A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Saturday, December 31, 2011

Transcript: 486 New Year's Non-Happenings

Apologies to our long-time listeners for the spotty podcasting over the past few months. We have pressure from other commitments, which we hope at some point will subside. But we cannot pass up the turn of the year and the opportunity to produce our annual list of events widely reported and sincerely repeated that did not actually happen.

Included on the list,
  • Housing prices bottomed and a recovery in housing began
  • Labor markets recovered, substantial improvements to employment
  • The European debt situation stabilized, banks were in good shape
  • The U.S. returned to more robust growth.
  • Investment rebounded, and provided an important upward impulse for GDP
  • U.S. banks stabilized, with sufficient capital and improving prospects.
  • Bank regulation via the Dodd-Frank Act has made the financial sector safer.

Listen to this episode

First, as most of you are aware, the much ballyhooed passage of the Dodd-Frank Act has resulted in 18 months of intensive backroom lobbying to create nothing. The Consumer Finance Protection Agency is stillborn because of an unprecedented refusal of Congressional Republicans to confirm its director. We had great hopes for this agency, not just to make fine print on the back page into big print on the front page, but to standardize financial products, and so structure the market, so the market could work. Such an organization brings a bit of market discipline, since banks, credit card companies and finance agencies can no longer disguise and misrepresent their products. Mortgages, credit cards, other financial products would be easier to understand and compare.

That would be a major setback to financial product engineers, since the agency would be flexible enough to respond to new products. At least the capacity would be there. The Congress is now blowing a smokescreen of smaller, less intrusive government to cover giving the keys back to Wall Street.

The tragedy of Dodd-Frank, sung in falsetto by designated Wall Street divas and rebroadcast by the Wall Street Journal, Bloomberg and others did not just happen. The exceptions, exclusions and conditions basically allow the big banks to continue in the same incentive structure, trading on their own accounts, continuing to write backroom bets, and continuing to carry massive losses without recognizing them.

This is probably the most important non-event of 2011. A non-change in corporate culture.

But there are others.

Let’s take the return to growth story, since it has some interesting twists. As you may remember, our forecast last January, well … here
As an economic recovery denier, Demand Side can hardly be expected to have the optimistic view of the world going forward that most economic forecasters are demonstrating. The blue chip forecasters are in the stratosphere compared to our assessment of the probable experience of the economy in 2011 and beyond.

Our short form for 2010 was the economy would continue to bounce along the bottom, with significant downside risks from European debt and banking problems and from domestic weakness in commercial real estate. We saw only modest manifestation of those risks in 2010.

The short form for our 2011 outlook is that those risks will be put in play in 2011, triggered by the traditional trigger, rising oil and commodity prices.

But ours was not so accurate.

And we’ll take a detailed look at that in an upcoming podcast.

One thing for today: If you look at the charts, the starting point number is the most wrong. We should have just continued the line from our previous forecast, instead we took the BEA’s number from Q3 2010, the usually final revision, and plugged it in. Only to find it rolled back down in an extraordinary revision in late spring 2011.

The chief state forecaster put it this way in a recent session we sat in on. “Forecasts are very sensitive to the last data point.” We muttered under our breath, “Forecasting the past.” But it wasn’t the latest data point we took, it was three data points back. Quack Quack Quack.

As we cling to our forecast of bouncing along the bottom, with downside risks, we are sometimes concerned that we are stubborn for our own account, not willing to admit defeat, preferring to save face rather than adapt our views. Nah.

Then we look at the media and the people they run up for the edification of their viewers and listeners. That leads us to Idiot of the Week co-winners Leslie Curwen of Business Daily and Pippa Malmgren, the advisor to George W. Bush on financial market issues for the President, which included corporate governance, bank regulation, Government Sponsored Enterprises, mortgages, deposit insurance. Curwen hosted a program with the auspicious title “In the Balance,” and ran Ms. Malmgren up on a panel with former British Chancellor Allistair Darling. Similar to running

But let’s take a listen
PIPPA MALMGREN: Without a doubt, look, Greece has already said, “At best, we’ll pay back 50% of the debt.” But the markets are discounting that they will be lucky to get 20 cents on the Euro out of the Greeks.

If you were Italian, or even Irish Irish, Why would you pay 100% of the debt if the other guys only have to pay half.

ALISTAIR DARLING: Greece is two percent of the Euro area economy

PIPPA MALMGREN: It doesn’t matter…


PIPPA MALMGREN: t doesn’t matter if it’s small. The problem is Italy, the problem is Spain, and even the problem is France, where their banks are on the brink of exactly the same kind of meltdown as we saw then. So the issue of default is imminent. It is with us now. And it remains a problem in an environment where we don’t have the cash to throw at it.

Governments do not create jobs. What we’ve got to do is find ways to lift the tax burden, lift the red tape, from that community, in order to get growth back. That is the end of the story.

Ms. Malmgren starts out as if she has some clue, that quickly dissolves as she conflates the problems of the sovereigns with those of the banks. Then she goes into the absurdity of entrepreneurial risk-taking being the magic ring. She postulates a magic of entrepreneurship that is a figment of her imagination. As must such analysts, she prefers an alternative universe, most likely for its efficacy in this one. It helps keep her job because it plays to the prejudices of her employers. It does not explain anything about this universe. If small business were so important, you’d think she’d talk to small businessmen.

According to the National Federation of Independent Business and its chief economist Bill Dunkelberg, who is hardly a left wing Keynesian, the biggest problem for small business is demand.

At best small business is the tractor. It is not the field, the crop, the rain or the sunshine. It works often quite nimbly if those things are provided, those components of demand. But by itself, it doesn’t produce anything. Saying entrepreneurship is going to save the day is like saying if we super-charge the tractor it is going to grow a crop in the garage.

But as bad as it is that Ms. Malmgren is still getting a hearing, with her history – George W. Bush’s chief advisor, self-proclaimed, on corporate governance, bank regulation, Government Sponsored Enterprises, mortgages, deposit insurance. (How well those turned out!), it is worse that the media – here Business Daily and Leslie Curwen, is still giving her that platform.

So Pippi Malmgren, Leslie Curwen, Business Daily.


We have not reached this place, stagnating employment combined with perpetual crises, because our guides knew where they were going. Record debt, enormous unemployment, massive use of planet-killing fossil fuels, crumbling infrastructure. It is as if your doctor said you have to keep smoking because you need to keep breathing, and don’t worry about the muscles and bones – they’ll take care of themselves when you get back to health.

Companies like Apple … well, maybe only Apple .. are cited as the exemplars of what could be done. We need to have a planet of Apples producing great gobs of technical advances so every nation can be an exporter. I mean, please.

Regardless of the arithmetic impossibility, we need to employ our people in useful tasks, not outfit the technologically advanced with new ways to do old things, no matter how magical. There are people to feed, clothe, house, educate, transport, and keep in good health.

Even more to the point, Apple does not produce the great net gain attributed to it. It takes from the old technologies. Newspapers are failing, traditional media is stagnating, landline telephones are like Model T’s. This is creative destruction, in Shumpeter’s terms, that is driving new investment. Great. But it is on a pitiful scale.

The creative destruction we need is to replace fossil fuels with clean energy, replace auto-based transportation with rail-based, somehow adapt or recreate a housing stock and an urban design with something that works for older people, and more people, and uses one-quarter the energy.

You just don’t get there by saying, first cheap gasoline, then trust the market.

And note, No country should be a net exporter. Sorry. That’s what has built the imbalances. Germany has created a virtue out of a vice, and now stands over Europe waving a promissory note. Shades of Economic Consequences of the Peace. That was Keynes’ break-out work, written after he quit the negotiations at Versailles in disgust. The Allies after World War I were in the process of imposing impossible austerity upon the Germans and he saw that it was, first, impossible, and second would lead to social disruption.

China has built an export machine while exposing its people to ever greater insecurity. The U.S. has borrowed its way to basically being an obese matron with tattoos and a nice hat.

So when the pundits nod sagely and say, “Yes, we have to endure a period of deleveraging and below-par employment growth,” don’t believe they know what they’re talking about. This time last year they were saying, “We’re on our way.” Two short years ago, they were saying, “The recovery is just over the hill. All we need to do is save the banks some more and make those corporations profitable. Investment will boom, companies will hire.” Well, we’re over the hill. This is not the road to recovery.

To say the least.

Saturday, December 17, 2011

Richard Parker on the Market as God and the Greek window

Wall Streetʼs Role in the European Financial Crisis - Richard Parker, Lecturer in Public Policy and Senior Fellow at the Shorenstein Center, Kennedy School of Government, Harvard University

Friday, December 16, 2011

Stephen Marglin on Alternatives to Mankiw's Ideology

Heterodox Economics: Alternatives to Mankiw’s Ideology - Stephen Marglin, Walter Barker Professor of Economics, Faculty of Arts and Sciences, Harvard University

Friday, December 9, 2011

Transcript 477: Will the Euro Survive? Wrong Question.

Today we return briefly to the podcast on the eve of the non-answer from the European heads of state. It must be a non-answer because it responds to the wrong question.

The question? “Will the euro survive?” Wrong question, since the euro could survive as the currency of a stable economic union or it could survive as the smoke above the rubble.
Listen to this episode

The real question is the debt. Enormous financial obligations have been incurred that cannot be paid back. Households and businesses and governments. Businesses somewhat less so because policy-makers have made the borrowing in that sector cheaper as one of their ineffectual ways of addressing problems that are not addressed by making borrowing for businesses cheaper.

These financial obligations are the liabilities of households and governments and the assets of the financial sector, investors and banks. Because they cannot be paid back, investors will lose money and banks will go under. Though there is the hope the governments can be persuaded or coerced into paying off at 100 cents on the dollar. And that is where we are now.

In the U.S. it was the Fed buying up trillions in mortgage backed securities and other financial instruments while at the same time financing banks and their traders at zero percent, even as the social safety net absorbed millions of people thrown out of work to make way for a corporate sector as profitable as it has been since …. well, it has never been more profitable. The current call is for the European Central Bank to follow suit, and the taxpayers of Europe to follow the lead of their American counterparts.

Why will these debts not be paid back? Because they cannot be paid back. Why can they not be paid back? Because there is no productive source from which to pay them back. They did not finance productive assets. They financed consumption and housing bubbles. Just like in the U.S. when a housing bubble produced massive paper wealth exactly because it was financed by debt. In the clear light of morning, when the value of housing as housing becomes the source of house payments, trillions of dollars in housing as a financial asset disappeared, leaving trillions of dollars in debt on household balance sheets for which there was no asset to balance. All that paper wealth and all that consumption is behind us. Just like the financial asset part of housing. Those dollars have been spent. Only the debt remains.

As Minsky taught us, we have productive finance – what he called “hedge”, we have rollover finance – what he called “speculative”, and we have Ponzi finance – his term. We floated our economies from 2000 to 2007 by building the debt. Now it’s time to pay the piper. But in a macroeconomic sense, unless there is a productive source, payback will appear as contraction, which will actually contract the ability to pay. The piper is going to have to be paid back with the memory of his own music.

So, let’s leave aside the necessary and essential ways of dealing with this debt – writing it down or taxing the winners to pay it off – and let’s look at what is happening in the Euro Crisis. Fundamentally, the banks and bond vigilantes are demanding action and the political establishment has been called in as enforcers. Enforcers of an austerity, the contraction of economies, starvation as opposed to production. Now it appears the banks and bond vigilantes need German control of all national budgets by the middle of next month. Such is the desperation.

This does not mean that the debts won’t be shifted by this action. Indeed, that is the purpose. To shift the assets from the banks who hold them to the taxpayers or central bank. But they won’t be repaid unless there is growth in value with which to repay them. Or unless the winners from the whole boom are taxed to pay them. Right now it is a scramble for the best fitted vigilantes to keep their Ponzi gains at the expense of the rest.

A parenthetical:

The Mundell Trilemma, aka the Unholy Trinity.

Robert Mundell proposed that a country can have any two of the following three options
  • A stable exchange rate
  • Free capital flows
  • Economic sovereignty

Here we have the Eurozone on the horns of this trilemma. The euro provides exchange rates that do not vary because there is only one. The Eurozone free capital flows washed in and are washing out. And the only answer everyone agrees upon is for nations to give up their taxing, interest rate, and spending decisions to some as-yet-unidentified fiscal general.

But the point is – It still doesn’t work. The idea that austerity or German prudence can produce net gains from which profligate German banks can be paid back is just wrong. There is no example of its working, and God knows the IMF has tried it everywhere. Abandoning the euro by a country such as Italy or Spain allows them to write down their debt by unilaterally re-denominating it in the domestic currency. The same thing could be done by a simple haircut in euros. Saves the euro, stabilizes economies, gets things going again.

But the banks don’t survive, either the collapse of the euro and the debts being recalibrated in domestic currencies, or a simple write-down of debt to payable levels, referred to by hysterical traders as a default. The whole Rube Goldberg financial sector contraption comes apart sooner or later, notwithstanding the fact that it has already begun to seize up. Bond investors, hedge funds, banks, all connected by a series of speculative financing structures, comes apart.

Well, that is what happens. Sooner or later. It’s just a case of a forty-pound parasite on a fifty-pound dog.

And before we leave, we should remember we saved the banking sector only a couple three years ago, absorbed its bad housing bets, bridge-loaned even the most egregious speculators – think Goldman Sachs – and set it up to continue doing what it was doing before. All in the name of “Banks first, economy to follow.” It was an explicit quid pro quo that turned into a failed experiment, or at least an experiment in failure. In fact, the experiment did produce the positive knowledge that socializing banking and investor losses doesn’t avert subsequent crises, nor does it lead the real economy back into the light.

The world and the U.S. economies are broken. The fixes are not cosmetic. Current plans to address the problems are ineffectual, or in the case of austerity actually are making matters worse. The policy-makers in thrall to an establishment continue to muddle around in a circus of impotence. Their economic theory is contradicted by events, predicts nothing, diagnoses nothing. It is run up as backdrop to the press conferences of banking and political establishments, but no longer expressed out loud. The diagnosis of a nervous condition, even as the bloodstains spread on the blankets, is malpractice. In the case of the Fed, administering blood thinners to a hemophiliac, it is worse.

On one hand you have a tepid recovery – what we at Demand Side call bouncing along the bottom – which orthodox apologists actually cite as evidence of some sort of success. On the other hand you have massive government deficits and ridiculously low interest rates, which are, in turn, cited as evidence of government being the problem and bankers doing what is necessary. GDP growth is barely above a flat line, in spite of these historically unprecedented interventions. This is not a sign of health or even stability. it is a sign of an economy on life support.

The real economy’s muscular and skeletal systems are atrophying as the patient lies abed. The labor market continues to shrink, jobs continue to deteriorate, median incomes continue to fall, infrastructure continues to crumble, environmental systems continue to decay, education continues to be hollowed out, health care continues to be too costly and not effective, and the transition to a sustainable future for an aging population is being pushed away, rather than brought forward.

Parenthetically, the looming climate crisis is likely to be annotated by the establishment in the same way as the financial crisis – “Why didn’t the government do something? Not our fault.” Well, government didn’t do something because you control government and you told them not to do anything.

Just to highlight how far we are from substantive measures, look at the current fight in Congress over the payroll tax. Obama and the Democrats want to extend the payroll tax cut for another year, at the cost of $180 billion. That’s gross. Net would be less, as some tax revenue will accrue. But what if they hired 4 million people at $45,000 per? They could do things we desperately need to have done. The job multiplier would add at least 3 million more. Income stagnation for the rest of us would end. Same cost. End of unemployment problem. It’s all very well and good to goose consumption for the middle class, I suppose, but it is not job holders who are suffering the most, and it is not by adding another consumer discretionary to the pantry that we are going to get out of this mess.

Is it better than nothing? Not if it is advertised as a solution when it is a placebo. Seven million jobs is direct pressure over a gaping wound.

Before we leave today, look on the blog for a couple of charts.

One from Calculated Risk shows the drop in household wealth. From 2007 to Q3 2011, a loss of about 100 percent of GDP. Nothing more clearly illustrates the bubbles of the 1990s in stocks and of the 2000s in housing. Nor does anything illustrate so well the Ponzi nature of this wealth. Hidden is the difference between debt and so-called equity, the definition of net worth. The debt is sliding a bit, but not as fast as the equity, and so we go into debt deflation.

The second chart taken off Bloomberg is an update of our bunny hops in commodity markets. We noted a couple of months ago the improbably regular pattern of mini-boom and bust that has marked this casino table. Since the peak of the commodities bubble back in April, there has been a two-month cycle, until the past few weeks.

The regular pattern would have us continuing down toward a negative ten in the index, or about $80 per barrel in oil. Not so quick, say the traders. We need some place to play now that Europe is needing the house to clean up our mess. A blip up. The end of the year will be interesting. Commodities are flat for the year, in spite of the 20 percent rise from January to April.

Happy gaming.

Tuesday, December 6, 2011

Joseph Stiglitz: Macroeconomics in Crisis

Joseph Stiglitz's presentation on the occasion of CERGE-EI's 20th anniversary on Monday, 10 October 2011 in Prague, Czech Republic.

The full video, and a highly edited (for style, not substance) series of audio files below.

Macroeconomics in Crisis
Audio Files:

Part 1

Part 2

Part 3

Part 4

Q&A Question 1

Q&A - Question 2A and 2B

Q&A - Question 3

Tuesday, October 25, 2011

Roubini Week: Summary of Perth Address

50 Percent Chance of Another Recession
by Nouriel Roubini

From Perth Now:

THE economist known as “Dr Doom” has tipped a more than 50 per cent chance of another global recession that could force the break-up of the eurozone.

Professor Nouriel Roubini spelled out for delegates at the Commonwealth Business Forum in Perth today there were potential positive and negative impacts stemming from the current global financial turbulence and uncertainty surrounding the Eurozone.

Specifically, he suggested there was a “significant probability” of a double dip recession engulfing most advanced economies around the world, stemming from unresolved issues in Europe.

“In my view, there’s a significant probability – more than 50 per cent – that over the next 12 months, there’s going to be another recession in most advanced economies,” the New York University professor said.

“If we look at the situation in the United States, in the Eurozone and in the United Kingdom, the chances of another recession are significant.

“Whether you call it a double dip recession, or a cultivation of the first recession or a second recession it doesn’t matter – it’s semantic.”

Professor Roubini also suggested there could be disorderly defaults and, in turn, a disorderly break up of the Eurozone

“If we’re asking ourselves whether the recession in advanced economies is going to be mild or whether it will be severe…the answer very much depends on what happens in the Eurozone,” he explained.

“If the Eurozone is able to control its own crisis, the recession will be relatively mild.

“But if the situation in the Eurozone becomes disorderly, with defaults by a number of countries, and [there is ] a disorderly exit of a number of members of the Eurozone, and eventually a break up, that shock could be as large, if not larger, than the disorderly collapse of Lehmann [Brothers] in the fall of 2008.”

He also mooted a “hard landing” for China’s economy in the not too distant future because of its “unsustainable model” based on significant over investment, which he said now makes up almost 50 per cent of the nation’s GDP.

“Over investment booms during the last 60 years have resulted in a hard landing for that economy,” he said.

He added that China’s massive growth will stall by 2013-14, increasing the chances of a hard landing.

Two rounds of thunderous applause greeted Professor Roubini at the close of his 45 minute presentation to the diverse corporate audience on the first day of the Commonwealth Business Forum.

Mining magnate Gina Rinehart and well-regarded deal-maker and Commonwealth Business Council member, Mark Barnaba were among the throng of business-minded attendees listening attentively to the speech from the man who predicted the global financial crisis two years prior to the fallout.

Even Dr Mohan Kaul, the boss of the Commonwealth Business Council which oversees the Forum, was impressed by the quality of Professor Roubini’s interpretation and forecast of global economic factors.

“Wow,” Dr Kaul said.

“What a speech!”

One member of the audience who wished to remain unidentified said he was blown away by the pace at which the economist delivered his dire predictions.

“He hardly even took a breath,” he said.

Wednesday, October 19, 2011

Net Real GDP Historical Charts

A long-time listener asked about historical charts for Net Real GDP. Here are some 1947 through 2006.

(click on the charts for a larger image in a new window)

Transcript 463: Forecast Interest Rates

Today on the podcast, interest rates. And the return of Idiot of the Week. Plus some audio from Robert Shiller, advocating direct employment of people in public works, the true Keynesian prescription.
Listen to this episode

First, Shiller. We like this audio because it uses the best metaphor for the economy and government – the family farm. We’ve used it before, and welcome its introduction to polite society. Here from Weekend Business with Jeff Sommer.

Well, part of the jobs bill was infrastructure investment. And another part of the bill was raising taxes to pay for it. There were other parts, too, but let's focus on those.

On a farm, there are times when unemployment becomes a problem. Notably, in the winter, right? There's no crops to plant. There's no fertilizer to use. There's no harvesting to do. So, what do you think a farm does? Well, people don't want to sit around doing nothing, so they fix the barn, or they build a bridge over the creek. Or whatever. And I think that's what this part of the Obama American Jobs Act was doing. It was putting people to work on sensible projects that are not being done.

Going back to the Nineteenth Century, this idea seems obvious to many people. Unemployed people doing nothing is a huge waste of human talent. And so they came up with all kinds of infrastructure ideas. You know, building canals, or dams, or railroads, or improving harbors. And some of those were done, but they had a bit of a problem. I think it's the same problem we are facing right now.

It's not "the Republicans." It's a long-standing attitude in this country that we don't tax some people to bail out others. Taxing the rich to bail out the poor, unemployed, has never been that popular in this country. There is a lot of opposition to tax increases.

You see, the thing that I am emphasizing is that if you take the part of the bill, the infrastructure and tax increase part of the bill, it was more than balanced budget. Those parts together would have helped cure the deficit as well. People are really opposed to tax increases and deficit spending. But I think in the new political environment, this could change. Because these demonstrations are having an effect.

You know, this crisis might last for years. We might have unemployment over nine percent three years from now. People are tired of this. It's been already four years since the recession began. And I think the political winds could change. I am not going to take it as a given that we can never do sensible things like raise taxes on higher-income people and put unemployed people back to work. That's sensible, and I think the American people may well support that.
Indeed, you hear people say, “Why can’t the government be more like me and my household? I don’t spend more than I make.” Well, if you have a mortgage, you are spending more than you make. Your indebtedness is right on par with many of the most profligate of national governments. You could sell your house, you say. Well, the government could sell Yellowstone Park or the Interstate Highway System, or a host of natural monopolies.

The point is, like a farm family, we have old people, young people, infrastructure needs, a future to plan for, and a complex of activities that are simplified out of existence in the household metaphor. We are not just going to work, collecting a paycheck, and coming home to pay the bills. We don’t have to worry about protecting ourselves from the neighbors, building roads to work, educating our children in-house, providing for the old people’s health and retirement, and so on, all of which – and more – you need to include in your calculations if you are going to do away with the support of public goods in your self-righteousness.


And now, Howard Davidowitz, Idiot of the Week. Appearing with Tom Keene and a doorpost,
DAVIDOWITZ: The single most important thing I did say is that receipts on American ports for retail merchandise were lighter than last year. That's important. That means that retailers are not optimistic about holiday. They're receiving less merchandise.

PRUITT: Well, we were talking with Dana Telsey earlier about how the inventory is pretty much already here, and any retailer who wants more is going to have to scramble. It will have to be air freighted in. It's going to cost more.

DAVIDOWITZ: I don't agree that it's already here. I thinks that's a little loony. It's certifiably mad. But the point is that it's not nearly all here. No retailer in his right mind would have it all here. A lot of it is here. But you can chart what's been received up to now, and that's what I'm talking ... If you chart it up to now, Retailers are planning on a conservative season, which I think is smart. I think it's a function of what American industry has done in this recession. They've been magnificent. They've fixed their balance sheet. They've been conservative. They've loaded with cash. Contrast with that with our deranged and dysfunctional, bought and paid for federal government, and look at their performance versus the performance of American industry. It's day and night.

I don’t know if you followed that. Davidowitz started out with how receipts are down in ports, and then laid into fellow analyst Telsey for saying retailers have their stock on hand already, before admitting that retailers have a lot of their stock on hand already. That petulance is not, of course, what got him featured on today’s Idiot of the Week. He is featured for his nonsense on how government should be like business.

We’re not going to repeat the analysis from last week, or the week before, that demonstrates that the profits Davidowitz so proudly claims for business come directly from the government deficits he cites as spawn of the blind bureaucrat

Instead, we are going to affirm that it is a good idea, on the eve of another government bailout of the financial sector, to review what government might do if it were truly run like a business.
  • It might charge fair market value for its roads and education and use of airwaves. 
  • It might exploit its power to tax in order to balance its budget, and likely it would go where the money is, to the wealthy. 
  • It might position its advocates on the boards of private companies like private companies position theirs in the legislatures of governments, particularly in the U.S., where such offices are up for sale through campaign donations.

Wouldn’t it be fun to see Bernie Sanders on the board of Exxon? In any event, with the power of taxation – universal (in theory) coercive revenue collection – government has no reason to be in arrears relative to private companies. A simple 50% profits tax, for example …

You might argue that the shareholders of government are the citizens and each one gets a vote – again ignoring the one dollar one vote policy in place in the U.S. – so maximizing shareholder value would mean the opposite of trickle down, which is a theory that helping the few will somehow … Well, you get the point. Run the government like a business? We say, go for it, but remember who the shareholders are and remember to wring the corruption out of the boardroom.



The failure to control credit and the decision to leave financing to the markets and their manipulators is the great failure. It is the genesis of the great financial crisis, and its legacy is the huge burden of debt that now crushes prospects for an orthodox recovery. The invisibility of financing and financing structures – as we’ve noted before – is what made the orthodox forecasters blind to the biggest economic event of the generation. And the unwillingness to deal with the misallocation of credit in a ruthless and rational way is what prevents policy-makers from putting the crisis behind us and real recovery in front. Instead we limp from crisis to crisis, always choosing to burden the future with more debt, always choosing to socialize the losses of the powerful and privatize the suffering of the powerless.

(click on the chart for a larger image in a new window)

Source: New York Times, Analysis of Current Population Survey data by Gordon W. Green, Jr., and John F. Coder, Sentier Research.(click on the chart for a larger image in a new window)

Today on the Forecast, we look at interest rates. We are forecasting interest rates to continue to trend downward. But we do not put much stock in the importance of interest rates to the real economy or see monetary policy as playing a positive role in recovery.

For several reasons:

1. Credit availability is not described by how low interest rates are. Particularly in the mortgage market, where banks once so happily lent to anyone and were even willing to lend the down payment. Banks will not now finance anyone who needs financing. They resist refinancing even the best risks, in fact, so as to keep the old higher interest mortgages paying. Not too different from squeezing credit card holders. But the point is, mortgages may be at four percent, but you can’t get one if you need it.

2. Low rates delight the market players who can finance their stacks of chips cheaply. This means speculation, and it means higher prices in commodities like oil and food and basic materials. This means higher and volatile prices for consumers than would be the case in a supply-demand market. Which means decreased consumer confidence and reduced private demand.

3. It is not ultimately the supply of credit that is the problem, it is the demand for credit.

4. Real interest rates for assets may actually be high when nominal rates are low. Deflation in the prices for investment goods means a zero nominal rate is actually positive. Two bullets on this:
  • It doesn’t seem that long ago that markets were efficient, by the accounts of the fundamentalists, and incorporated new information with seamless efficiency. Outguessing the market was futile according to Eugene Fama and the Chicago School, and better to be passive. Now it seems that investors are stupid and their information is deluded when they take the two percent ten-year Treasuries. They need to be coaxed by the enlightened fund managers. Well, maybe investors are not so stupid. Housing as a surrogate for investment goods? Prices are dropping. A hundred dollars in a ten-year at two percent yields five percent versus a house that drops three percent in value….
  • Consumer price inflation is not relevant to calculating real interest rates. As we’ve said, if it were any more than commodity speculation, inflation in wages and incomes would be rising, too.
5. It is a lot easier to stall an economy with hikes in interest rates than it is to restart it by lowering rates. This is, again, because demand comes first. It is the demand for products and thus investment goods driven by the prospect of profit that causes people to invest. It is not the supply price of inputs.
You can see this on today’s chart. We’ve mapped GDP on the right axis with an inverted scale. So it should be going in the same direction as interest rates. And it does in many of the negative cases. The well-worn plot has been: The Fed sees inflation in its tea leaves, myopically searches for its only button, the big red EASY button, and punches it. The economy stalls. Our chart goes back only to 1991, but the pattern is similar since the Fed became the independent authority over monetary policy in 1951.

In our chart, the dot.com bust as well as the latest greatest recession both were triggered in part by the inability to lay off the interest rate button. Parenthetically, in both cases, rising energy prices were accomplices, and in fact, it was the real … ah … short-sightedness of the Fed in not seeing that its inflation fears were rooted in the price of oil that compounded the blunder of raising rates.

There is more in our chart. First, we see that one recovery was actually helped by lower interest rates. That was the recovery of 1992. The Budget Deal raised taxes and the Three Amigos – Greenspan, Summers and Rubin – brought rates down. Millions of homeowners refinanced, producing billions in new demand. Interest rates went back up in 1994, but GDP stayed strong – Plus Four was the norm through the 90’s.

And – yes – low oil prices. Don’t forget the Gulf War oil prices helped trigger the 1991 recession and then, not exclusively through the brilliance of Bill Clinton, oil prices came down to the $15 per barrel range throughout most of his presidency. That’s one-five. Fifteen. Dollars a barrel.

And further on. yes, in 2009 GDP bounced back up – or down in our inverted scale – as an apparent response to interest rates. But was it the rate of interest? No. It was the federal stimulus and the massive give-aways to the financial sector.

What else do you see?

Interest rates in the boom of the 1990s were substantially higher – five to eight percent for Treasury ten-years, seven to nine percent for triple A bonds and 30-year mortgages. They are now stretching toward two for ten-year notes and four for mortgages and triple A paper.

But you see the pogo stick at the Fed. Six percent effective federal funds rate PLUS in ’91. Three percent in ’92. Six percent in ’94, followed by a little bit of stability in the five to six range, before going up to six point five in 1999 to trigger the recession of 2001 and then diving from six and a half to one and three-quarters in 2001, finally settling in at one percent on into 2004 as a way of throwing gasoline on the housing bubble. Then? Bernanke to five plus in 2006 and Wile E. Coyote down to the zero of today.

And you see the bars for QE I and QE II. These quantitative easings were happy news for stock markets, but for the real economy, not so much. Yes, the intended interest rates did come down, though not really in sync with the QE’s, but no, the push on housing and other investment has not been observed.

Below is a chart from the Federal Reserve describing the QE’s in terms of the Fed’s balance sheet. You see the pig of direct loans to banks that was gulped in September ’08, subsequently passed in favor of the cow that is the mortgage backed securities. Which at one point were intended to be resold, but which now are apparently a permanent feature of the balance sheet, since the only buyer of MBS’s is the government. And while retaining the cow, the Fed added the long-term treasuries beginning in the fall of ’10, to no great effect on anything except financial markets.

And you see our forecast at the end, an extension of the trends because there is no reason for optimism on either the recovery front or the monetary policy front.

Friday, October 14, 2011

Transcript 462: Forecast Real GDP and Net Real GDP

You’ll see in today’s forecast of Real GDP and Net Real GDP the same chart we presented in January. It bounces, but it’s bouncing along the bottom, a bottom sloped downward, with craters from easily predictable crises.

We also have audio from Justin Rowlatt of Business Daily and Brian Lucey of Trinity College Dublin, nicely laying out the true dynamics of the European mess .
Listen to this episode
First, a note on how the economics profession has given up its claim to be a science. Being blind to the great financial crisis of 2008 until it was on top of us was bad, but not fatal to the pretences of economists. But then failing to revise our thinking, not giving credibility to the few who got it right and the relevance of debt and financing structures, and simply clinging to the old schemes … that was fatal. We had evidence disproving the long-held hypotheses and evidence supporting the Minsky view. But as a profession, we have ignored the evidence and have continued with the failed paradigms.

Nothing more clearly illustrates this than the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, sometimes known as the Nobel Prize in Economics. Thomas Sargent of NYU and Christopher Sims of Princeton shared the prize. One of these guys did how to forecast economic outcomes without economic theory (basically regression and extrapolation), the other did how to make your predictions robust (by which he meant survive bad assumptions). Neither one came close to predicting the biggest economic event in recent history. I think both, if they were honest, and they are, would say their work is not particularly relevant to today. Depressing.

Now a somewhat scattered exchange lifted from Business Daily, with Justin Rowlatt interviewing Brian Lucey of Trinity College Dublin.
ROWLATT: The latest dramatic installment of the soap opera that is the Eurozone crisis came on Sunday, when the Belgian government stepped in to buy the Belgian division of Dexia, the struggling Franco-Belgian bank. The $5.4 billion nationalization makes Dexia the biggest victim of the crisis to date. And there was another dramatic plot twist on the weekend. France and Germany said they had reached agreement on how to recapitalize Europe’s other crisis-hit banks. But, as in all good soap operas, this was left as a cliff-hanger, with no details of the agreement available. But there is no question that it will be an expensive process. Some estimates put the total cost at 200 billion Euros. I am joined by Brian Lucey, professor of economics at Trinity College, Dublin. Brian, Where is the cash going to come from?

LUCEY: The cash is going to come from the taxpayer, and in fact, Dexia at $5.4 billion seems like a complete bargain –

ROWLATT: -- You mean a bargain for taxpayers. They’re going to make a profit, are they?

LUCEY: No. God, no. Absolutely not. The reality is that these things cost more, take longer and are more difficult to get out of than governments think. The U.K. and Ireland have been three years down the road of dealing with banks, broken banks, partially nationalizing them, you know, doing that which is deemed necessary. Now, to put it in context. $5.4 billion is really nothing to Belgian and French governments. In terms of their GDP, it’s, it’s, I think it’s a percent. Anglo-Irish Bank, the world’s worst bank, close quote, has cost the Irish state, the Irish taxpayer, something of the order of $27 billion at the moment, and is likely to cost in excess, hold your breath, $90 billion.

ROWLATT: $90 billion. But, Where… You say the money comes from taxpayers. Where does the money come from?

LUCEY: Well, it’s going to basically come from future taxpayers. From your children and your children’s children. The same way as the U.K. government when it recapitalized the banks in ’07-’08 basically borrowed that money. That’s exactly what’s going to have to happen …

ROWLATT: But How far, how far are we mortgaging the future?

LUCEY: We’re mortgaging the future for these banks for decades, generations, literally, two generations ahead.

ROWLATT: You know, the estimates of the recapitalization… You know, we’re talking about sort of $200 billion, I mean just absolutely --

LUCEY: -- The Irish bank, the Irish bank crisis will have cost us, by the time it’s all wound down --

ROWLATT: -- You mean, “us” the Irish people.

LUCEY: “Us” the Irish people, probably 150 billion euro. Now anybody who thinks that’s going to be approximately the same size as recapitalizing and restructuring the entirety of the Eurozone banks frankly needs their head examined. There are literally hundreds more billions -- possibly a trillion euro will be required. Gone are the days when we used to worry about tens or hundreds or thousands of Euros. We’re now talking trillions, blasé. But the reality is that most of Europe’s banks are very heavily over-levered. In other words, they’ve borrowed from each other, from private individuals, from sovereign wealth funds. They have lent that out, in many cases very foolishly, to either Irish property speculators or to the Greek government. Greece, for example, cannot repay its debts. And yet, it’s buying 400 main battle tanks.

ROWLATT: Well, this is the absurdity that people struggle to understand, that we’re taking on yet more debt to get out of a debt crisis.

LUCEY: You cannot – exactly – do that. You cannot do that.

ROWLATT: That’s necessarily what we’re on to, isn’t it?

LUCEY: Governments will do the right thing when all possible alternatives are done. And that’s what’s happening, is that the European governments are going down the line of austerity and debt. It’s not going to work. What we need are a realization that some of these debts are not going to be repaid. A writing down of those debts, a realization that – that may leave banks bankrupt, but that’s the problem we have to deal with.

ROWLATT: But that’s what the recapitalization is about, filling the holes left by sovereign debt.

LUCEY: Unfortunately, it’s not. At the moment the recapitalization is about – in the most part – bailing out the bond holders of the banks that have lent the money to the banks, the banks have lent that money foolishly. Capitalism in its normal workings would say, “If you lend me money and I can’t repay that, well, then you’re at loss.”

ROWLATT: So what you’re saying, in a sense, is a kind of nationalization of the debt, from private institutions , the banks that lent the money …

LUCEY: It’s a socialization of the debt.

ROWLATT: … being taken on by sovereign governments.

LUCEY: And you have the unique situation that the Left and the Right, politically and economically, are at one on this – that that is not how Capitalism is supposed to work. Everybody agrees that we need to have banks. Everybody agrees we can’t have banks closing up and ATMs stopping. However, how you insure that that happens, how you insure the credit transmission mechanism, the liquidity transmission mechanism of banks, is another way. It may well be that you need think about separating – going back to very old-fashioned approaches – and separating out the utility element of banks from the more –

ROWLATT: -- which is what Britain’s talking about at the moment. Why aren’t they talking about this across Europe. Because that would be a way of hiving off the risky bits …

LUCEY: As I said at the start of the program, Britain and Ireland are about three years ahead of the rest of Europe on this. This, too, shall come to pass.

You heard much the same here six months ago, and more, not in the crisp and gory detail, but the bullet points were the same. European banking meltdown with contagion to US banks. Rumor has it Morgan Stanley may be the first, with its exposure to French banks

So it comes around again. A debt bubble promoted, sponsored, funded and enabled by a runaway financial sector culminated in the 2008 banking bust. Private debt was socialized by the sovereigns, including the U.S., who also absorbed what Richard Koo calls a balance sheet recession and a burden that came in the form of increased demand for services and decreased revenues. The creditors and bond holders of the banks were bailed out and immediately moved to the sidelines to demand austerity – the madness of austerity – the pound of flesh – from citizens and governments so as to further encourage their “confidence.” That austerity continues to weaken economies, starve future productive growth, and in the end sap the ability of taxpayers to fund the bailouts, and ultimately frustrate even the bond vigilantes.

Now, as the European banks melt down, we hear the cries come up that “something needs to be done for the banks.” Hundreds of billions of euros. The true number is in the trillions of euros, just as the true number in the US was in the trillions of dollars. Nouriel Roubini has called for a two trillion euro “bazooka.” He has also opined that such a remedy is beyond the established public policy structure to provide.

We have the experiment of 2008 to guide us. We tried the Bernanke hypothesis. It failed. Yet we are in denial. That denial is, of course, sponsored by the bond vigilantes. But in the U.S. we also have a political mob intent on torching the economy for the purposes of taking control of the blackened fields. All of it is enabled by an economics profession that is tied to its own professional capital, an economics profession that is at sea with its analysis and/or is engaged in advocacy economics for Wall Street or market fundamentalism.

So, the Forecast: Real GDP and Net Real GDP

We always want to get to the “I told you so” part. But we’re preoccupied with what is in front of us as well. What we have told you, in time for you to do something about it, is we are bouncing along a bottom that is sloped downward, with risks of new financial crises arising from European bank leverage slash exposure to sovereigns (not exclusively Greece) and from commercial real estate and its importance to local and regional banks that are not too big to fail. (click on chart for larger image in new window)

GDP – gross domestic product – is economic activity. At present – looking at it from the demand side – that economic activity, GDP, in the US is underwritten by massive government activity.

We hear dissonant messages from the same mouths that (1) the economy is in recovery and (2) government spending is out of control. Both cannot be true. As we’ve shown in previous podcasts and posts, it takes only Algebra, Kalecki’s and Minsky’s Algebra, to demonstrate that the profits of corporations in the absence of investment are logically linked to these deficits.

So, GDP less government deficits should show us the underlying strength of a private economy. We call this metric Net Real GDP. Remarkably, or perhaps not, this calculation portrays an economy that looks very much like the economy portrayed by unemployment, real investment and median incomes.

And this has been true for decades. In the Bush II era of the early 2000s, and in spite of the immense private debt build-up, jobs languished and with them Net Real GDP. The supposed strength of the economy during the post 2001 recession was due in large part to very large budget deficits. Prior to that, the relative strength of the economy under Clinton is mirrored in the strength of Net Real GDP, and prior to that, in the Reagan-Bush I years, massive government borrowing supported the top line Real GDP number.

Of course, previous to Reagan, public borrowing was quite a bit more restrained. We paid for public services then. More under Democrats than Republicans, but more under both than under the Reagan trickle down policies. Since Reagan it has become the norm to demand services, but to be insulted when asked to pay for them.

And interesting here is to note that private debt has exploded in the past two decades, particularly since 2000, but this private deficit spending has not affected GDP to the same degree as public deficit spending. This is not visible in any of our charts, but

I suppose we should note here that the only metric that IS up is profits. Kind of sad for those who claimed – and still claim – that profitable companies spur wage growth and economic vitality. Seems to be one of the hypotheses that will survive all evidence to the contrary. Can it be called a hypothesis, if it is not vulnerable to being disproven by evidence? More of an article of faith, I would say.

This profits lead to prosperity seems to be one of the hypotheses that will survive all evidence to the contrary. Those profits, we find, were obtained by Draconian austerity by the corporations on their workforces, by Fed-sponsored interest rates that make corporate debt service as light as it could possibly be, and by demand supported not from the private sector BUT FROM FEDERAL DEFICIT SPENDING.

The charts are up, featuring our accounting for past forecasts in the We Told You So dotted lines. They look pretty good. Please note these are authentic forecasts, issued 9-12 months in advance at least. These are not adjusted for data at the end of the quarter they are forecasting. Compare us with anybody else.

Going forward we’re going to project another divot in the road. We’ve already made much of our call for negative Real GDP in the second half of this year. A call issued in January, not in the second half of the year. These are Depression numbers.

Parenthetically, we do think corporate profits will contract along with deficits.

Why would it be different? The demand side says that contracting government, households burdened with debt, and a corporate sector run for the benefit of its managers mean there is no upside.

There is no shortage of those who disagree. But insofar as I can detect, there is no explanation for an imminent recovery. There is the premise that the amazing austerity across the globe will starve returns out of the productive capacity of the economy – most notably labor – that are needed to ratify existing financial claims. But how that leads to economic recovery is not explained. Even that theory is wrong. Those claims can be ratified only to the extent that we employ that capacity.

Monday, October 3, 2011

Transcript 461: Forecast Commodities

Long-time listeners will appreciate that our call for negative growth in the second half of 2011 was made in the first days of 2011, not at the end of Q3.

Now, just as last month the turning in the sky was from recovery to no recovery, it is now from recovery to recession. This was epitomized by Laksman Achutan of Economic Cycle Research Institute when he rushed to press in the last days of September to announce, yes, recession, either now or in the 4th quarter. But Demand Side listeners had the same information back when it would have made a difference to planning. That was a forecast. Saying it is happening now is not a forecast.
Listen to this episode
And we can’t go very far without a comment on Europe. As the same January forecast made clear, and even into last year, we said – following Nouriel Roubini and others – that there was no option but default for Greece. We added that this was essentially a cost of the financial crisis and would not be a problem except that it exposed the banks. That is, policy makers would be willing for Greece to undergo whatever austerity they could impose, but asking the banks to take a hit on the other side of the contract for bonds? There would be hysteria. Now there is hysteria.

And we’re going to cut it there.

We are in 1932, 2008 was 1929. Now as then, we didn’t fix the problem but kicked the can down the road. Now we’ve run out of road. The kicking of the can has let us imagine we are going somewhere. But we needed to fix the road and the bridge, not comfort ourselves or our elites.

Long-time correspondent and frequent contributor to the Demand Side Economics dot net comments section, David Lazarus, commented again this week. Most of the time we don’t have much to say in response because we agree with him, and take more than a few notes on what he says. This time, however, he disagrees with us.

And as we look back to retrieve the comment, we see the blog ate it. For this we apologize to David. His comments are a very useful part of our blog. We have it up there now. I’m not following on how those disappear sometimes, but it is now there and it says, in part,
I think that there are serious problems with the definitions of investment as you portrayed them. An office building is often defined as an investment. The problem is that once the building is resold it is not an investment. It becomes a fixed cost for that next business. So if a building increases in value from $1 million to $10 million it is not an increase in total investment. That increase in value is inflation not investment. For a business that is starting out it is simply a tax on start ups. It is a capital gain for a business but not investment.

This is undoubtedly true, and I am sorry if I portrayed investment in a way that conflicts with this. In our simple two-good model, there are investment goods and consumption goods. Investment goods are those which require capital and which foresee a return over time to pay off the production of the good and add a profit. Once the good has been produced, it is an asset, as David goes on to discuss in the comment. Its value is bid up or down by the prospects for its return as an asset. It is a real asset, but often the claims on it go into the financial asset territory.

The thing about investment goods production is that they are what grows the productive capacity of the economy, and they are produced by workers not involved in the production of consumption goods. If all workers were involved in consumption goods production, there would be no inflation, in our simple model, because there would be no incomes that were not the result of consumption goods production. If some workers are involved in producing investment goods, there will be more incomes bidding for the same amount of consumption goods, thus inflation.

This could take off into a whole discussion, which we might have, but a point here is that Steve Keen has pointed out that the bidding up and down of asset prices is a playground for debt and Ponzi financing. We’ll leave it there.

And in doing this section, we apologize to Nathan Tankus, another frequent correspondent for having misfiled his contribution on Modern Monetary Theory. That was our bad, not bloggers. We’ll get that up soon.

In cleaning up the transition from DemandSideEconomics to DemandSideForecast dot nets, we’re going to change our mind. What we’re going to do is cast the Forecast site in more objective tones and make it a resource that can be mailed without the political tones. We see economics and politics as intimately entwined, particularly since policy can only be enacted through a political process and particularly because one political attitude has corrupted 90 percent of economics as it is practiced today. Market fundamentalism is a politically sponsored approach looking for any theoretical cover it can find. When supply side fails, it moves to rational expectations, monetarism, and down the line. Not by an experimental process to find out what works, but by a careful path to avoid the economics that does work, which is not particularly kind to the powerful or to entrenched interests.

So that should make it obvious. The Forecast section of the podcast will be scrubbed and set up on the Forecast dot net site. The full Monty will be as usual on the Economics dot net site.

That’s our plan. We take them seriously. Doesn’t mean you have to.

This week is forecast lite.


Demand Side is an economic forecaster, not a market predictor. In terms of investment advice, we don’t. The markets are a herd or behavioral field. They react to what they perceive the economy to be doing. That perception today is the perception of a herd of cattle in a lightning storm.

And today we are forecasting markets. We are not forecasting demand and supply for individual commodities based on global production. Because all that is washed out by the market dynamics. Commodities are trading in close correlation with other financial assets. Financial assets? Commodities are goods, right? Not when the traders need a profit. Your food and fuel is their bread and butter.

The market is being driven not by demand for the product, but by demand for financial returns. Speculation. There is immense liquidity sloshing around in the system. There is massive paper wealth looking for a place to be. Markets resist going down together. That money has to go somewhere. This is part of the dynamics of commodities. As the real economy failed over the past dozen years, that money has moved more and more into liquid financial assets and away from real productive assets. No investment in the private economy, particularly with the housing crash. As we noted a couple of weeks ago, there is a glut of productive capacity in any event, brought on by focus on the private consumer economy at the expense of the public goods economy.

In any event, this massive amount of capital needs a home. It can go into cash. But at its base cash is just a government bond with no interest on it. “Federal Reserve Note.” It has gone into stocks, bonds and commodities and derivatives of these. Commodities are perceived to be a liquid asset that will maintain its value. This is in spite of all evidence to the contrary.

The commodities bubble of 2011, which is now collapsing, was a core predictor of the new leg down in the economy. We used it in January, saying it would be the trigger. And so it has proven out. So far, 2011 is a repeat of 2008, only on a weaker economy, with far less appetite for the stimulus of 2008-09, and thus much more likelihood of serious further suffering. We didn’t fix the banks the first time. All the old troubles are still with us. We kicked the can down the road instead of fixing the bridge.

Shall we do copper?

Shall we do Gold?

Gold is interesting as a commodity, because it has no real industrial use. Other precious metals do. Gold is simply a bet. Some see it as inflation hedge. Some see it as a hedge against instability. But it is a bet that people will continue to buy gold. The new ETF’s for gold have undoubtedly raised the price by allowing purchase of gold without holding it in your house. If you have one, look closely, it may be a virtual fund which operates on the “value” of gold, rather than actually owning gold.

So recently when commodity prices went south, gold should have gone north. it didn’t. We have a very loose understanding, but it came a little tighter when someone revealed that traders take positions in gold as a liquid value that can be tapped to cover other positions. This is what we think happened to gold. As stocks and bond yields came down, investors covered their losses by liquidating gold. Much to the consternation of the world. Or at least to the financial speculators. We understand the buying of gold to hold in India and China dried up when the price went over $1,700. They may be coming back now.

What about oil?

Here is the poster child for all commodities. You can see the up-to-the minute action on the right side panel on the transcript. The bubble is bursting, hopping down now to under $79 a barrel West Texas and under $103 in the much more relevant Brent Crude.

Oil and commodities are bouncing around in complete correlation with the rest of the markets. A correlation incidentally that is closer than at any time since the maps of correlation became detailed.

Last week we did L.Randall Wray on the commodities nuclear winter approaching.

But speculation as the cause. Senator Bernie Sanders let the cat out of the bag in August by leaking data from the CFTC, Commodities Futures Trading Commission, which clearly shows that financial traders have positions in oil futures which dwarf those of any legitimate hedger. And as we showed last year, it is the futures market – not the spot market – where real oil prices are set. Apologies to Paul Krugman. Here is Sanders, making his point.

This is information that I think our friends on Wall Street did not want to come out. It is supposed to be top secret information. And in fact, many of the folks on Wall Street were very disturbed that we made it public.

The reason that we made it public is we wanted to end this debate about whether or not excessive oil speculation is driving up gas and oil prices.

The answer is, when you have companies like Goldman Sachs and Morgan Stanley owning and buying and selling hundreds of millions of barrels of oil, dominating the oil futures market, there is no more debate. Excessive speculation is one of the reasons the price of oil is where it is today.

We have got to do what Congress passed legislation to do, and that is mandate that the Commodities Futures Trading Commission end excessive speculation, and have limits on how much these companies can own.

So, that’s commodities.

We were ahead on the bubble, and our only glitch is the bunny hops down, which are visible in the charts but which have yet to be explained in any terms that make sense. Our view is again, a trading strategy designed to limit losses in the Big Houses. Big house? Don’t you wish that’s where they were.

We’re leaving a lot on the cutting room floor.

Next week we’ll get to the GDP and Net Real GDP and point out the obvious. The so-called recovery was borne on the back of the much-maligned government deficits. Without government deficit spending, the private economy would be generating growth right down there with house prices and unemployment rates. Without government deficits, the corporate earnings that floated Wall Street would be negative, even with the brutal downsizing they have undergone to keep their bonuses up on the top floor. Government deficits have saved this economy. Those who work on Wall Street or in corporate America and play holier than thou with regard to government spending don’t know what they are talking about, or are being cynically malicious.

Monday, September 26, 2011

Transcript 460: Forecast Inflation


Backing the Fed and monetary policy is like watching your horse come in last in every race and still putting money on it in the Derby.


It is often claimed that the Federal Reserve has a dual mandate. Indeed, there is such a thing in law. The Humphrey-Hawkins Full Employment Act of 1978 established full employment and price stability, along with requiring the Fed’s Chair to report to Congress and a list of other things designed to bring the Fed back into concern with the real economy.
Listen to this episode
But as soon as the ink was dry, the Fed was back at work, not promoting full employment, nor price stability. Then, as soon as Carter’s presidency turned into Reagan’s, the Full Employment Act became a footnote. What survived was basically the mandatory appearances before Congress by the Chairman.
The Fed sees its single mandate neither as price stability nor full employment, but protection and encouragement of the banking sector. There is little room for debate on the point. The Fed is a captured regulator. Its concern with inflation is not concern for inflation, but concern for the returns on fixed rate investments.

Ben Bernanke was brought on board largely because of appreciation for his work on the Great Depression, which he analyzed forty years after the fact as primarily the result of not protecting the banks. The past four years of aggressive monetary policy, massive guarantees to bank credit, wholesale purchases of shoddy mortgage-backed securities and other direct if secret support to banks and quasi-banks, ahs been a test of Bernanke’s hypothesis. The result four years on? Hypothesis rejected. Bailing out the banks, holding their managements and creditors harmless, shifting trillions upward in the wealth scale, has not prevented the Second Depression.

We didn’t mean to get off on this, but the manifest failure of monetary policy illustrates the manifest ineptness of the Fed and its governors.

Maestro Magoo, Alan Greenspan also protected banks and markets to the exclusion of full employment, never shrinking from massive liquidity injections when things were rocky for markets. “The Greenspan Put” became the aggressive stock pickers ace in the hole. Greenspan would never let markets fall. But they did fall, late in the 1990s, and soon after we got Greenspan’s Put Two, 1% interest rates for years to jinn up a housing bubble. Previous to Greenspan, the now-venerated Paul Volcker made his reputation by sacrificing millions of jobs on the altar of low inflation. Volcker’s hypothesis, actually Milton Friedman’s hypothesis, was also untested: “Inflation is always and everywhere a monetary phenomenon.” Turns out, didn’t matter how you squeezed the money supply, inflation continued until you shut down the economy.

And on back to the Treasury Accord of 1951. Excess interest payments as a result of Fed favoritism to the banking sector and rentiers were, by the accounts of Leon Keyserling, the economist who led the transition from War to Peace under Truman, were tremendous even prior to 1980.

So when you hear, “the Fed targets inflation,” realize the Fed and its version of monetary policy are chosen not because they control anything, but because they serve the purposes of the financial sector.

So we should expect them to have a good idea about inflation. Right? No they don’t. That’s apparent by the wide diversion of opinion on their own self-selected Board.

Inflation and unemployment are the two horns of their dilemma. That is indisputable the way it is characterized. Raise rates to fight inflation. Lower rates to boost the economy and fight unemployment. Do I hear anybody who disagrees that this is how they work it? Basically a roomful of people operating a toggle switch? No.

It hasn’t worked, it won’t work, it can’t work.

Three years after the collapse of inflation with the collapse of the last commodities bubble, the central bankers are still running out their inflation horse. There is conflict at the fed, sadly, not about what to do about deflation or unemployment, but about how not to do anything more aggressive because of high inflation. As if…

And inflation, we assure you, is the subject of today’s forecast.

Unemployment is the cancer in a diseased economy. Inflation is body temperature. Or blood pressure. The two are not alternatives. One is a disease. The other is an indicator. To manage an economy to stabilize inflation without regard to what is going on with the patient is like forcing the blood pressure down or up to a medium level whether the patient is vigorously exercising or comatose.

What is inflation? First:

Is there inflation? No. There is no inflation. There is deflation. House prices are deflating, labor prices are deflating, investment goods prices are deflating.

But core CPI is on the uptick. Headline CPIO is going up.

Inflation is properly defined as a rise in the general price level. Core CPI, Headline CPI, PPI are the aggregate of many prices. So 95% of prices could be going down and one could be going up, dramatically, and the official measures would record an increase in inflation, CPI, or PPI.

Which is what we have. Here is Chad Moutray, chief economist at the National Association of Manufacturers, when he lets the cat out of the bag at a recent presentation at the National Economists Club.

Yes, the rise in producer prices is due exclusively to a rise in industrial commodity prices, we suggest as a result of financial market speculation.

Bottom line, we don’t have a rise in the general price level.

Here are our predictions anyway, for core inflation, all items, health care and energy components. Making sure you understand our point, that these are the indicators of prices of different sectors, they are not general inflation. Putting them together and adding them up does not necessarily approximate inflation.

Now our rendition here captures some of the volatility of prices that escape year-over-year comparisons. Ours is a 6-month moving average rendered at the mid-point. At least you can see why high-frequency inflation hawks get disturbed when you look at this. There is steepness you don’t see. You can imagine one of the hysteria hawks losing sleep over that.

But more interesting and instructive to us is the energy component driving the core and all items. Energy quickly becomes embedded in the all-items headline number, but look at core. Core, as we’ve noted, being a measure that eliminates energy and food – that is commodities – ends up measuring labor input. And here you see one of our – actually following from Warwick University professor Andrew Oswald’s – key observations. Everything in the world is made of energy and labor. If prices are going to remain steady, when the price of one of these components goes up, the other must go down. Energy up, returns to labor down. Looking closely, you can see, even the past ten years – Oh, expand the first chart by clicking on it – that just such a relationship is shown. Energy prices up, all items up, core down. If we lagged it right, you could see it even more clearly.

Now we don’t expect a recovery in labor – core – this time, because we are in a deflationary cycle. When energy prices go down this time, as always led and defined by oil, or as they fluctuate lower over time as you see in our forecast, labor prices will not go up. The deflationary cycle.

Where is the deflation?

It is in asset prices. House prices, financial asset prices, investment goods, capital goods, whatever you want to call it, that’s where the deflation is. We divide them between financial assets and investment goods. Where is my forecast for the index of those? There is no index for asset price deflation. Maybe the stock market. House price indicators. But the rest is locked behind obtuseness. Ask the owner of a downtown office tower how it’s going for the price of his investment good. He won’t say it’s inflating, and he’ll likely say the next owner will be the bank.

This deflation is critical. It kills construction. It stops the investment sector that is the engine of growth. Getting some life back in investments is the only way out of the continuing Depression. As we’ve said, though, there is no life in private investments and these investments will have to be made in public goods.
And as we said, this asset price deflation – or the inflation in previous decades to asset prices – is invisible to the inflation hawks and the Great Moderators. House price inflation was running at ten and twenty percent when Alan Greenspan had his interest rates locked in at one percent. What would have happened had he simply incorporated that inflation number into the CPI. Likely he wouldn’t have been so concerned then about deflation. Might have even raised rates enough to forestall the great financial crisis. Well, no, probably not. Greenspan was in the business of engineering whatever economic activity he could find.
But wait, you say, there has been inflation.

No. There has been commodity speculation. Not investment. Goods are not investments, they are the products of investments. Playing computer games to milk the futures or options markets may make money for the trading house, but it may come up craps, too. Has anybody else noticed the bunny hops in the commodities indexes since the peak of the most recent bubble?

I’ll put that up online.

Tracks of the carnivore in the snow, I say.

This commodity bubble was the trigger for the most recent downturn. We correctly cited that in January, and even back in November 2010. The trigger because it sucks demand out of the economy in a sharp way. In this case, like punching an old man, because the economy is sick and frail. It has grown sick and frail from decades of supply side nonsense and public goods atrophy. Will it blow up? This commodities bubble.

Here From L.Randall Wray

Now, to be sure, the whole thing is going to blow up, in what Frank Veneroso calls a commodities nuclear winter. As prices rise, consumption of the commodities falls (as we are already observing) both through substitution and through conservation. At the same time, additional supplies come on line. Real world suppliers feel the imperative to slash prices to have some actual real world sales. They cannot forever live in never-never land with rising prices and collapsing sales.

There are many shoes that will drop, bringing back the Global Financial Crisis with a vengeance. Commodities crash, default by a Euro periphery nation, failure of a Euro bank, or the closure of Bank of America or Citi. All of these are likely events, less than one standard deviation from the mean; probably all of them will happen within the next year.
No matter what the triggering event is, that commodities nuclear winter will happen.
Nuclear winter. So why is our forecast, even as low as it is, not lower? Because it’s lower than anybody else’s already. Not that watching forecasters is a good idea, but we have leverage on the downside. We have core inflation below zero for an extended period. We have headline dipping below. We have energy prices fluctuating widely – notice they are marked to the right axis, which is basically three times the scale of the left axis where everything else is graphed, and they are still the biggest waves on the screen.

Secondly, it is asset price deflation and unemployment that will reflect the road down, the bottom sloped downward. Commodity prices coming down will put people out of business, perhaps, but there will be an increase in disposable incomes reciprocal to that of the decrease on the way up. Maybe we’ll come up with an asset price index some night.


Now, before we let you go today, we want to bring your attention to a transition we are making from one platform to another. For the near future, you can find us at both demandsideeconomcs.net and demandsideforecast.net. The latter reflects our attempt to get more exposure, capitalizing on being right for the past four years. Relatively right, I suppose. The demand side perspective needs to get into the thought train of more people and find its way into policy.

You can help us by re-upping your review on iTunes. Thank you very much for all those nice words over the past years. We see that some of the things you most liked we’ve gotten away from. But time is limited. We learn a lot from it every time we sit down.

You can also follow us on Twitter, for whatever good that will do. I’ll try to get that straightened out. Link to the posts. Get the Email version. Give us your feedback in the comments or at the address demandside@live.com. Making money is low on the priority list here. Any ads you see are not endorsed by us. We will probably opt out of the ads soon, but since we can’t see them from our terminal, they don’t really bother us.

We were inspired to go more mainstream, to take advantage of accuracy, just last month. It was the first week in August when we saw in the sky the great turning of economists and pundits, like a flock of birds turning in one motion. Previously the recovery, now the no recovery. It was a beautiful thing.

Here on the ground we, like many of you, saw there has been no recovery. The current non-policy of genuflecting to the powerful hasn’t worked, it won’t work, it can’t work. For anybody.

Ah well, at least they’re going in the right direction now. Too bad they’re still so far above the real world. You know, it’s not brilliance that makes the demand side work when all that hypothetical and market fundamentalism doesn’t. Look at what we’ve got today. When people trot out in their two thousand dollar suits and talk about how important it is to have investor confidence, and that’s bought on the backs of austerity and suffering. When bailing out governments is important only when they can’t pay their bankers. When the Washington Consensus, a program with no successes, is the order of the day. That’s the “confidence” that they are in charge of governments. It seems to me.

Sunday, September 18, 2011

Transcript 459: Forecast Capacity Utilization

Listen to this episode

The forecast today: Capacity Utilization, trending down for 45 years and going to record lows, is our projection. First a note on “Leadership.”

We’re looking for leadership these days, I’m told by the newly anxious. Leadership is what you call for when things are going wrong and people need to step up and do the right thing. We have been calling for leadership for the past three and a half years.

I suppose what the right thing is depends on who you are. When you ask for leadership, you want people to do what you want them to do, not what anybody else who is calling for leadership wants them to do. And here’s another take, right off the top of Bloomberg.
TOM KEENE:  Greg Anderson starts us off from Citigroup FX.  Greg, good morning.

GREG ANDERSON:  Hi, how are you?  Good morning.

TOM KEENE:  Very good.  Well you have in your very fine print in your statement on the dollar.It says here there are few alternatives to the U.S. dollar.  There are also few alternatives to a coordinated response to European crisis.  This is the Market simply telling the political leaders and financial elites what to do, isn't it?

GREG ANDERSON:  Ah.  It is.  And they don't necessarily like to be told what to do.  But yeah, the Markets will force the hands of politicians in reducing debt burdens and in resolving Europe's situation one way or another.  I would say, look, it lets you know that policy makers are gearing up for the potential of major volatility like we saw in 2008, and they're sort of proactively going back to 2008 type measures.

The 2008 measures they are talking about is TARP. Bail out the banks. Yes, folks, we’re back. The issue is not liquidity, so what the central bankers did early last week is as much the precursor to bad things as it was in the dark days of the subprime crisis. It is solvency, not liquidity. The banks want another bailout. “We lost a hand, no fair, we’ve used up our chips. If you want us to keep playing, you’d better give us another stack.”

It’s not Greece. As we’ve said since late last year. The default that is on the minds of the markets is the banks. It is Soc Gen, Deutche Bank, and yes, Citigroup. Greece is, on the great scale of things, even smaller to Europe than the subprime sector was to the U.S. On whose minds? Who is worried about default in the great mega-banks of Europe. It is the megabanks of the U.S. U.S. banks have withdrawn their short-term funding, and the long-term bets of their European brothers (or competitors) combined with the credit default swaps that link them all together have made banks too fragile to survive and to interconnected not to bail out.

Wall Street is worried. They sent their emissary Tim Geithner to the finance ministers meeting in Poland at the end of the week. Tim got a chilly reception. The Europeans don’t want to hear about it. They have a problem to solve, and it is the problem Wall Street, the world’s Wall Street, and Lombard Street made.

Are we going to bail them out again? Angela Merkel is is on the political hot seat. Germans still think it’s the Greeks. Maybe they’ll never figure it out. The best thing for the Euro would be if Germany left it. Then there could be a rational revaluation. German capitalists would never let it happen. They are the major beneficiaries of the weak euro. They don’t even have to peg it like the Chinese do to the dollar.

Pretty soon Barack Obama will be sitting in Merkel’s seat. Not only are the banks connected to the European mess, those in the U.S. are still holding a lot of the bad mortgages, with more coming as former customers demand their money back on shoddy securities unloaded during the 2008 crisis. Will Obama really ask for another bailout? Where will the leadership be? Carrying the flag for …. You ask. Wall Street, the banks, or a real economy that needs a rational financial sector, not a casino.

Now the forecast.

It is capacity utilization.

Of course, industrial capacity will be used less as the economy flags, according to the Demand Side projections, even though no more capacity is being built. It’s part of the debt-deflation cycle. The point with capacity utilization is that it’s been grading down for forty years, and this illustrates a primary mistake made by the orthodox economists in charge of the current muddle.

That point is made clearly by Steve Keen in the paper of the week. At Real World Economics Review, it’s
Economic growth, asset markets and the credit accelerator (link on the transcript) (http://www.paecon.net/PAEReview/issue57/Keen57.pdf)

Keen says
“Firstly, and contrary to the neoclassical model, a capitalist economy is characterized by excess supply at virtually all times. There is normally excess labor and excess productive capacity, even during booms. This is not per se a bad thing, but merely an inherent characteristic of capitalism – and it is one of the reasons that capitalist economies generate a much higher rate of innovation than did socialist economies. The main constraint facing capitalist economies is therefore not supply, but demand.”
And that is what you see in the capacity utilization numbers.

Since the total index was begun in 1967, the trend has been down. You can see it on the transcript. Prior to 1967 there was no total index, but there was a manufacturing index of capacity utilization. That index has tracked the total index fairly closely since, although manufacturing utilization has sunk a bit from the total index as time has worn on. In any event, we append the earlier series so as to get a reading back to 1948.

As you can see by the trendlines, prior to 1967 the trend was up. This reflects the privileged place America found itself in after the Second World War. During the war the industrial capacity of Europe and Japan was decimated. This left a virtual monopoly for American industry, which benefitted further from the Marshall Plan and the rebuilding of Europe. Once other capitalists came on line, that monopoly eroded. Footnote: It also marks the heyday of American unionism, which split the take with the capitalists in the monopoly economy.

But today is long past 1967, and the point is, unused capacity in the private sector has been growing for decades. Excess productive capacity means investment has been redundant. Particularly since a lot of productive capacity has moved overseas, where Chinese and Germans are making things and shipping them into the American market.

Not to say there isn’t a need for productive capacity, but it is just not in the satiated consumer economy, the private economy dominated by consumerism. So returns to capital came down and investors went looking for yield in the financial sector and in a housing bubble.

Yes, we have need. This is the ultimate frustration. No more frustrating, I suppose, than when the one of the supply side talking heads complains about government deficits in one breath and then in the next says, “But I just came back from (fill in the blank of Asian or European country) and when I came back, it was obvious that the U.S. is falling behind in infrastructure. We are approaching Third World status.” Often they add, “The budget will have to come out of entitlement spending.” How that follows from the European example, I’m not sure, but it often does.

Yes, we have need. But need is not demand unless, as Keen says, it comes with money.
Secondly, all demand is monetary, and there are two sources of money: incomes, and the change in debt. The second factor is ignored by classical economics, but is vital to understanding a capitalist economy. Aggregate demand is therefore equal to Aggregate Supply plus the change in debt.

and he goes on to explain how a capitalist economy buys not only new goods and services, but also bids up the value of existing assets.

But we have a mixed economy, a capitaliist private sector and a public sector charged with providing the structure and groundwork for capitalism and the public goods and social insurance capitalism by itself will never provide. Monetary demand can come from an agency able to borrow at near zero or tax from its privileged citzens and spend on useful, even vital – though not consumer – goods and services.

Let’s take an example. Transportation infrastructure. The U.S. depends on a tremendous fleet of trucks utilizing the public highways. Other nations have built up their rail systems, which are lower maintenance and lower cost per mile. Our system requires lots of fossil fuels, a semi wears at the road surface at the rate of 16,000 tiimes that of a passenger car, and the privately operated railroads ship bulk commodities like grain and coal or intermodal containers. It is parallel to the health care industry, where the profitable portion of the operation is segregated for the private corporations to maximize, and the remainder is shunted onto the public sector.

So, forecast, trending down, below the trendline, not in a gradual line, but in the dives and surges typical of this index. The 2008 dive was to a historic low, and we expect to see another record low by 2014. Capacity utilization in the form of private industrial capacity will, in fact, be lowered, not raised by tax incentives for private investment. We don’t need it any more than we needed McMansions. Capacity in the form of public infrastructure, education, and preparation for climate change is not on the horizon.

You figure it out.