Stocks higher? Famed investor says don't bet on it

Dec 27, 2009
By BERNARD CONDON

NEW YORK (AP) - Homes are selling at their fastest clip in nearly three years, the unemployment rate is falling and stocks are up 66 percent since their March lows - the best performance since the 1930s. What's not to like?
Plenty, according to Mohamed El-Erian, chief executive of giant bond manager Pimco. The investor says the recovery may be gaining steam but is no different than a kid who eats too much candy at one of the birthday parties his 6-year-old daughter attends.
"We're on a sugar high," El-Erian says. "It feels good for a while but is unsustainable." His point: This burst of economic activity fed by government spending and near-zero interest rates will soon peter out. As CEO at Newport Beach, Calif.-based Pimco, El-Erian, 51, oversees nearly $1 trillion in assets, more than the gross domestic product of most countries. So when he talks, people listen. What he's saying now:

_Stocks will drop 10 percent in the space of three or four weeks, bringing the Standard & Poor's 500 index below 1,000 - though he's not predicting when.

_The unemployment rate will be hovering above 8 percent a year from now.

_U.S. gross domestic product will grow at an average 2 percent or so for years to come - a third slower than we're used to.

El-Erian and his famous partner, Pimco founder Bill Gross, are watched closely because they've made investors a lot of money over the years. The Pimco Total Return Fund, which at $203 billion is the world's largest mutual fund, has returned an average 7.6 percent annually over 10 years, after fees, versus 6.3 percent for Barclays Capital U.S. Aggregate fixed income index fund. The hotshots at Pimco have made money by anticipating big moves in the economy and interest rates way before other investors. In the depths of the financial crisis last year, for instance, Pimco sold some of its Treasury bonds to panicked investors looking for a safe haven and put the proceeds into government-backed mortgages and bank debt - in time to catch the big upswing in prices of those and other riskier securities this year. Now Pimco is once again changing tack. El-Erian says people are fooling themselves if they think all the bullish data of late means a strong recovery is in the offing. So he's buying Treasurys and selling riskier stuff.
His bet: Investors will get scared again and want U.S.-guaranteed debt so they know they'll get repaid. At Total Return, government-related securities, including Treasurys and corporate debt backed by Washington, comprised 48 percent of the fund's holdings in September. That was up from 9 percent at the beginning of the year. One of Pimco's newest funds, the Global Multi-Asset Fund, a hybrid stock-bond offering, is 35 percent in equities now, down from 60 percent earlier this year. Investors betting on stocks or high-yield bonds are likely to be disappointed, El-Erian says.
Markets for those securities are rallying not because people like them but because they hate the puny yields of safer investments like money markets and feel they have no choice but to buy, he says. He quips that that makes the bull market as likely to last as a forced marriage.

The danger: If stock and junk bond prices start falling, lots of investors are likely to bail, feeding the drop. Of course, there are plenty of true believers in the bull who are not buying the El-Erian line. James Paulsen, chief strategist at Wells Capital Management in Minneapolis, with $355 billion under management, has been pounding the table for months to buy stocks. Just like in the early 1980s, the recovery will take the form of a "V," he says. The reason: Companies have cut inventories and payrolls to the bone, so just a little revenue growth could translate into a bumper crop of profits. El-Erian says many of the bulls don't appreciate just how much the government props still under the economy are masking its weakness. Instead of focusing on the fundamentals today, he says, they're looking to the past, expecting a quick economic rebound because that's what's happened before. We're trained to think the "farther you fall, the higher you'll bounce back," El-Erian says. "We're hostage to the V." El-Erian says he learned to be open to many different views on the world (and markets) from his father, an Egyptian diplomat who insisted on reading several newspapers everyday, both on the right and the left. El-Erian had hoped to become a college professor. But when his father died, he took a job at the International Monetary Fund to support the family. He rose through the ranks, eventually becoming deputy director. In 1999 he joined Pimco, where he quickly made a name for himself with some prescient bets on emerging markets. One of his biggest wins: selling Argentine bonds in 2000 while they were still popular with investors. When the country defaulted the next year, the emerging markets fund that El-Erian managed returned 28 percent versus negative 1 percent for the Emerging Market Bond Index. He eventually left to head the group that manages Harvard University's massive endowment, returning to Pimco in January 2008 in time catch the depths of the financial crisis.
El-Erian says we've probably seen the worst of the crisis but consumers, and not just Washington, need to start spending again for the recovery to really take hold. He doesn't expect that to happen soon. Like in the Great Depression, Americans are saving more and borrowing less - a shift in attitudes toward family finances that Pimco thinks will last a generation. That, plus the impact of more regulation and higher taxes, El-Erian says, will crimp growth for years to come. Whatever the merits of that view, Pimco is not exactly knocking the lights out right now. So far this year, the Total Return Fund has returned 14 percent, impressive in normal times but no better than average for similar funds during the rally, according to Morningstar. The 19.1 percent return for Global Multi-Asset, which El-Erian co-manages, lags two-thirds of its peers. El-Erian says he sold equities "too early" but is convinced his view on the market will prove correct - even if it strikes many as a tad too pessimistic. "I'm calling it as I see it," he says. "I'm not optimistic or pessimistic - I'm realistic."

Mayors Sound Alarm Over Drop in City Revenues

The Wall Street Journal
November 19, 2009
By CONOR DOUGHERTY

WASHINGTON -- Mayors from four U.S. cities said they are facing a once-in-a-generation fiscal crisis and that federal stimulus funds have, so far, been largely unhelpful in helping them balance budgets hit by steep drops in nearly every source of municipal revenue. The comments, from mayors of Philadelphia, San Jose, Calif; Mesa, Ariz., and Bowling Green, Ky., at a panel discussion sponsored by the Brookings Institution and the National League of Cities, underscore how the recession for local government is far from over. Mesa's mayor, Scott Smith, said the steep drops in sales-tax revenue, the city's primary source of money, are "changing our reality."
"We treat this financial crisis as something we're not going to get out of," said Mr. Smith, whose city has about 500,000 citizens and is in the Phoenix metropolitan area. Even as economists declare the recession over, local revenues continue to fall. That's because the lion's share of their receipts -- sales, income and property taxes -- are connected to the job market and real-estate prices. Jobs and real-estate prices are expected to lag the broader economic recovery, reducing city revenues for months or years after the technical end of the recession.
"This is unknown for our generation," said Chris Hoene, director of the center for research and innovation at the National League of Cities. Mr. Hoene said it was likely to be 18 to 24 months before local government revenues resume growing. The mayors said deep budget gaps have forced them to make cuts to basic services including police and fire protection, that the financial crisis has turned cities and states against each other and that fiscal strains emphasize the need for money-saving changes to pension and health benefits in the heavily unionized public sector. "Change has to come and this moment of crisis is going to force it," said Michael Nutter, mayor of Philadelphia. While federal stimulus funds have helped states close budget gaps and preserved jobs for many state and school-board employees, the mayors said federal money hasn't done much to ease their day-to-day budget problems. "The stimulus is going to special things," said Chuck Reed, mayor of San Jose. Beyond budget and services cuts, the mayors discussed new ways to raise revenue at a time when incomes are stagnant and the national unemployment rate is at 10.2%. Philadelphia, for instance, has temporarily increased its sales tax while Mesa has levied a property tax for the first time.
Write to Conor Dougherty at conor.dougherty@wsj.com

29 States show rising unemployment

California Was Among States With Record Unemployment (Update3)
By Courtney Schlisserman
November 20, 2009 (Bloomberg) -- California, Delaware, South Carolina and Florida registered record rates of unemployment in October as weakness in the labor market stretches from coast to coast and limits the economic recovery. Joblessness rose in 29 U.S. states last month compared with 22 in September, the Labor Department said today in Washington. Michigan had the highest jobless rate at 15.1 percent, followed by Nevada at 13 percent and Rhode Island at 12.9 percent. The national rate last month reached a 26-year high of 10.2 percent, weighing on consumer spending that accounts for about 70 percent of the economy. Federal Reserve Chairman Ben S. Bernanke said Nov. 17 that joblessness “likely will decline only slowly,” a reason policy makers will keep interest rates near zero to ensure growth is sustained. “We’ve had a surprisingly sharp jump in the jobless rate,” said Richard DeKaser, president of Woodley Park Research in Washington. “Businesses have truly been doing an extraordinary job of wringing out productivity from the labor force.” Stocks fell for a third day, with the Standard & Poor’s 500 Index declining 0.3 percent to 1,091.38 at 4:03 p.m. in New York. Dell Inc., the third-largest maker of personal computers, dropped 10 percent after reporting a 54 percent drop in profit.

Declines in 13 States
The unemployment rate fell in 13 states, including Massachusetts, where it declined to 8.9 percent from 9.3 percent; New Hampshire, with a drop to 6.8 percent from 7.2 percent; and West Virginia, which fell to 8.5 percent from 8.9 percent. The number of states with at least 10 percent unemployment held at 14 last month, the Labor Department’s report showed. The states reporting a record jobless rate were California at 12.5 percent, South Carolina at 12.1 percent, Florida at 11.2 percent and Delaware at 8.7 percent. The District of Columbia also set a high with an 11.9 percent rate. “Virtually every sector aside from the health-care sector is losing jobs,” said Sean Snaith, University of Central Florida economist in Orlando. “Housing has been central to Florida’s economic story throughout the entire cycle. Unfortunately, it has spread well beyond the sectors directly involved in the housing market.” President Barack Obama on Nov. 6 signed into law a plan to extend jobless benefits, expand a tax credit for first-time homebuyers and provide tax refunds to money-losing companies. The measure gives jobless people as many as 20 additional weeks of unemployment assistance. The president has also announced plans to convene a jobs summit at the White House next month.

State Payrolls
Payrolls declined last month in 21 states, today’s report showed. New York showed the biggest drop, with a loss of 15,300. Florida had 8,500 job losses, followed by Georgia with 7,500 and Virginia with 7,100. “When you apply for a job, because there are so many other people looking for jobs, you have to be the absolute perfect candidate and lucky, or be someone’s brother-in-law, to get a job,” said Mary Kough of Tellico Plains, Tennessee. “In this economy there are very few jobs for which to even apply.” Kough has been looking for work for four months, applying for as many as 25 positions. She’s been interviewed once. The 47-year-old said she has about 20 years of experience, including jobs as a customer service manager, supervisor and purchasing agent. Tennessee’s unemployment rate held at 10.5 percent in October, the Labor Department’s report showed.

Taking Comfort
“I try not to get discouraged,” Kough said. “I know that you will get a certain percentage of what you apply for, and since there are less jobs to apply for, I know it will just take a little longer. I take comfort in knowing that. I have faith.” Applied Materials Inc. is among companies still planning to cut jobs. The world’s biggest maker of chip equipment, based in Santa Clara, California, said Nov. 11 it plans to eliminate as many as 1,500 positions within 18 months. Over the last year, California showed the biggest loss of jobs, with payrolls falling by 687,700 workers, today’s report showed. Nationally, payrolls fell by 190,000 in October, the Labor Department said Nov. 6. The U.S. has lost 7.3 million jobs since the start of the recession in December 2007, the most of any downturn since the Great Depression. Other measures corroborate that while firms are firing fewer workers, it is harder for the unemployed to find work. The number of people getting extended payments jumped in the week ended Oct. 31 even as the number of Americans filing first-time claims for unemployment benefits held at a 10-month low last week, according to government data released yesterday.
To contact the reporter on this story: Courtney Schlisserman in Washington at cschlisserma@bloomberg.net Last Updated:

Payback Time: Wave of Debt Payments Facing U.S. Government

By EDMUND L. ANDREWS
The New York Times
November 23, 2009

WASHINGTON — The United States government is financing its more than trillion-dollar-a-year borrowing with i.o.u.’s on terms that seem too good to be true. But that happy situation, aided by ultralow interest rates, may not last much longer. Treasury officials now face a trifecta of headaches: a mountain of new debt, a balloon of short-term borrowings that come due in the months ahead, and interest rates that are sure to climb back to normal as soon as the Federal Reserve decides that the emergency has passed. Even as Treasury officials are racing to lock in today’s low rates by exchanging short-term borrowings for long-term bonds, the government faces a payment shock similar to those that sent legions of overstretched homeowners into default on their mortgages. With the national debt now topping $12 trillion, the White House estimates that the government’s tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. Other forecasters say the figure could be much higher. In concrete terms, an additional $500 billion a year in interest expense would total more than the combined federal budgets this year for education, energy, homeland security and the wars in Iraq and Afghanistan. The potential for rapidly escalating interest payouts is just one of the wrenching challenges facing the United States after decades of living beyond its means. The surge in borrowing over the last year or two is widely judged to have been a necessary response to the financial crisis and the deep recession, and there is still a raging debate over how aggressively to bring down deficits over the next few years. But there is little doubt that the United States’ long-term budget crisis is becoming too big to postpone.

Americans now have to climb out of two deep holes: as debt-loaded consumers, whose personal wealth sank along with housing and stock prices; and as taxpayers, whose government debt has almost doubled in the last two years alone, just as costs tied to benefits for retiring baby boomers are set to explode. The competing demands could deepen political battles over the size and role of the government, the trade-offs between taxes and spending, the choices between helping older generations versus younger ones, and the bottom-line questions about who should ultimately shoulder the burden.
“The government is on teaser rates,” said Robert Bixby, executive director of the Concord Coalition, a nonpartisan group that advocates lower deficits. “We’re taking out a huge mortgage right now, but we won’t feel the pain until later.”
So far, the demand for Treasury securities from investors and other governments around the world has remained strong enough to hold down the interest rates that the United States must offer to sell them. Indeed, the government paid less interest on its debt this year than in 2008, even though it added almost $2 trillion in debt. The government’s average interest rate on new borrowing last year fell below 1 percent. For short-term i.o.u.’s like one-month Treasury bills, its average rate was only sixteen-hundredths of a percent. “All of the auction results have been solid,” said Matthew Rutherford, the Treasury’s deputy assistant secretary in charge of finance operations. “Investor demand has been very broad, and it’s been increasing in the last couple of years.” The problem, many analysts say, is that record government deficits have arrived just as the long-feared explosion begins in spending on benefits under Medicare and Social Security. The nation’s oldest baby boomers are approaching 65, setting off what experts have warned for years will be a fiscal nightmare for the government. “What a good country or a good squirrel should be doing is stashing away nuts for the winter,” said William H. Gross, managing director of the Pimco Group, the giant bond-management firm. “The United States is not only not saving nuts, it’s eating the ones left over from the last winter.” The current low rates on the country’s debt were caused by temporary factors that are already beginning to fade. One factor was the economic crisis itself, which caused panicked investors around the world to plow their money into the comparative safety of Treasury bills and notes. Even though the United States was the epicenter of the global crisis, investors viewed Treasury securities as the least dangerous place to park their money. On top of that, the Fed used almost every tool in its arsenal to push interest rates down even further. It cut the overnight federal funds rate, the rate at which banks lend reserves to one another, to almost zero. And to reduce longer-term rates, it bought more than $1.5 trillion worth of Treasury bonds and government-guaranteed securities linked to mortgages. Those conditions are already beginning to change. Global investors are shifting money into riskier investments like stocks and corporate bonds, and they have been pouring money into fast-growing countries like Brazil and China. The Fed, meanwhile, is already halting its efforts at tamping down long-term interest rates. Fed officials ended their $300 billion program to buy up Treasury bonds last month, and they have announced plans to stop buying mortgage-backed securities by the end of next March. Eventually, though probably not until at least mid-2010, the Fed will also start raising its benchmark interest rate back to more historically normal levels. The United States will not be the only government competing to refinance huge debt. Japan, Germany, Britain and other industrialized countries have even higher government debt loads, measured as a share of their gross domestic product, and they too borrowed heavily to combat the financial crisis and economic downturn. As the global economy recovers and businesses raise capital to finance their growth, all that new government debt is likely to put more upward pressure on interest rates. Even a small increase in interest rates has a big impact. An increase of one percentage point in the Treasury’s average cost of borrowing would cost American taxpayers an extra $80 billion this year — about equal to the combined budgets of the Department of Energy and the Department of Education. But that could seem like a relatively modest pinch. Alan Levenson, chief economist at T. Rowe Price, estimated that the Treasury’s tab for debt service this year would have been $221 billion higher if it had faced the same interest rates as it did last year. The White House estimates that the government will have to borrow about $3.5 trillion more over the next three years. On top of that, the Treasury has to refinance, or roll over, a huge amount of short-term debt that was issued during the financial crisis. Treasury officials estimate that about 36 percent of the government’s marketable debt — about $1.6 trillion — is coming due in the months ahead. To lock in low interest rates in the years ahead, Treasury officials are trying to replace one-month and three-month bills with 10-year and 30-year Treasury securities. That strategy will save taxpayers money in the long run. But it pushes up costs drastically in the short run, because interest rates are higher for long-term debt. Adding to the pressure, the Fed is set to begin reversing some of the policies it has been using to prop up the economy. Wall Street firms advising the Treasury recently estimated that the Fed’s purchases of Treasury bonds and mortgage-backed securities pushed down long-term interest rates by about one-half of a percentage point. Removing that support could in itself add $40 billion to the government’s annual tab for debt service. This month, the Treasury Department’s private-sector advisory committee on debt management warned of the risks ahead. “Inflation, higher interest rate and rollover risk should be the primary concerns,” declared the Treasury Borrowing Advisory Committee, a group of market experts that provide guidance to the government, on Nov. 4. “Clever debt management strategy,” the group said, “can’t completely substitute for prudent fiscal policy.”

Could the US become a "Banana Republic"?

WASHINGTON (CNN) – A leading fiscal mind on Capitol Hill and a one-time Obama Cabinet pick sounded the alarm Sunday over the projected long-term financial challenges the country faces. “This deficit is driven by us,” New Hampshire Republican Sen. Judd Gregg candidly said Sunday on CNN’s State of the Union when asked about the federal government’s projected $1.42 trillion operating deficit for the 2009 fiscal year. “You talk about systemic risk. The systemic risk today is the Congress of the United States,“ the Ranking Republican on the Senate Budget Committee told CNN Chief National Correspondent John King, “that we’re creating these massive debts which we’re passing on to our children. We’re going to undermine fundamentally the quality of life for our children by doing this.” “Now you can’t blame that on [former President] George [W.] Bush,” Greg said, noting that using the Obama administration’s projections the budget deficit for the next ten years is $1 trillion per year. And Gregg said that during the same ten-year period, public debt as a percentage of gross domestic product would increase from 40 percent - which Gregg called “tolerable but still too high” - up to 80 percent. The figures, Gregg told King, “mean we’re basically on the path to a banana-republic-type of financial situation in this country. And you just can’t do that. You can’t keep running these [federal] programs out [into the future] and not paying for them. And you can’t keep throwing debt on top of debt.” “Standards of living will drop if we keep this up,” Gregg also said.After repeated promises from the White House that the final health care reform bill will be deficit neutral, Gregg said a Democratic plan to avoid otherwise automatic Medicare cuts without having a funding source for the projected expense of $250 billion over the next decade was “gamesmanship.” Asked about criticism leveled Sunday by former Republican-turned-Democrat Sen. Arlen Specter of Pennsylvania that Republicans were being obstructionist in the health care reform debate, Gregg replied, “Well, I suppose he has to call us something now that he’s left the party.” Responding to the Democratic charge that the GOP is “the party of ‘no,’” Gregg pointed to Republican health care reform proposals including his own and another co-sponsored by Republican Sens. Tom Coburn and Sen. Richard Burr, as well as a bipartisan proposal put forward by Sens. Ron Wyden (D-OR) and Robert Bennett (R-UT).” Gregg said the versions of health care reform voted out of the Senate Finance Committee and the Senate Health, Education, Labor and Pensions Committee would amount to “a huge expansion of government.”
“You’re talking about taking the government and increasing it by $1-$2 trillion over the next ten years,” Gregg said. He added that he thought growing government at that rate would have a “very debilitating effect” on the overall economy and the ability of Americans to get health care in the future. At one point earlier this year, Gregg, who is not seeking re-election to his Senate seat in 2010, was President Obama’s choice to head the Commerce Department. But the fiscal hawk removed himself from consideration because of differences with the new administration on several policy issues.

Dollar's Slide Gives Rise to Calls for New Reserve

By Frank Ahrens
Washington Post
Wednesday, October 7, 2009
The U.S. dollar continued its six-month slide Tuesday amid a growing international chorus that wants the dollar replaced -- or at least supplemented -- as the world's reserve currency, a move that would end the greenback's six decades of global dominance. The dollar has come under attack from abroad as the economic crisis has played out, thanks to the Federal Reserve's decision to flood a seized-up financial system with liquidity last fall. The central bank's moves likely staved off deflation, but the massive influx of new dollars has devalued existing ones. Foreign nations are worried that the massive U.S. national debt and rising deficits are not being addressed. And though inflation is not yet a concern in the United States, a prolonged slide in the dollar's value could lead to higher prices for consumers. Further, large emerging economies -- such as China, Russia, Brazil and India -- are tired of kow-towing to the American buck, and sense an opportunity to knock a weakened dollar off its imperial perch. "The U.S. dollar is headed for also-ran status, and it will continue to lose its value against many other currencies and assets," Miller Tabak equity strategist Peter Boockvar said. "The rest of the world wants the U.S. dollar to lose influence, but no one wants it to be abrupt, as it's in no one's interest. An evolutionary process is what is wanted." The question is: When will that happen? "In the next two to three years, it is highly unlikely to see the dollar replaced," said Eswar Prasad, an economics professor at Cornell University and a senior fellow at the Brookings Institution in Washington. "Over the next decade, though, we would expect to see other currencies play a much more significant role." The dollar fell to nearly its lowest point of the year against the yen and euro on Tuesday, which sent the price of gold surging to a record intraday high above $1,045 per ounce, as investors sought a hedge against inflation and foreign nations continued to stockpile the precious metal. For the American consumer, a falling dollar means U.S. exports sell better overseas, which can lead to more jobs here. But it also means imports costs more, which means higher prices at U.S. stores. "For the average Joe, the implications of a crisis of confidence in the dollar could end up in higher borrowing costs, lower government expenditures -- so that means reduced services -- and higher taxes," Prasad said. "Most likely, some combination of all of the above." Stocks, which typically move opposite of the dollar, staged a strong rally on Tuesday, continuing their fast Monday start. The Dow Jones industrial average and the broader Standard & Poor's 500-stock index both gained 1.4 percent, while the tech-heavy Nasdaq surged 1.7 percent. The U.S. dollar has been the world's reserve currency since World War II. Central banks and financial institutions in other nations hold dollars to pay off foreign obligations, or to influence their currency's exchange rate. Commodities, such as oil, are priced in dollars, which spreads the dollar's influence around the world. But the dollar's dominance is being challenged, thanks to the crisis. China was the first major power to attack the greenback, calling in March for the dollar to be replaced as the world's reserve currency. China holds more U.S. debt than any other country -- about $800 billion -- and the further the dollar drops, the less the value of the U.S. debt owed to China.
Other nations have followed China's criticism. In March, Kazakhstan criticized the dollar and called for the creation of a new currency it calls the "acmetal" (a coinage combining "acme" and "capital"). Last month, Iran shifted its reserve currency from the dollar to the euro, a move that is likely more political than economic and a response to harsh U.S. criticism of Iran's nuclear moves. But major powers have spoken against the dollar, as well. In September, Russia said it remains satisfied with the dollar as a reserve currency but said others are also needed. At an international investment summit last month, Russian Prime Minister Vladimir Putin criticized the United States -- and implicitly, Federal Reserve Chairman Ben S. Bernanke, who controls the money supply -- for "uncontrolled issue of dollars." Both China and Russia have called for a new "global supercurrency," similar but larger in scale to the euro, that would replace the dollar. Even the world's big financial institutions are piling on. "The United States would be mistaken to take for granted the dollar's place as the world's predominant reserve currency," World Bank President Robert Zoellick said in a speech last week.

The end of the dollar spells the rise of a new order

October 6, 2009
The Independent

Last autumn's global financial crisis set off an economic earthquake. And we are still feeling the tremors. The latest sign of the ground shifting beneath our feet is our report today of plans by Gulf states, China, Russia, France and Japan to end their practice of conducting oil deals in US dollars, switching instead to a diverse basket of currencies. It is not hard to see the motivation for oil exporters to move away from the dollar. The value of the US currency has fallen sharply since last year's meltdown. And fears are growing, in the light of a spiralling US government deficit, that a further depreciation is likely. They do not want to sell their wares in return for a currency with an uncertain future. It is also easy to see why China would like a world trading system that is underpinned by other currencies as well as the dollar. For the past decade Beijing has been recycling the proceeds of its giant national trade surplus into purchases of US government bonds and other dollar-denominated assets. China too stands to make a significant loss if the value of the dollar falls. For China, however, the timing is much more sensitive. Beijing needs to reduce its dollar holdings, but if it does so too quickly it will bring about the very devaluation it fears. This explains why Chinese officials appear to want this transition to take place gradually over the next decade. But the significance of this development goes much further. Since the end of the Second World War the dollar has been the bedrock of world trade. The pre-eminence of the American currency flowed naturally from the economic dominance of the US. Virtually everyone traded with America so it made sense to use their currency. But the US is not the dominant power that it once was. The financial crisis has left it hobbled with significant government and household debts and sharply reduced prospects for growth. Developing nations such as China, Brazil and India, on the other hand, have weathered the economic storm significantly better. So while this latest proposal is born of financial calculation, it is also a reflection of a new economic world order. We should not be sentimental for the dollar. It makes economic sense for world trade to be conducted in a variety of currencies. Relying on one only has the advantage of clarity, but it also creates instability if the economy that underpins it faces uncertain prospects. Yet we need to understand that exchange rate volatility is a symptom, rather than a cause, of what truly ails the world economy. The biggest driver of global economic instability in recent years has been the determination of China to boost its export sector at all costs. Beijing's persistently large trade surpluses and manipulation to prevent its own currency from appreciating have effectively forced Western nations into running persistently large trade deficits. It was this pressure that blew up various asset bubbles that burst with such disastrous effect last year. A gradual move away from the dollar makes sense. But without a commitment from world governments - both in the rich and developing world - to reduce these destabilising global trade imbalances we will enter an uncertain new era; and one that could yet make us pine for the days of the dominant greenback.

The demise of the dollar

In a graphic illustration of the new world order, Arab states have launched secret moves with China, Russia and France to stop using the US currency for oil trading

By Robert Fisk
Tuesday, 6 October 2009

In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar. Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars. The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years. The Americans, who are aware the meetings have taken place – although they have not discovered the details – are sure to fight this international cabal which will include hitherto loyal allies Japan and the Gulf Arabs. Against the background to these currency meetings, Sun Bigan, China's former special envoy to the Middle East, has warned there is a risk of deepening divisions between China and the US over influence and oil in the Middle East. "Bilateral quarrels and clashes are unavoidable," he told the Asia and Africa Review. "We cannot lower vigilance against hostility in the Middle East over energy interests and security." This sounds like a dangerous prediction of a future economic war between the US and China over Middle East oil – yet again turning the region's conflicts into a battle for great power supremacy. China uses more oil incrementally than the US because its growth is less energy efficient. The transitional currency in the move away from dollars, according to Chinese banking sources, may well be gold. An indication of the huge amounts involved can be gained from the wealth of Abu Dhabi, Saudi Arabia, Kuwait and Qatar who together hold an estimated $2.1 trillion in dollar reserves. The decline of American economic power linked to the current global recession was implicitly acknowledged by the World Bank president Robert Zoellick. "One of the legacies of this crisis may be a recognition of changed economic power relations," he said in Istanbul ahead of meetings this week of the IMF and World Bank. But it is China's extraordinary new financial power – along with past anger among oil-producing and oil-consuming nations at America's power to interfere in the international financial system – which has prompted the latest discussions involving the Gulf states. Brazil has shown interest in collaborating in non-dollar oil payments, along with India. Indeed, China appears to be the most enthusiastic of all the financial powers involved, not least because of its enormous trade with the Middle East. China imports 60 per cent of its oil, much of it from the Middle East and Russia. The Chinese have oil production concessions in Iraq – blocked by the US until this year – and since 2008 have held an $8bn agreement with Iran to develop refining capacity and gas resources. China has oil deals in Sudan (where it has substituted for US interests) and has been negotiating for oil concessions with Libya, where all such contracts are joint ventures. Furthermore, Chinese exports to the region now account for no fewer than 10 per cent of the imports of every country in the Middle East, including a huge range of products from cars to weapon systems, food, clothes, even dolls. In a clear sign of China's growing financial muscle, the president of the European Central Bank, Jean-Claude Trichet, yesterday pleaded with Beijing to let the yuan appreciate against a sliding dollar and, by extension, loosen China's reliance on US monetary policy, to help rebalance the world economy and ease upward pressure on the euro. Ever since the Bretton Woods agreements – the accords after the Second World War which bequeathed the architecture for the modern international financial system – America's trading partners have been left to cope with the impact of Washington's control and, in more recent years, the hegemony of the dollar as the dominant global reserve currency. The Chinese believe, for example, that the Americans persuaded Britain to stay out of the euro in order to prevent an earlier move away from the dollar. But Chinese banking sources say their discussions have gone too far to be blocked now. "The Russians will eventually bring in the rouble to the basket of currencies," a prominent Hong Kong broker told The Independent. "The Brits are stuck in the middle and will come into the euro. They have no choice because they won't be able to use the US dollar." Chinese financial sources believe President Barack Obama is too busy fixing the US economy to concentrate on the extraordinary implications of the transition from the dollar in nine years' time. The current deadline for the currency transition is 2018. The US discussed the trend briefly at the G20 summit in Pittsburgh; the Chinese Central Bank governor and other officials have been worrying aloud about the dollar for years. Their problem is that much of their national wealth is tied up in dollar assets. "These plans will change the face of international financial transactions," one Chinese banker said. "America and Britain must be very worried. You will know how worried by the thunder of denials this news will generate." Iran announced late last month that its foreign currency reserves would henceforth be held in euros rather than dollars. Bankers remember, of course, what happened to the last Middle East oil producer to sell its oil in euros rather than dollars. A few months after Saddam Hussein trumpeted his decision, the Americans and British invaded Iraq.

Gold hits record high on 'plan' to ditch dollar

LONDON (AFP) – The price of gold struck an all-time high at 1,038.65 dollars an ounce here on Tuesday as the dollar fell on a reported plan by Gulf states to stop using the greenback for oil trading. Gold reached the level in late afternoon trade on the London Bullion Market, beating the previous record high of 1,032.70 dollars an ounce struck in March, 2008. "Gold prices hit an all-time high as the dollar weakens," said Barclays Capital precious metals analyst Suki Cooper. "The dollar weakness appears to be related to ... (reported) secret talks about oil being priced in a basket of currencies including gold rather than the dollar, which has added to concerns about the future role of the dollar in international financial markets." The dollar's future as the world's top currency was thrown into doubt on Tuesday as a report said Arab states had launched secret moves with China and Russia to stop using the greenback for oil trading. Arab states have launched steps with China, Russia, Japan and France to stop using the dollar for oil trades, British daily The Independent reported on Tuesday, but the report was denied by Kuwait and Qatar and reportedly by other nations. The United Nations meanwhile on Tuesday called for a new global reserve currency to end dollar supremacy, which has allowed the United States the "privilege" of building a huge trade deficit. The Independent's Middle East correspondent Robert Fisk wrote in his paper: "In the most profound financial change in recent Middle East history, Gulf Arabs are planning -- along with China, Russia, Japan and France -- to end dollar dealings for oil." They would instead switch "to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council (GCC), including Saudi Arabia, Abu Dhabi, Kuwait and Qatar," added Fisk. Gold, viewed as a safe-haven investment, has won back favour in recent months as the global economy struggles out of its worst slump in decades. The run-up in gold has been largely driven by weakness in the dollar, which makes dollar-priced commodities cheaper for holders of stronger currencies, boosting demand. Gold also wins support from fears about higher inflation because the metal is widely regarded by investors as a safe store of value. Precious metals consultancy GFMS last month warned that the current upward trend in gold may not be sustainable should global stimulus packages fail to boost flagging demand in the battered world economy and inflation fall as a result. The Group of 20 leaders of emerging and developed nations recently agreed at a summit in Pittsburgh not to roll back massive stimulus measures that helped contain a severe global recession.

World Bank could 'run out of money' within 12 months

The World Bank is close to running out of money, its president, Robert Zoellick, has disclosed.

By Edmund Conway, Economics Editor in Istanbul
02 Oct 2009
REUTERS

The Bank, whose job it is to support low-income countries, has had to hand out so much cash in the wake of the financial crisis that its resources could run dry within 12 months. “By the middle of next year we will face serious constraints,” said its president Robert Zoellick, as he launched a major campaign to persuade rich nations to pour more money into the Washington-based institution. He conceded that such a task was likely to be extremely difficult, given the difficulties facing countries in the wake of the developed world’s biggest recession since the Second World War. However, Mr Zoellick, speaking at the opening of the IMF and World Bank annual meetings in Istanbul, said the Bank needed a capital increase of as much as $11.1bn (£6.9bn) to keep functioning. He said he hoped that its shareholders, including the UK and other leading nations, would decide on resources before its spring meeting next April. The money would be shared between the International Bank for Reconstruction and Development – the key part of the bank, which lends to poor nations – and the International Financial Corporation (IFC), which lends to companies. Mr Zoellick said: “We recognise that all countries are under budgetary strain and it is not an easy time to be asking for these things”. He said that a shortfall of cash for the IFC was a cause for particular concern, Mr Zoellick added, “because one of the issues in this recovery is the hand-off from government stimulus programs to private-sector development.” The Bank has had to lend significantly more cash than the three-year $100bn programme it committed to last year because of the virulence of the financial and economic crisis. The majority of the money has been spent ensuring the survival of the most vulnerable nations.

Roubini Says Stocks Have Risen ‘Too Much, Too Soon, Too Fast’

By Shamim Adam and Francine Lacqua
Oct. 5 (Bloomberg) -- New York University Professor Nouriel Roubini, who predicted the financial crisis, said stock and commodity markets may drop in coming months as the gradual pace of the economic recovery disappoints investors.
“Markets have gone up too much, too soon, too fast,” Roubini said in an interview in Istanbul on Oct. 3. “I see the risk of a correction, especially when the markets now realize that the recovery is not rapid and V-shaped, but more like U- shaped. That might be in the fourth quarter or the first quarter of next year.” Stocks have surged around the world in the past six months as evidence mounts that the economy is emerging from its deepest recession since the 1930s. The Standard & Poor’s 500 Index has soared 51 percent from a 12-year low in March while Europe’s Dow Jones Stoxx 600 is up 48 percent. The euphoria contrasts with the cautious tone of Group of Seven policy makers, who said after meeting in Istanbul over the weekend that prospects for growth “remain fragile.”
“The real economy is barely recovering while markets are going this way,” Roubini said. If growth doesn’t rebound rapidly, “eventually markets are going to flatten out and correct to valuations that are justified. I see a growing gap between what markets are doing and the weaker real economic activities.”

‘Anemic’ Recovery

The International Monetary Fund predicts the global economy will expand 3.1 percent in 2010, led by growth in Asia, after a 1.1 percent contraction this year. That is still “anemic” and “very weak,” Roubini said. U.S. stocks fell last week after manufacturing expanded less than anticipated and unemployment climbed to a 26-year high, fueling concern the economy is rebounding more slowly than forecast.
Gains in the S&P 500 have pushed valuations in the index to more than 19 times reported operating profits from the past year, data compiled by Bloomberg show. That’s near the most expensive level since 2004. The performance of the U.S. economy is probably more sluggish than reflected in stock markets, risking a correction in equities, Nobel Prize-winning economist Michael Spence said last month. U.S. stock-market investors have “over processed” the stabilization of growth in the world’s largest economy, Spence said.

Creating Bubbles

The global equity rally has added about $20.1 trillion to the value of stocks worldwide since this year’s low on March 9. Governments have poured about $2 trillion of stimulus into the global economy while central banks have cut interest rates to close to zero in efforts to revive growth. “In the short run we need monetary and fiscal stimulus to avoid another tipping point and to avoid deflation, but now this easy money has already started to create asset bubbles in equities, commodities, credit and emerging markets,” Roubini said. “For the sake of achieving growth stability again and avoiding deflation, we may be planting the seeds of the next cycle of financial instability.”

To contact the reporters on this story: Shamim Adam in Istanbul at sadam2@bloomberg.net; Francine Lacqua in Istanbul at flacqua@bloomberg.net

Banks With 20% Unpaid Loans at 18-Year High Amid Recovery Doubt

By James Sterngold, Linda Shen and Dakin Campbell
Oct. 2 (Bloomberg) -- The number of U.S. lenders that can’t collect on at least 20 percent of their loans hit an 18-year high, signaling that more bank failures and losses could slow an economic recovery.
Units of Frontier Financial Corp.,Towne Bancorp Inc. and Steel Partners Holdings LP are among 26 firms with more than one-fifth of their loans 90 days overdue or not accruing interest as of June 30 -- a level of distress almost five times the national average -- according to Federal Deposit Insurance Corp. data compiled for Bloomberg News by SNL Financial, a bank research firm. Three reported almost half of their loans weren’t being paid. While regulators may not force firms on the list to close, requiring them to raise capital and curb loans may impede recovery in Florida, Illinois and seven other states. The banks are among the most vulnerable of a larger group of lenders whose failures the FDIC said could cost $100 billion by 2013. “There are some zombie banks out there,” said Bert Ely, chief executive officer at Ely & Co., a bank consulting firm in Alexandria, Virginia. “Neither the banking industry nor the economy benefits from keeping weak banks in business.” Ninety-five banks have failed this year at the fastest pace in almost two decades, depleting the FDIC’s insurance fund. The agency proposed on Sept. 29 that financial firms prepay three years of premiums, which would add $45 billion of reserves. The fund sank to $10.4 billion as of June 30, the lowest since 1993. It will run at a deficit starting this quarter, the agency said.
Non-Current Loans
The cost of this year’s failures to the FDIC equals 25 percent of the banks’ assets, according to agency data. Applying the same ratio to the $14.1 billion of assets held by the 26 lenders on SNL’s list means the FDIC could face additional losses of $3.5 billion. Non-current loans averaged 4.35 percent of the total at U.S. banks as of June 30, the most in 26 years of FDIC data. Regulators typically take notice at 5 percent, according to Walter Mix, a former commissioner of the California Department of Financial Institutions. Corus Bankshares Inc.’s bank unit in Chicago was shut Sept. 11 after 71 percent of its loans soured. The last time so many banks had 20 percent of their loans more than 90 days overdue was in 1991, near the end of the savings-and-loan crisis, when there were 60, according to an SNL analysis of FDIC data. That year the number of bank failures was less than half those at the peak of the crisis in 1988; this year closings are almost four times what they were in 2008. For banks with 20 percent of loans overdue, “either they’ve got a massive amount of capital, or the FDIC just hasn’t gotten around to them,” said Jeff Davis, an analyst with FTN Equity Capital Markets in Nashville. Lack of staff and money are slowing shutdowns, he said.
Enforcement Orders
At least 17 of the 26 banks have been hit with civil penalties or enforcement orders that demand improved management and more capital, according to data compiled by Bloomberg. Failure to comply can lead to seizure. The number of distressed banks is larger, with the FDIC counting 416 companies on its confidential list of “problem” lenders at mid-year. The data were compiled by Charlottesville, Virginia-based SNL from FDIC records. Institutions that had loans less than 50 percent of assets were excluded, as were those closed since the end of June. The calculation didn’t include restructured loans modified after borrowers couldn’t keep up with the original terms, which have default rates of 40 percent to 60 percent within two months, according to SNL senior analyst Sebastian Hindman. Had such loans been included, the list would have swelled to 49 lenders holding $48.4 billion in assets.
Local Impact
Firms range in size from Frontier Bank in Everett, Washington, with $3.98 billion in assets, to Gordon Bank in Gordon, Georgia, with $35 million in assets. Six of the banks are in Florida and five in Illinois. “While these aren’t your giant banks, they are the guys your local strip mall and commercial real estate investors get their funds from,” said Joseph Mason, a Louisiana State University banking professor and visiting scholar at the FDIC. The bank with the highest level of non-current loans, 49 percent, is Community Bank of Lemont in Lemont, Illinois, a town of about 13,000 people 30 miles southwest of Chicago. Bad loans at the bank, about a third of them in construction and development, increased fivefold from a year earlier, according to FDIC data. In February, the FDIC ordered Lemont, a unit of Oak Park, Illinois-based FBOP Corp., to stop “operating with management whose policies and practices are detrimental to the bank and jeopardize the safety of its deposits.” Calls to the bank seeking comment weren’t returned.
’A Surprise’
Another Illinois lender, Benchmark Bank, also had an increase in non-current loans, to 25 percent as of June 30 from about 1 percent a year earlier. “Everything was so positive for so long in this area, it came as a surprise when it stopped,” said John Medernach, Benchmark’s CEO, who added that a building boom and bust in his region may have wrecked more than just his balance sheet. “I stop and think of all the rich farmland that has been developed into subdivisions during the boom years,” Medernach said. “It makes you wonder what we’ve been doing.” Frontier Bank, owned by Frontier Financial, reported a sixfold rise in overdue loans to $764.6 million in the quarter ended June 30 from a year earlier, or 22 percent, according to FDIC data. More than 43 percent of the bank’s delinquent loans were in construction and development, FDIC data show. The bank has 51 branches in northwestern Oregon and western Washington.
Steel Partners
In July, Frontier Financial agreed to be acquired by SP Acquisition Holdings Inc., controlled by CEO Warren Lichtenstein, who heads the New York-based investment firm Steel Partners LLC, according to a presentation on the bank’s Web site. The deal would give Frontier access to about $456 million and create ’’an over-capitalized bank’’ that may consider acquisitions, the presentation said. The stock-swap transaction is scheduled to be completed in the fourth quarter. Frontier “was a well-run organization for the majority of its history,” said Jeffrey Rulis, a banking analyst at D.A. Davidson & Co. in Lake Oswego, Oregon. The offer by SP Acquisition is “probably not what current shareholders envisioned a couple of years ago.” The company’s stock has dropped 92 percent in the last 12 months, and the bank posted an $84 million loss in the first half. Patrick Fahey, Frontier’s CEO, said the transaction will resolve the bank’s credit issues. He declined to elaborate while a shareholder vote is pending.
Regulatory Art
Lichtenstein’s Steel Partners Holdings LP controls WebBank, a Salt Lake City lender with $35.5 million in assets and 31 percent of its loans overdue, according to SNL. More than 90 percent of construction and development loans weren’t current as of June 30, according to the FDIC. John McNamara, WebBank’s chairman and a managing director at Steel, declined to comment.
Determining which banks to close is “more of an art than a science,” said William Ruberry, spokesman at the Office of Thrift Supervision, which regulates four of the 26 lenders. “Examiners and the supervisory people have a lot of information that’s not public, and they know the circumstances of an institution and everything that goes into it.” FDIC spokesman Greg Hernandez said in an e-mail that the agency doesn’t comment on individual institutions. Capital levels, profitability and financial strength of the owners are considered in addition to soured loans when deciding a bank’s fate, Hernandez said.
Sources of Capital
“There may be personal guarantees, there may be other collateral that will more than make up for the impairment on the 20 percent,” said Tom Giallanza, assistant superintendent for the State of Arizona Department of Financial Institutions, in a Sept. 15 interview. One bank on the list, Mesa, Arizona-based Towne Bank of Arizona, is in Giallanza’s state, with 28 percent of its loans non-current. Towne Bancorp CEO Patrick Patrick declined to comment. H&R Block Bank, with 29 percent of its loans overdue, is dwarfed by the Kansas City, Missouri-based tax preparer that owns it. The bank’s deposits totaled $720.1 million as of June 30; assets at the parent company, H&R Block Inc., included more than $1 billion in cash and cash equivalents on July 31. The lender’s balance sheet is strong enough to be considered “well- capitalized” by regulators, according to FDIC reports. The bank is a legacy of H&R Block’s subprime home lending that ended with more than $1 billion of losses for the parent company. The unit was kept open because it’s an inexpensive way to fund the company’s financial products, President Russell Smyth said a year ago. Spokeswoman Elizabeth McKinley didn’t respond to requests for comment.
Pace of Closures
Regulators may be pacing themselves on closings because the FDIC fund “is only so big,” there isn’t enough staff to close all the struggling banks at once and customers aren’t staging mass withdrawals that would force action, said Kevin Fitzsimmons, a managing director at Sandler O’Neill & Partners LP, a New York brokerage firm specializing in banks.
While a high level of non-performing assets doesn’t mean a bank can’t survive, “in some cases it creates a hole that’s too deep to climb out of,” Fitzsimmons said.
To contact the reporters on this story: James Sterngold in New York at jsterngold2@bloomberg.net; Linda Shen in New York at lshen21@bloomberg.net; Dakin Campbell in San Francisco at dcampbell27@bloomberg.net.

Social Security strained by early retirements

By STEPHEN OHLEMACHER
September 27, 2009

WASHINGTON (AP) - Big job losses and a spike in early retirement claims from laid-off seniors will force Social Security to pay out more in benefits than it collects in taxes the next two years, the first time that's happened since the 1980s.
The deficits - $10 billion in 2010 and $9 billion in 2011 - won't affect payments to retirees because Social Security has accumulated surpluses from previous years totaling $2.5 trillion. But they will add to the overall federal deficit. Applications for retirement benefits are 23 percent higher than last year, while disability claims have risen by about 20 percent. Social Security officials had expected applications to increase from the growing number of baby boomers reaching retirement, but they didn't expect the increase to be so large.
What happened? The recession hit and many older workers suddenly found themselves laid off with no place to turn but Social Security. "A lot of people who in better times would have continued working are opting to retire," said Alan J. Auerbach, an economics and law professor at the University of California, Berkeley. "If they were younger, we would call them unemployed."
Job losses are forcing more retirements even though an increasing number of older people want to keep working. Many can't afford to retire, especially after the financial collapse demolished their nest eggs. Some have no choice. Marylyn Kish turns 62 in December, making her eligible for early benefits. She wants to put off applying for Social Security until she is at least 67 because the longer you wait, the larger your monthly check. But she first needs to find a job. Kish lives in tiny Concord Township in Lake County, Ohio, northeast of Cleveland. The region, like many others, has been hit hard by the recession. She was laid off about a year ago from her job as an office manager at an employment agency and now spends hours each morning scouring job sites on the Internet. Neither she nor her husband, Raymond, has health insurance. "I want to work," she said. "I have a brain and I want to use it."
Kish is far from alone. The share of U.S. residents in their 60s either working or looking for work has climbed steadily since the mid-1990s, according to data from the Bureau of Labor Statistics. This year, more than 55 percent of people age 60 to 64 are still in the labor force, compared with about 46 percent a decade ago. Kish said her husband already gets early benefits. She will have to apply, too, if she doesn't soon find a job. "We won't starve," she said. "But I want more than that. I want to be able to do more than just pay my bills." Nearly 2.2 million people applied for Social Security retirement benefits from start of the budget year in October through July, compared with just under 1.8 million in the same period last year. The increase in early retirements is hurting Social Security's short-term finances, already strained from the loss of 6.9 million U.S. jobs. Social Security is funded through payroll taxes, which are down because of so many lost jobs.
The Congressional Budget Office is projecting that Social Security will pay out more in benefits than it collects in taxes next year and in 2011, a first since the early 1980s, when Congress last overhauled Social Security.
Social Security is projected to start generating surpluses again in 2012 before permanently returning to deficits in 2016 unless Congress acts again to shore up the program. Without a new fix, the $2.5 trillion in Social Security's trust funds will be exhausted in 2037. Those funds have actually been spent over the years on other government programs. They are now represented by government bonds, or IOUs, that will have to be repaid as Social Security draws down its trust fund.
President Barack Obama has said he would like to tackle Social Security next year. "The thing to keep in mind is that it's unlikely we are going to pull out (of the recession) with a strong recovery," said Kent Smetters, an associate professor at the University of Pennsylvania's Wharton School. "These deficits may last longer than a year or two." About 43 million retirees and their dependents receive Social Security benefits. An additional 9.5 million receive disability benefits. The average monthly benefit for retirees is $1,100 while the average disability benefit is about $920.
The recession is also fueling applications for disability benefits, said Stephen C. Goss, the Social Security Administration's chief actuary. In a typical year, about 2.5 million people apply for disability benefits, including Supplemental Security Income. Applications are on pace to reach 3 million in the budget year that ends this month and even more are expected next year, Goss said. A lot of people who had been working despite their disabilities are applying for benefits after losing their jobs. "When there's a bad recession and we lose 6 million jobs, people of all types are going to be part of that," Goss said.
Nancy Rhoades said she dreads applying for disability benefits because of her multiple sclerosis. Rhoades, who lives in Orange, Va., about 75 miles northwest of Richmond, said her illness is physically draining, but she takes pride in working and caring for herself. In June, however, her hours were cut in half - to just 10 a week - at a community services organization. She lost her health benefits, though she is able to buy insurance through work, for about $530 a month. "I've had to go into my retirement annuity for medical costs," she said. Her husband, Wayne, turned 62 on Sunday, and has applied for early Social Security benefits. He still works part time. Nancy Rhoades is just 56, so she won't be eligible for retirement benefits for six more years. She's pretty confident she would qualify for disability benefits, but would rather work. "You don't think of things like this happening to you," she said. "You want to be in a position to work until retirement, and even after retirement."

The dead end kids

By RICHARD WILNER
September 27, 2009
The New York Post

The unemployment rate for young Americans has exploded to 52.2 percent -- a post-World War II high, according to the Labor Dept. -- meaning millions of Americans are staring at the likelihood that their lifetime earning potential will be diminished and, combined with the predicted slow economic recovery, their transition into productive members of society could be put on hold for an extended period of time.
And worse, without a clear economic recovery plan aimed at creating entry-level jobs, the odds of many of these young adults -- aged 16 to 24, excluding students -- getting a job and moving out of their parents' houses are long. Young workers have been among the hardest hit during the current recession -- in which a total of 9.5 million jobs have been lost.
"It's an extremely dire situation in the short run," said Heidi Shierholz, an economist with the Washington-based Economic Policy Institute. "This group won't do as well as their parents unless the jobs situation changes."
Al Angrisani, the former assistant Labor Department secretary under President Reagan, doesn't see a turnaround in the jobs picture for entry-level workers and places the blame squarely on the Obama administration and the construction of its stimulus bill.
"There is no assistance provided for the development of job growth through small businesses, which create 70 percent of the jobs in the country," Angrisani said in an interview last week. "All those [unemployed young people] should be getting hired by small businesses."
There are six million small businesses in the country, those that employ less than 100 people, and a jobs stimulus bill should include tax credits to give incentives to those businesses to hire people, the former Labor official said.
"If each of the businesses hired just one person, we would go a long way in growing ourselves back to where we were before the recession," Angrisani noted.
During previous recessions, in the early '80s, early '90s and after Sept. 11, 2001, unemployment among 16-to-24 year olds never went above 50 percent. Except after 9/11, jobs growth followed within two years.
A much slower recovery is forecast today. Shierholz believes it could take four or five years to ramp up jobs again.
A study from the National Longitudinal Survey of Youth, a government database, said the damage to a new career by a recession can last 15 years. And if young Americans are not working and becoming productive members of society, they are less likely to make major purchases -- from cars to homes -- thus putting the US economy further behind the eight ball.
Angrisani said he believes that Obama's economic team, led by Larry Summers, has a blind spot for small business because no senior member of the team -- dominated by academics and veterans of big business -- has ever started and grown a business.
"The Reagan administration had people who knew of small business," he said.
"They should carve out $100 billion right now and create something like $5,000 to $6,000 job credits that would drive the hiring of young, idled workers by small business."
Angrisani said the stimulus money going to extending unemployment benefits is like a narcotic that is keeping the unemployed content -- but doing little to get them jobs.
Labor Dept. statistics also show that the number of chronically unemployed -- those without a job for 27 weeks or more -- has also hit a post-WWII high.

Health-Care Reform and the Constitution: Why hasn't the Commerce Clause been read to allow interstate insurance sales?

By Andrew P. Napolitano
September 15, 2009, 8:57 A.M. ET

Last week, I asked South Carolina Congressman James Clyburn, the third-ranking Democrat in the House of Representatives, where in the Constitution it authorizes the federal government to regulate the delivery of health care. He replied: "There's nothing in the Constitution that says that the federal government has anything to do with most of the stuff we do." Then he shot back: "How about [you] show me where in the Constitution it prohibits the federal government from doing this?"

Rep. Clyburn, like many of his colleagues, seems to have conveniently forgotten that the federal government has only specific enumerated powers. He also seems to have overlooked the Ninth and 10th Amendments, which limit Congress's powers only to those granted in the Constitution. One of those powers—the power "to regulate" interstate commerce—is the favorite hook on which Congress hangs its hat in order to justify the regulation of anything it wants to control. Unfortunately, a notoriously tendentious New Deal-era Supreme Court decision has given Congress a green light to use the Commerce Clause to regulate noncommercial, and even purely local, private behavior. In Wickard v. Filburn (1942), the Supreme Court held that a farmer who grew wheat just for the consumption of his own family violated federal agricultural guidelines enacted pursuant to the Commerce Clause. Though the wheat did not move across state lines—indeed, it never left his farm—the Court held that if other similarly situated farmers were permitted to do the same it, might have an aggregate effect on interstate commerce. James Madison, who argued that to regulate meant to keep regular, would have shuddered at such circular reasoning. Madison's understanding was the commonly held one in 1789, since the principle reason for the Constitutional Convention was to establish a central government that would prevent ruinous state-imposed tariffs that favored in-state businesses. It would do so by assuring that commerce between the states was kept "regular."

The Supreme Court finally came to its senses when it invalidated a congressional ban on illegal guns within 1,000 feet of public schools. In United States v. Lopez (1995), the Court ruled that the Commerce Clause may only be used by Congress to regulate human activity that is truly commercial at its core and that has not traditionally been regulated by the states. The movement of illegal guns from one state to another, the Court ruled, was criminal and not commercial at its core, and school safety has historically been a state function. Applying these principles to President Barack Obama's health-care proposal, it's clear that his plan is unconstitutional at its core. The practice of medicine consists of the delivery of intimate services to the human body. In almost all instances, the delivery of medical services occurs in one place and does not move across interstate lines. One goes to a physician not to engage in commercial activity, as the Framers of the Constitution understood, but to improve one's health. And the practice of medicine, much like public school safety, has been regulated by states for the past century. The same Congress that wants to tell family farmers what to grow in their backyards has declined "to keep regular" the commercial sale of insurance policies. It has permitted all 50 states to erect the type of barriers that the Commerce Clause was written precisely to tear down. Insurers are barred from selling policies to people in another state.

That's right: Congress refuses to keep commerce regular when the commercial activity is the sale of insurance, but claims it can regulate the removal of a person's appendix because that constitutes interstate commerce. What we have here is raw abuse of power by the federal government for political purposes. The president and his colleagues want to reward their supporters with "free" health care that the rest of us will end up paying for. Their only restraint on their exercise of Commerce Clause power is whatever they can get away with. They aren't upholding the Constitution—they are evading it. Mr. Napolitano, who served on the bench of the Superior Court of New Jersey between 1987 and 1995, is the senior judicial analyst at the Fox News Channel. His latest book is "Dred Scott's Revenge: A Legal History of Race and Freedom in America" (Nelson, 2009).

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

Both bank credit and the M3 money supply in the United States have been contracting at rates comparable to the onset of the Great Depression since early summer, raising fears of a double-dip recession in 2010 and a slide into debt-deflation.

By Ambrose Evans-Pritchard, International Business Editor
14 Sep 2009

Professor Tim Congdon from International Monetary Research said US bank loans have fallen at an annual pace of almost 14pc in the three months to August (from $7,147bn to $6,886bn). "There has been nothing like this in the USA since the 1930s," he said. "The rapid destruction of money balances is madness." The M3 "broad" money supply, watched as an early warning signal for the economy a year or so later, has been falling at a 5pc annual rate. Similar concerns have been raised by David Rosenberg, chief strategist at Gluskin Sheff, who said that over the four weeks up to August 24, bank credit shrank at an "epic" 9pc annual pace, the M2 money supply shrank at 12.2pc and M1 shrank at 6.5pc. "For the first time in the post-WW2 [Second World War] era, we have deflation in credit, wages and rents and, from our lens, this is a toxic brew," he said. It is unclear why the US Federal Reserve has allowed this to occur. Chairman Ben Bernanke is an expert on the "credit channel" causes of depressions and has given eloquent speeches about the risks of deflation in the past.

He is not a monetary economist, however, and there are indications that the Fed has had to pare back its policy of quantitative easing (buying bonds) in order to reassure China and other foreign creditors that the US is not trying to devalue its debts by stealth monetisation. Mr Congdon said a key reason for credit contraction is pressure on banks to raise their capital ratios. While this is well-advised in boom times, it makes matters worse in a downturn. "The current drive to make banks less leveraged and safer is having the perverse consequence of destroying money balances," he said. "It strengthens the deflationary forces in the world economy. That increases the risks of a double-dip recession in 2010."

Referring to the debt-purge policy of US Treasury Secretary Andrew Mellon in the early 1930s, he added: "The pressure on banks to de-risk and to de-leverage is the modern version of liquidationism: it is potentially just as dangerous." US banks are cutting lending by around 1pc a month. A similar process is occurring in the eurozone, where private sector credit has been contracting and M3 has been flat for almost a year. Mr Congdon said IMF chief Dominique Strauss-Kahn is wrong to argue that the history of financial crises shows that "speedy recovery" depends on "cleansing banks' balance sheets of toxic assets". "The message of all financial crises is that policy-makers' priority must be to stop the quantity of money falling and, ideally, to get it rising again," he said. He predicted that the Federal Reserve and other central banks will be forced to engage in outright monetisation of government debt by next year, whatever they say now.

Economist warns of double-dip recession

By Robert Cookson and Sundeep Tucker in Hong Kong

September 14 2009 15:01 | Last updated: September 14 2009 15:01

The world has not tackled the problems at the heart of the economic downturn and is likely to slip back into recession, according to one of the few mainstream economists who predicted the financial crisis.

Speaking at the Sibos conference in Hong Kong on Monday, William White, the highly-respected former chief economist at the Bank for International Settlements, also warned that government actions to help the economy in the short run may be sowing the seeds for future crises. “Are we going into a W[-shaped recession]? Almost certainly. Are we going into an L? I would not be in the slightest bit surprised,” he said, referring to the risks of a so-called double-dip recession or a protracted stagnation like Japan suffered in the 1990s. “The only thing that would really surprise me is a rapid and sustainable recovery from the position we’re in.” The comments from Mr White, who ran the economic department at the central banks’ bank from 1995 to 2008, carry weight because he was one of the few senior figures to predict the financial crisis in the years before it struck.

Mr White repeatedly warned of dangerous imbalances in the global financial system as far back as 2003 and – breaking a great taboo in central banking circles at the time – he dared to challenge Alan Greenspan, then chairman of the Federal Reserve, over his policy of persistent cheap money. On Monday Mr White questioned how sustainable the signs of life in the global economy would prove to be once governments and central banks started to withdraw their unprecedented stimulus measures. “The green shoots are certainly out there – the question is what kind of fertiliser is being used on them,” he said.

Worldwide, central banks have pumped thousands of billions of dollars of new money into the financial system over the past two years in an effort to prevent a depression. Meanwhile, governments have gone to similar extremes, taking on vast sums of debt to prop up industries from banking to car making. These measures may already be inflating a bubble in asset prices, from equities to commodities, he said, and there was a small risk that inflation would get out of control over the medium term if central banks miss-time their “exit strategies”. Meanwhile, the underlying problems in the global economy, such as unsustainable trade imbalances between the US, Europe and Asia, had not been resolved, he said. Also present at the Sibos conference was Joseph Yam, who is stepping down as chief executive of the Hong Kong Monetary Authority after 16 years. He told delegates of the myriad “challenges” facing those working for greater stability in the financial sector.

In a hard-hitting address, Mr Yam said that large banking profits and staff bonuses led to lower financial efficiency and contributed to the financial crisis. Mr Yam is tipped to become an adviser to the People’s Bank of China, the country’s central bank, after he leaves his post next month. He said there was a conflict between the private, short term interest of financial groups to maximise profits and the public interest of effective financial intermediation that provided support to the economy. “This conflict has not been talked about much, if at all, even in central banking forums,” he said.

Why some economists could see it coming

By Dirk Bezemer

September 8 2009 03:00 | Last updated: September 8 2009 03:00

From the beginning of the credit crisis and ensuing recession, it has become conventional wisdom that "no one saw this coming". Anatole Kaletsky wrote in The Times of "those who failed to foresee the gravity of this crisis" - a group that included "almost every leading economist and financier in the world". Glenn Stevens, governor of the Reserve Bank of Australia, said: "I do not know anyone who predicted this course of events. But it has occurred, it has implications, and so we must reflect on it." We must indeed.

Because, in fact, many had seen it coming for years. They were ignored by an establishment that, as the former Federal Reserve chairman Alan Greenspan professed in his October 2008 testimony to Congress, watched with "shocked disbelief" as its "whole intellectual edifice collapsed in the summer [of 2007]". Official models missed the crisis not because the conditions were so unusual, as we are often told. They missed it by design. It is impossible to warn against a debt deflation recession in a model world where debt does not exist. This is the world our policymakers have been living in. They urgently need to change habitat.

I undertook a study of the models used by those who did see it coming.* They include Kurt Richebächer, an investment newsletter writer, who wrote in 2001 that "the new housing bubble - together with the bond and stock bubbles - will [inevitably] implode in the foreseeable future, plunging the US economy into a protracted, deep recession"; and in 2006, when the housing market turned, that "all remaining questions pertain solely to [the] speed, depth and duration of the economy's downturn". Wynne Godley of the Levy Economics Institute wrote in 2006 that "the small slowdown in the rate at which US household debt levels are rising resulting from the house price decline, will immediately lead to a sustained growth recession before 2010". Michael Hudson of the University of Missouri wrote in 2006 that "debt deflation will shrink the 'real' economy, drive down real wages, and push our debt-ridden economy into Japan-style stagnation or worse". Importantly, these and other analysts not only foresaw and timed the end of the credit boom, but also perceived this would inevitably produce recession in the US. How did they do it?

Central to the contrarians' thinking is an accounting of financial flows (of credit, interest, profit and wages) and stocks (debt and wealth) in the economy, as well as a sharp distinction between the real economy and the financial sector (including property). In these "flow-of-funds" models, liquidity generated in the financial sector flows to companies, households and the government as they borrow. This may facilitate fixed-capital investment, production and consumption, but also asset-price inflation and debt growth. Liquidity returns to the financial sector as investment or in debt service and fees.

It follows that there is a trade-off in the use of credit, so that financial investment may crowd out the financing of production. A second key insight is that, since the economy's assets and liabilities must balance, growing financial asset markets find their counterpart in a growing debt burden. They also swell payment flows of debt service and financial fees. Flow-of-funds models quantify the sustainability of the debt burden and the financial sector's drain on the real economy. This allows their users to foresee when finance's relation to the real economy turns from supportive to extractive, and when a breaking point will be reached.

Such calculations are conspicuous by their absence in official forecasters' models in the US, the UK and the Organisation for Economic Co-operation and Development. In line with mainstream economic theory, balance sheet variables are assumed to adapt automatically to changes in the real economy, and can thus be safely omitted. This practice ignores the fact that in most advanced economies, financial sector turnover is many times larger than total gross domestic product; or that growth in the US and UK has been finance-driven since the turn of the millennium.

Perhaps because of this omission, the OECD commented in August 2007 that "the current economic situation is in many ways better then what we have experienced in years . . . Our central forecast remains indeed quite benign: a soft landing in the United States [and] a strong and sustained recovery in Europe." Official US forecasters could tell Reuters as late as September 2007 that the recession in the US was "not a dominant risk". This was well after the Levy Economics Institute, for example, predicted in April of that year that output growth would slow "almost to zero sometime between now and 2008".

Policymakers have resisted inclusion of balance sheets and the flow of funds in their models by arguing that bubbles cannot be easily identified, nor their effects reliably anticipated. The above analysts have shown that this is, in fact, feasible, and indeed essential if we are to "see it coming" next time. The financial sector is just as real as the real economy. Our policymakers, and the analysts they rely on, ignore balance sheets and the flow of funds at their peril - and ours.

* ' No One Saw This Coming': Understanding Financial Crisis Through Accounting Models, MPRA

The writer is a fellow at the economics and business department of the University of Groningen in the Netherlands