have no increase in money supply held by the public.

The second way the Fed increased liquidity was by changing the terms of the accounts they held with the banks. In the past, if the Fed added an entry to a bank’s account, the bank would put that money to use, typically by lending it out overnight. They did this because the Fed did not pay interest on any money that sat in the account overnight and the bank could get interest in the overnight lending trade. However, during this crisis, the overnight lending trade came to be viewed as suspect by most banks because they didn’t know what banks were solvent and what banks weren’t. So they weren’t inclined to lend that money out and the Fed helped them out by starting to pay interest on accounts. Now, the banks could just leave the money sitting there and still make money. This situation allowed the Fed to essentially borrow directly from the public because they can increase account balances without having to worry about money getting into the system.

Of course, all of this is still inflationary because money is essentially being created out of thin air. Plenty of people worry about this and Ben Bernake wants people to know that they have a plan for getting out of the situation once the economy turns around which he detailed in the Wall Street Journal Op-Ed linked above. He argues that the Fed can just increase the interest rates it pays on the accounts banks hold with it once the economy turns around. By increasing the interest rates, it can ensure that banks will continue holding money with the Fed instead of loaning it out to the public.

This is where theory is going to meet reality in what is liable to be a very ugly street fight. Increasing interest rates sounds real easy but in fact, is a highly political process, one that Alan Greenspan failed at spectacularly in 2002-2003 when the economy was coming out of recession. Increasing interest rates naturally inhibits growth because it is more expensive to borrow money to fund expansion. Imagine a scenario where we start to come out of the worst recession we’ve seen since WWII. Unemployment is starting to level out, probably around 11% or so. Spending is starting to increase somewhat. If suddenly growth starts to shoot up a little, banks will be inclined to lend that money that the Fed gave them out. If at this point, the Fed raises interest rates, it takes a huge political risk in that it may nip the growth in the bud and return us to a recession. Can you imagine the political fallout from a move like that? The electorate would scream bloody murder and whoever was in charge at the Fed would be the scapegoat. In reality, the interest rates probably wouldn’t get raised at all and once the banks started lending that money out, we’d see a highly inflationary environment.

Because the plan the Fed has is in effect a political plan and not a monetary plan, it is likely to be a broken plan from the outset. The US economy is headed towards a precipice with a tiny tightrope to the other side, on one side of the rope is long term stagnation and on the other a hyper-inflationary scenario that turns us into Argentina or worse, Zimbabwe. I highly doubt that we will have the ability to walk the tightrope between the two and will likely end up in the second situation because it will be an easier political decision to make. This is the problem that comes up when you have highly technical people in control of what is essentially a political problem. In theory, their reasoning goes, we can fix this, no problem. In reality, it’s never that easy.

Green Shoots Are Sometimes Weeds

As any gardener will tell you, healthy lawns hardly ever have weeds in them. This is because when a lawn is healthy, it is lush and thick and weeds don’t have a chance to grow. Weeds only show up in a lawn when there is something wrong with the underlying soil or lawn. If the lawn is unhealthy or the soil isn’t providing the right nutrients, weeds have a better chance of germinating and propagating throughout the lawn.

There has been some talk of green shoots in the economy lately and the stock market has certainly been doing its part with the S&P up over 30% from its March lows. There seems to be some optimism out there and people are starting to talk like the worst recession since 1930 might end in a V rebound to prosperity. The question is, are the green shoots really a healthy lawn rebounding after a cold winter or is the lawn dead, the soil useless and thus what we’re seeing are essentially weeds?

I’d argue we’re getting awfully excited about a bunch of dandelions. All of this excitement is almost certainly wishful thinking and the people pouring money back into the market right now are likely to be very disappointed come summer when it gets hot and the weeds shrivel up and die. The data over the past 3 months has been overwhelmingly negative yet because the “stress tests” our esteemed government ran on the banks came out positive (ignoring the fact that there was no negative option, it was set up as win-win), the market has acted as though nothing bad was going on. S&P earnings are down an unheard of 90% over the past 20 months, unemployment continues to rise and we’re about to go through the bankruptcy of two large automakers in the US. There is a pending disaster waiting in the wings of commercial real estate and foreclosures are increasing while home prices continue to fall. The state of California may go bankrupt or our federal government will be forced to bail them out, either outcome leading to a ripple effect throughout the economy.

Every bear market has runs of 20-30% that trick people into putting money back in at the highs before crushing their hopes of a recovery by testing new lows. We may not see the lows in the S&P that we saw back in March but I have serious doubts that the run up we have recently seen is sustainable given the overall severity of the recession we are in.

Richardson Tea Party

I went to the Richardson Tea Party yesterday and it was pretty interesting. The crowd looked like it was around 700 or so which is pretty good for a lunch day protest rally. We weren’t centered in one place like in other tea parties around the country. Most everyone was walking around the park waving at cars. There was lots of supportive honking and only one idiot woman who flipped us off. There were all different types of people there as you can see from the pictures below.

I feel like there is definitely something brewing with this movement. Here’s hoping anyway. Instapundit has lots more coverage and pictures including one from Dallas.



Tax Day Tea Party Protests

If you’ve been reading anything about politics lately, you’ve surely seen at least cursory coverage of local tea parties around the country where people are coming together to protest the unbelievable spending that the federal government is doing in an attempt to get us out of the economic mess we’re in. These people are starting to understand that throwing more easy money at a problem caused by easy money can’t possibly be the fix we need.

April 15th is a day that was chosen to host these protests all across the country. You can find out if one is being held near you at Tax Day Tea Party. I’m planning on going to the Richardson one tomorrow at noon and probably the Plano one at 5, just to show my support as well as to make sure some coverage of the events take place. I’ll post photos and my thoughts tomorrow night. If you’re interested, drop me a line in the comments to tell me you’ll be there. Or if you have photos from other protests, feel free to send them to me and I’ll post them.

This could be the beginning of what I thought would be completely impossible in our country, the founding of a viable third party. It will be interesting over the next few months to see if this grassroots movement continues to build steam.

Advice We Don’t Need

There’s nothing like having the Europeans tell us how to handle our housing crisis. “But as the housing bubble deflates, it also drags innocent victims into a wave of foreclosures” they crow! Please. What innocent victims are being dragged into a wave of foreclosures? Either you can afford the house you live in or you can’t. If you have a house payment that’s more than 28% or so of your monthly income, you’re probably not so innocent. You bought a house you can’t afford. Just because you now lost your job doesn’t make you any less innocent.

If you don’t have a rainy day fund of around 6 months expenses, you probably aren’t so innocent. You probably spend more than you save. That article makes it seem like thousands of people who are the epitome of financial purity are about to be foreclosed upon and I find that ridiculous. Sure there are some out there who played by the rules and just have had a string of bad luck. But $275 billion worth of mortgages in that category? I seriously doubt it.

This bill plunges $200 billion back into Freddie and Fannie who have already proven to be poor stewards of the public’s trust. They are allowed now to finance up to 105 percent of a home’s value. That sounds like a fantastic idea. Really it does.

“But the plan is well targeted: the administration aims to contain the fallout, not to keep everyone in their home. The plan helps only those with a reasonable chance to retain their house.” How can people who have a debt-to-income ratio of more than 38% realistically have a chance of keeping their house? That’s a full 10% over the accepted norms and doesn’t even begin to take into account the overall debt ratio that includes other debt payments like cars and credit cards. These people don’t have a reasonable chance.

Most crucially, fighting foreclosures is a political imperative. The administration needs a lot more money to save the US banking system – money that will be forthcoming only from voters who feel they, and not just Wall Street, are being rescued. This plan may help win them over. At $275bn, that seems like a bargain.

Finally we get the real meat. Like all government handouts, it’s a way to slip future ones by us without us noticing. For that, the Europeans probably are the ones that ought to be giving us advice.

When A Billion Isn’t Big Anymore

Not so long ago, a billion dollars was a lot of money. Now? Not so much. This morning, news on the wire says Obama is setting aside $75 billion to slow foreclosures. First of all, where did that $75 billion come from that he’s setting aside? Oh yeah: “committing $75 billion of taxpayer money to back the initiative.” Tax payer money. Right. Yours and mine. Helping slow down foreclosures.

Second, what’s the plan gonna look like?

“The plan I’m announcing focuses on rescuing families who have played by the rules and acted responsibly: by refinancing loans for millions of families in traditional mortgages who are underwater or close to it; by modifying loans for families stuck in sub-prime mortgages they can’t afford as a result of skyrocketing interest rates or personal misfortune; and by taking broader steps to keep mortgage rates low so that families can secure loans with affordable monthly payments,” President Barack Obama said in prepared remarks.

That sounds awesome. It’s a plan for people who played by the rules and acted responsibly. Anyone could support that, right? Oh wait a minute. “Refinancing loans for millions of families in traditional mortgages who are underwater or close to it”? Why would we do that? If they are in traditional mortgages, their payments aren’t going up and they aren’t at risk for foreclosure. They just happen to have an asset that is worth less than they paid for it. Why in God’s name would we try to artificially support the price of those assets? All that part of the plan will do is tempt normal people to try and get in on the government teat for a little milky goodnesss.

What about this part? “by modifying loans for families stuck in sub-prime mortgages they can’t afford as a result of skyrocketing interest rates or personal misfortune;” Hold it right there. Those people didn’t play by the damn rules. They bought too much house and they should be foreclosed on. They didn’t act responsibly. They acted irresponsibly. We’re rewarding people for being stupid which will only serve to encourage people to act stupidly in the future. Our government is like anti-evolution.

And that last sentence? “and by taking broader steps to keep mortgage rates low so that families can secure loans with affordable monthly payments,” In the name of all that is holy, that is the dumbest thing I have ever seen written in public. A) Mortgage rates are at AN ALL TIME LOW! Is the man so empty that he doesn’t know that? Or is he just counting on the fact that the American populace has become so numb and stupid to the entire fiasco that nothing will happen when he says something so stupid? On top of that, we don’t need broad steps to secure loans with affordable monthly payments. Throughout time immemorial, people had affordable monthly payments without 75 bill-ya-fucking-dollars worth of taxpayer money. They did that by BUYING HOMES THEY COULD AFFORD.

Here’s what we’re doing. We have a damn crisis that was caused by greed, stupidity and a whole wad of cheap money courtesy of Alan Greenspan. We’re fixing the crisis by giving stupid people more money instead of looking at them in the eye and saying, you are a stupid fool and you need to learn from this mistake. I cannot believe that people aren’t rioting in the streets over things like this. What scares me is that some day they will be. But it will be because the government has finally turned off the spigot and people, who by that time will have become surgically attached to the government largesse, will riot because they think they deserve a free ride.

I hope I live in Belize by then.

Can You Cure An Addict By Giving Him More Drugs?

Only if you want to kill him. Caroline Baum discusses this very topic on Bloomberg. Imagine a doctor who, faced with an alcoholic, diagnosed more alcohol as a treatment. A doctor like that would be thrown out of the medical profession and rightfully so. Yet, our political leaders, when faced by a crisis created by years of easy money and debt, are prescribing that the cure will come from more debt and easy money. The market is naturally going through a correction caused and yet our political leaders act as if we have a god given right to never experience a recession or downturn.

Our years of profligate spending at both a governmental and individual level has come home to haunt us and the only fix is a painful return to thrift and saving. Instead, our leaders are trying to lower mortgage rates so that people can keep buying houses which only serves to artificially inflate prices. They are attempting to force banks to lend to people so that we can go on buying things we can’t afford. They are flooding the market with money in an attempt to get the economy going again but this can only delay the inevitable and make it much, much worse when we finally have to go through some real day of reckoning.

I think once all this cheap money the government is creating hits the market, we’re going to see some very serious inflation followed by a crash much worse than what we have experienced this year. It’s sad that we don’t have enough serious leaders to step up to the plate and say that we had our cake and ate it for far too long and now is the time to pay the piper. Instead, we’re only prolonging the inevitable.