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Thursday, September 30, 2010 6:38 PM

Views from the Trenches: Business Owner Discusses QE, a Retired Teacher Supports Chris Christie

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Here is a quick post from an East coast airport. I am traveling today.

In response to $30 Billion Offer No One Wants - Small Businesses Hit by Deflation I received this email from the owner of an e-commerce business.

Danny writes ...


I enjoy your blog very much. I thought I would take a moment and let you know what is happening in the "real world" - and why QE one, two or five hundred and two will not help small businesses like ours.

My partner and I own a successful e-commerce website. We started it in the late 1990's by ourselves and now we have five employees. Our growth came from personal resources, as well as credit card lines. Each year we saw sales increases of at least 10-20%. However, in late 2008/early 2009, we started seeing our sales slipping. As a result (and watching our competitors) we lowered our on-line prices to continue to drive sales. As of today, our prices are 40% below where they were in 2008. However, we have the same number of customers - we just work a heck of a lot harder!

On the negative side, we saw all of our credit card lines cut, so we can no longer use them. Bank financing is completely out as we have no business assets so to speak (our business is online - not manufacturing). We have cut costs by moving to a cheaper office location, letting one employee go and demanding lower prices from our own suppliers (mostly successful). As a result of our cost cutting, our bottom line has only slipped 10%. We feel very fortunate in this regard.

As to what would help our small business grow and hire people again - simple; more sales! We do NOT need to borrow more money as we already owe enough and our capacity is only at 50%. So what would we borrow money for? More production? We don't have the sales.

So QE actions by the Fed have no effect on us. Interest rates could go to zero and it still would not matter. What we are NOT seeing are credit card rates going down - now THAT might help us somewhat. Regardless, it seems that the economists in charge are playing from the old handbook of everyone borrowing money to spend money. Needless to say, it's not working - but you already knew that. Thanks again and keep telling the truth.

Austin, Texas
Retired Teacher Supports Christie

Joan, a retired teacher writes ...
Hello Mish

I'm a retired teacher, who remembers all too well the teachers who were completely incompetent in math skills. They may have been poor at reading too. I used to fancy an education methods course entitled: "How To Teach Without Knowing Nothing".

Schools of education at the college level were complicit in supporting this scandalous incompetence, at least according to what I experienced. Governor Christie hit the nail on the head, I believe.

Joan was writing in response to Governor Christie to Test Teachers in Reading and Math

Thanks Joan and Danny.

Mike "Mish" Shedlock
Click Here To Scroll Thru My Recent Post List

10:52 AM

Huge Flaw in Municipal Bond Assumptions

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Everyone plowing into municipal bonds on the assumption the federal government will bail out the states may have another thing coming says Herbert Gold at Institutional Risk Analyst.

Please consider The Great Contraction Coming in State Finances

Back in August, the U.S. House of Representatives took a break from its recess to pass legislation giving $26 billion to the States for education and healthcare. This $26 billion is a stealth bailout for States on the verge of default. As such it is a band-aid that prolongs the crisis while sending a false signal to the markets. In the event of a State default Washington will not rescue the States.

The municipal debt crisis is well known. California by some measures has the world's 8th largest economy, yet it faces the prospect of once again issuing IOUs to its creditors as its government continues to struggle to pay its bills. Illinois, America's fifth most populous state, is running nearly half a year behind on meeting many of its obligations. New York and New Jersey, the latter despite some bold political moves by Governor Chris Christie, are similarly situated. Indeed, according to the Center on Budget and Policy Priorities only four states have avoided budget shortfalls this year.

Despite these conditions the market for State debt remains placid. Municipal securities continue to trade at favorable rates even though the larger economy has shown no solid signs of meaningful growth. The reason for this lies both in the fact that States historically don't default, and the belief that Washington will provide funding in the event of a true crisis.

The market continues to assume the federal government would not let a big issuer like California default. But this theory has a huge flaw: absent a vote from Congress there is no easy mechanism for the federal government to rescue the States. And after the political backlash from the TARP vote it is safe to say Congress will be loathe to issue any more blank checks to bail out the states.

It's unlikely the Fed would be inclined to bailout a State in distress given the political backlash the institution would face after another open-ended program that told the world (yet again) the US was ready to simply print its way out of its problems.

The market remains convinced that, in the worst-case scenario, Congress would not risk the disruption that would follow a State default. But countering this idea is the role federalism plays in our political system as well as an appreciation of the damage done to politicians who supported TARP.

Senator Bob Bennett (R-UT), a highly respected member of the Senate, was unceremoniously dropped from the ballot in the Republican primary in Utah in large part because of his vote on TARP. At least five other sitting officeholders have lost in their own party primary this year for the same reason, to say nothing of the large- scale losses likely to occur this November. Any politician interested in keeping his or her job would be very wary of voting for a State bailout. And this does not account for the role the States play in America's governing system. Ask a citizen of Oregon to bailout California, or a citizen of Michigan to bailout Illinois, and you are likely to get the same cold silence.

Treasury prefers to allow Illinois to borrow at low rates for as long as possible in the hope that somehow they will stumble through this crisis. From Treasury's perspective it is a free option, but the real price of this false confidence will only become clear after it is too late.

The genius of the American system is its flexibility, allowing States to be responsible for their own governance and finances. If some must bear the burden for reckless spending it should be the citizens of those States. Washington won't bail out the States and the market should be prepared for defaults. But just remember that it won't be the first time that an American state has defaulted on its debt.
Financial Reform Act Impacts

There is more in the article including an analysis of how the Dodd-Frank Wall Street Reform and Consumer Protection Act ended the Treasury's authority to bail out the states and how President Obama and Treasury Secretary Tim Geithner may rue this decision.

If so, that revision may be the only worthwhile thing in the entire bill.

Unfortunately, I think Congress will try to "do something", they always do. However, I am equally convinced severe austerity measures are on the way to more than a handful of states. If so, none of this is factored into lofty stock market valuations, and equally absurd valuations of municipal bonds.

Harrisburg, Pennsylvania Explores Bankruptcy

I have commented on this before but it finally appears the bankruptcy writing is on the wall for Harrisburg. Bloomberg reports Harrisburg, Pennsylvania, Council Votes to Explore Bankruptcy

The City Council’s 5-2 vote last night rebuked a personal plea from first-year Mayor Linda Thompson. Harrisburg needed state aid two weeks earlier to avoid becoming the second-largest borrower to default on a general-obligation bond this year.

“The whole world is watching Harrisburg,” Thompson said in a 40-minute speech to the council, where she had a seat until becoming mayor in January. “Our bondholders are looking to make us the poster child of the world to municipalities in financial difficulties. And they don’t plan on losing.”

Councilor Brad Koplinski, who proposed considering bankruptcy protection, said it would take a “devastating tax increase” to cover the debts.

“I’m not going to have that $210 million payment on the backs of taxpayers,” he said in an interview after the vote. “Bankruptcy, I don’t think, would kill our city. I think the tax increases would kill our city.”
Certainly Councilor Brad Koplinski understands the situation properly.

In contrast mayor Linda Thompson is beholden to the bondholders. Either she is a complete economic dunce or someone is financing her campaign. Either way, she is unfit for office.

Mike "Mish" Shedlock
Click Here To Scroll Thru My Recent Post List

4:29 AM

Defending China's Trade Policies; a "What If?" Thought Test

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In America’s China Bashing: A Compendium of Junk Economics Michael Hudson takes Paul Krugman, protectionists, Congress, and other China bashers to task, citing six economic errors they all make.

The following snip comprises a portion of economic errors 3-6. I encourage you to read the entire article. It's worth a good look.

Michael Hudson: Prof. Krugman describes China as “deliberately keeping its currency artificially weak. … feeding a huge trade surplus,” adding that “in a depressed world economy, any country running an artificial trade surplus is depriving other nations of much-needed sales and jobs.” In his reading the problem is not that America has let its economy be financialized, or that easy bank credit has bid up housing prices for American workers and loaded down their budgets with debt service that, by itself, exceeds the wage levels of most Asian workers. “An undervalued currency always promotes trade surpluses,” he explains.

But this is only true if trade is “price-elastic,” with other countries able to produce similar goods of their own at only marginally different prices. This is less and less the case as the United States and Europe de-industrialize and as their capital investment shrinks as a result of their expanding financial overhead ends in a wave of negative equity. To assume that higher exchange rates automatically reduce rather than increase a nation’s trade surplus is Junk Economics Error #4. It is a tenet of the free market fundamentalism that Prof. Krugman usually criticizes, except where China is concerned.
Mish Comment: Another Krugman flaw is that he seldom if ever looks at the consequences of what he proposes. Even IF manufacturing jobs returned to the US after tariff hikes, it would be at the expense of dock workers unloading ships, truckers hauling goods from coast to coast, and most importantly higher prices for consumers everywhere. Higher prices are not good thing. Higher prices would benefit the few whose jobs were saved, at the expense of everyone else. Higher prices also benefit governments that take a sales tax bite out of every transaction and squander it on needless projects.
Michael Hudson: Chinese currency appreciation would let speculators and arbitrageurs make a killing on the currency shift. Its exports would cost more – but is it believable that America would rebuild its factories and re-employ the workforce that has been downsized and outsourced? To imagine that long-term investment responds to immediately is Junk Economics Error #5.

Prof. Krugman urges the United States to do what it “normally does” when other countries subsidize their exports: impose a tariff to offset the supposed subsidy. Congress is increasing the drumbeat of accusations that China is violating international trade rules by protecting itself from financialization. “Democrats in Congress are threatening to … slap huge tariffs on Chinese goods to undermine the advantages Beijing has enjoyed from a currency, the renminbi, that experts say is artificially weakened by 20 to 25 percent.” The aim is to make China “lift the strict controls on its currency, which keep Chinese exports competitive and more factory workers employed.” But such legislation is illegal under world trade rules.

This has not stopped the United States in the past, but the belief that it might succeed internationally is Junk Economics Error #6.

The cover story is that foreign exchange controls and purchases of U.S. securities keep the renminbi’s exchange rate low, artificially spurring its exports. The reality, of course, is that these controls protect China from U.S. banks creating free “keyboard credit” to buy out Chinese companies to buy out Chinese companies or load down its economy with loans to be paid off in renminbi whose value will rise against the deficit-ridden dollar. It’s the Wall Street arbitrage opportunity of the century that banks are pressing for, not the welfare of American workers.

The House Ways and Means Committee is demanding that China raise its exchange rate by 20%. This would enable speculators to put down 1% equity – say, $1 million to borrow $99 million and buy Chinese renminbi forward. The revaluation being demanded would produce a 20,000% profit, turning the $100 million bet (and just $1 million “serious money”) into making $2 billion. It also would bankrupt Chinese exporters who had signed dollarized contracts with U.S. retailers.
Mish Comment: I am not sure how Hudson arrives at $2 billion. 20% of $100 million is $20 million. Making $19 million on $1 million is 1,900% not 20,000%. Otherwise, his point is accurate and well expressed.
Michael Hudson: This is a compendium of the kind of propaganda Americans are being subjected to these days. There is little acknowledgment that the United States is as guilty of “managing the dollar” by its policy of quantitative easing that depresses the exchange rate below what would be normal for any other economy suffering so gigantic and chronic payments deficits. It is the United States that is out of line with every other economy.
Mish Comment: Does Hudson mean "depresses the exchange rate" or "depresses interest rates"? In context, the latter would seem to fit better. Certainly the goal is to bring back jobs by depressing the exchange rate, but it has not done so, nor will it do so for reasons cited. Otherwise, I agree with what seems to be the central idea of the paragraph, that the US is as guilty of manipulation as China.
Michael Hudson: Wall Street’s idea of “equilibrium” is that if only foreign countries would commit financial suicide along the lines that the United States is doing, then global equilibrium could be restored. But the most successful economies have kept their FIRE-sector costs of living and doing business within reasonable bounds, and are not remotely as debt-leveraged as the United States. German workers pay only about 20% of their income for housing – about half the rate of their U.S. counterparts. German practice is not to make 100% mortgage loans, but to require down payments in the range of 30% such as still characterized the United States as recently as the 1980s.

The FIRE sector’s business plan has priced U.S. labor out of world markets. There seems little likelihood of making Chinese and German workers pay rents or mortgage interest as high as the United States? How can American economic strategists force them to raise the price of their college and university tuition so that they must take on the enormous student loans of the magnitude that Americans have to take on? How can they be persuaded to follow the high-cost U.S. practice of adding FICA-type wage withholding to the cost of living to save up pensions, Social Security and medical insurance in advance, instead of the pay-as-you-go basis that Germany quite rightly follows?
Mish Comment: The preceding two paragraphs get straight to the heart of the matter. They are consistent with something I have said 100 times. It is not the wage that matters, but rather how far wages go that matters. All this talk about "fair wages" and "fair trade" is nonsense. If the US stopped being the world's policeman, slashed military expenditures by 65%, paid government workers what they were worth, and killed defined benefit pension plans for government employees along the way, the dollar would soar, prices would drop, and we would not be in this big of a mess. Instead, we push the envelope between the "haves" and the "have-nots"
Michael Hudson: China is trying to help by voluntarily cutting back its rare earth exports. It has almost a monopoly, accounting for 97% of global trade in these 17 metallic elements. They are used in military and other high-technology applications, from guided missile steering systems and computer hard drives to hybrid electric automobile batteries. This has prompted China to recently cut back its exports to save its land from depletion (and also environmental pollution), and build up its own stockpile for future use.

I have a modest suggestion. Let China raise the price from a few dollars a pound to a few hundred dollars a pound. According to theory put forth by Mr. Krugman, the U.S. Congress and other China bashers, this should slow Chinese exports. It certainly would help promote world peace and demilitarization, because these rare earths are key elements in military technology. China should build up its national security stockpile of these key metallic minerals for the future – say, the next prospective five years of exportation.

It won’t, of course, because these exports are “price inelastic.” So are many of its other exports, and this category will rise as Chinese technology increases relative to that of financialized economies cutting back long-term investment, research and development in order to squeeze out returns more rapidly. That is the problem with financial management: its time frame is short-term.
Look on the Bright Side

I have to laugh about Hudson's proposal. I made a similar (but sarcastic) statement along the same lines yesterday in Pentagon Loses Control of Laser Guided Bombs to China; Shades of "Avatar", Rare Earth Metals a Potential "Unobtanium"; The "Bright Side"
The Bright Side

Although "unobtanium" is a cause of concern for warmongers everywhere, being the ever-optimist that I am, I prefer to look at the bright side.

Prices are soaring. Isn't that what Bernanke wants?
Laughter, the Best Medicine

At least one person appreciated the sarcasm. Here is an email from Danny ...
Dear Mish:

My wife came into the computer room, drawn by the unusual noise, to find me rolling on the floor, fearing that I was having a heart attack. Of course eventually she figured out that I was laughing so hard I couldn't get up. In explanation all I could do was point out your quote:

"being the ever-optimist that I am, I prefer to look at the bright side. Prices are soaring. Isn't that what Bernanke wants?"

It took me several minutes to explain to her what caused my uproar and she wasn't amused. She just didn't get it. All I can say is that if laughter is the best medicine, all my ailments were instantly cured. Mish, you and your family are in my prayers, keep up the good works.

I am still chuckling
Defending Free Trade

Inquiring minds are reading Biography of Frederic Bastiat on Mises.
CLAUDE FREDERIC BASTIAT was a French economist, legislator, and writer who championed private property, free markets, and limited government. Perhaps the main underlying theme of Bastiat's writings was that the free market was inherently a source of "economic harmony" among individuals, as long as government was restricted to the function of protecting the lives, liberties, and property of citizens from theft or aggression. To Bastiat, governmental coercion was only legitimate if it served "to guarantee security of person, liberty, and property rights, to cause justice to reign over all."

Bastiat's greatest contribution to subjective value theory was how he rigorously applied the theory in his essay, "What is Seen and What is Not Seen." In that essay, Bastiat, by relentlessly focusing on the hidden opportunity costs of governmental resource allocation, destroyed the proto-Keynesian notion that government spending can create jobs and wealth.

As with contemporary Austrians, Bastiat viewed economics as "the Theory of Exchange" where the desires of market participants "cannot be weighed or measured. . . . Exchange is necessary in order to determine value." Thus, to Bastiat, as with contemporary Austrians, value is subjective, and the only way of knowing how people value things is through their demonstrated preferences as revealed in market exchanges. Voluntary exchange, therefore, is necessarily mutually advantageous.

While establishing the inherent harmony of voluntary trade, Bastiat also explained how governmental resource allocation is necessarily antagonistic and destructive of the free market s natural harmony. Since government produces no wealth of its own, it must necessarily take from some to give to others robbing Peter to pay Paul is the essence of government, as Bastiat described it. Moreover, as special-interest groups seek more and more of other peoples money through the aegis of the state, they undermine the productive capacities of the free market by engaging in politics rather than in productive behavior. "The state," wrote Bastiat, "is the great fictitious entity by which everyone seeks to live at the expense of everyone else."

The slogan, "if goods don t cross borders, armies will," is often attributed to Bastiat because he so forcefully made the case that free trade was perhaps the surest route to peace as well as prosperity. He understood that throughout history, tariffs had been a major cause of war. Protectionism, after all, is an attempt by governments to inflict on their own citizens in peacetime the same kinds of harm their enemies attempt (with naval blockades) during wars.
Proper Perspective

We buy goods from China voluntarily. No one forces us too. If China underprices its exports, consumers in the entire rest of the world benefit, with the possible exception of a tiny number of manufacturers.

Bear in mind I think China should float the Yuan. However, I also think the US should stop monetizing debt and let the market set interest rates. Every country should do the same.

Multiple wrongs by multiple countries do not make a right, and it helps to see things from that perspective.

It also helps to understand what China's fears are. Some of those fears are legitimate. Finally it is important to understand that an undervalued Yuan is the least of our problems.

A "What If?" Thought Test

Here's a thought test. What would happen if China raised prices 20% across the board via an export tax or reevaluation of the Yuan, starting tomorrow?

For starters, the Chinese economy would implode overnight along with collapsing exports. US importers such as Walmart, Target, Best Buy, and Kohls would seek new supply chains from Vietnam, Korea, Singapore, or India, but that would take time. In the meantime, US stores would run out of some goods. US consumers would go on strike until the supply chains were restored. Hundreds of small businesses would go bankrupt. Finally, businesses going bankrupt would pressure the banking system.

Of course, China could raise the export tax 1% a month for 20 months. In that case, instead of an overnight collapse, China would implode in a few months as US importers made other arrangements.

Would any jobs return to the US in either scenario?

In theory, a handful of manufacturing jobs might, but only if US importers could not find another source of supplies. What if every country voluntarily placed a 20% export tax on goods headed for the US, or the US placed 20% tariffs on all allegedly "underpriced" goods.

In that case, global trade would collapse and we would lose manufacturing jobs and millions of other jobs as well. In other words, there would be a global depression if prices rose 20% via export taxes or tariffs, whether overnight or over the course of a year.

Thus, Krugman is simply off his rocker, as is anyone else who think tariffs will solve our problems. For further discussion, please see Pied Piper Politics; Krugman and Candle Makers Complain about the Sun

Mike "Mish" Shedlock
Click Here To Scroll Thru My Recent Post List

Wednesday, September 29, 2010 8:37 PM

Pentagon Loses Control of Laser Guided Bombs to China; Shades of "Avatar", Rare Earth Metals a Potential "Unobtanium"; The "Bright Side"

Mish Moved to MishTalk.Com Click to Visit.

Last Sunday in Prepare for Currency/Trade Wars; How Might China Respond to US Tariffs? I mentioned the possibility China might shut off exports of rare earth metals used in making glass for solar panels, motors that help propel hybrid cars like the Toyota Prius, and laser guided bombs.

Indeed, it was the shutoff of rare earth metals to Japan that caused Japan to "cry uncle" and release a Chinese boat captain detained by the Japanese in disputed waters.

For details, please see Rare Earth Diplomacy: Japan Holds Chinese Boat Captain;China Blocks Rare Earth Exports to Japan;China Holds 4 Japanese on Spy Charges;Captain Set Free

Rare Earth Metals a Potential "Unobtanium"

In light of the above, it should be no surprise to see Bloomberg report about the sudden growing concern Pentagon Losing Control of Bombs to China’s Monopoly

“It’s a seller’s market now,” says Bai Baosheng, 43, puffing a cigarette in his office in Baotou, China, where his company sells bags of powder containing a metallic element known as neodymium, vital in tiny magnets that direct the fins of bombs dropped by U.S. Air Force jets in Afghanistan.

The U.S. handed its main economic rival power to dictate access to these building blocks of modern weapons by ceding control of prices and supply, according to dozens of interviews with industry executives, congressional leaders and policy experts. China in July reduced rare-earth export quotas for the rest of the year by 72 percent, sending prices up more than sixfold for some elements.

Military officials are only now conducting an inventory of where and how U.S. suppliers use the obscure but essential substances -- including those that silence the whoosh of Boeing Co. helicopter blades, direct Raytheon Co. missiles and target guns in General Dynamics Corp. tanks.

“The Pentagon has been incredibly negligent,” said Peter Leitner, who was a senior strategic trade adviser at the Defense Department from 1986 to 2007. “There are plenty of early warning signs that China will use its leverage over these materials as a weapon.”

While two rare-earth projects are scheduled to ramp up production by the end of 2012 -- one owned by Molycorp Inc. in California and another by Lynas Corp. in Australia -- the GAO says it may take 15 years to rebuild a U.S. manufacturing supply chain. China makes virtually all the metals refined from rare earths, the agency says. The elements are also needed for hybrid-electric cars and wind turbines, one reason supply may fall short of demand in 2014 even with the new mines, according to Kingsnorth of Imcoa.

Just how far U.S. manufacturing has waned is apparent at a factory in Valparaiso, Indiana, where dogs skitter across a bare concrete shop floor, their nails clicking. This brick plant on Elm Street once made 80 percent of the rare-earth magnets in laser-guided U.S. smart bombs, according to U.S. Senator Evan Bayh, a Democrat from Indiana. In 2003, the plant’s owner shifted work to China, costing 230 jobs.

Now the plant houses Coco’s Canine Cabana, a doggy day care the current tenants started to supplement sagging income from their machine shop.

It’s taking as long as 10 weeks to get neodymium magnets, double the previous wait time, said Joe Schrantz, group supply chain manager at Moog Inc. in East Aurora, New York.

For Western companies, China’s policies are creating the real “unobtanium,” the fictional mineral fought over in James Cameron’s 2009 film “Avatar.”

Rising neodymium prices are forcing up the price of magnets, which typically cost between $2 and $30 apiece. That’s having a “significant” effect on profit, and suppliers say costs will keep going up, Schrantz said. The company is considering buying blocks of raw material and storing it.

“If everybody does that, then it’s going to get really crazy,” he said.
There is much more in the article. Please give it a look.

The Bright Side

Although "unobtanium" is a cause of concern for warmongers everywhere, being the ever-optimist that I am, I prefer to look at the bright side.

Prices are soaring. Isn't that what Bernanke wants?

Mike "Mish" Shedlock
Click Here To Scroll Thru My Recent Post List

4:05 PM

Cheap, (I Mean Really Cheap) Stores

Mish Moved to MishTalk.Com Click to Visit.

Reader Jed writes ....

Hello Mish,
Here is a humorous image of a sign I took yesterday at the Southdale Mall in Edina.

Thanks Jed but that store has a long, long way to compete with stores in Japan that sell things for 10 Yen (about 12 cents by current calculation).

Here is a Forex Currency Conversion Link.

¥10 Shops in Japan

Mike in Tokyo Rogers reports ¥10 Yen Shops in Japan! Proof of Deflation!
The Asia Times Online shows what 20 years of Japan's economic policies have brought us: Severe deflation.

We have ¥10 yen shops selling daily items and doing brisk business in Japan.

The ¥10 yen shops sell loss leader items to attract the customers but the other items sell for about ¥88 each, so they even beat out the ¥100 yen shops.

The store that accomplishes all of this is called the Recycle Garden.

Deflation Dilemma

The article Mike Rogers referred to is Ten-yen stores capture deflation dilemma
With many worrying that the United States economy headed towards a painful Japanese-style deflation, the concept of "Japanization" is increasingly being bandied around the world. But what is "Japanization"?

One answer is found in Kawasaki City, about 20 kilometers southwest of downtown Tokyo. There, a 10 yen-shop called Recycle Garden (equivalent to a 10 cent store in the US) is attracting large numbers of customers by word of mouth. The outlet is one of nine Recycle Garden branches operated in the Kanto region centered on Tokyo and including Yokohama, Kawasaki and Atsugi.

At Recycle Garden, 10 yen buys the customer everyday items such as chopsticks, kitchen goods, nail-scissors, hand sanitizers, or air fresheners. A colored plastic hair clasp is also 10 yen. In the Kawasaki shop alone, the product lineup consists of about 1,000 items at 10 yen, with the number of goods totaling around 30,000. It's all there.

Surprisingly, most of those products are made in Japan, not in China, Vietnam or Cambodia, from where usually cheaper and lower-quality goods flow into Japan.

"Everything is incredibly cheap," said Kyoko Yamada, 52, a careworker, who lives in Tsurumi Ward adjoining Kawasaki, who on a recent visit to Recycle Garden bought 10 items such bath agents.

How is such unprecedented price-slashing possible?

The mechanism is this: amid an increasingly fierce pricing war among neighborhood retail shops such as 100-yen convenience stores, Recycle Garden makes bulk purchases of those goods from bankrupt shops and firms as from deceased manufacturing and wholesale merchants. In most cases, on hearing the news about a bankruptcy, Recycle Garden workers dash to the failed firms with large dump trucks, and buy up and take away immediately to their chain store a vast amount of goods.

"We are cutting prices to the bone," said Tadafumi Fukuda, 41, manager at Recycle Garden's Kawasaki outlet. "Since we also sell other items at 88 yen and above, 10-yen goods serve as a crowd puller." The number of customers visiting the shop has increased 20% from a year ago, when the shop started to sell 10-yen goods, he said.
Can this happen in the US? I think it can, no matter what Bernanke thinks.

Mike "Mish" Shedlock
Click Here To Scroll Thru My Recent Post List

1:58 PM

Open Dissent at the Fed: Charles Plosser (Philly Fed) Opposes QE2; Thomas Hoenig (Kansas City) attends Tea Party

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An open battle exists at the Fed concerning Bernanke's second round of Quantitative Easing (QE2).

Hoenig Attends Tea Party

Bloomberg reports Fed Dissenter Hoenig Wages Lonely Campaign Against Easy Credit

Thomas M. Hoenig, dressed in a gray suit, white shirt with French cuffs, and baby-blue tie, faces an edgy crowd of 150 people in a hotel meeting room in suburban Lenexa, Kan. A large “Kansas City Tea Party” banner covers a table at the door. Attendees wear anti-tax stickers on their lapels. This is not an after-dinner speech for which most central bankers would volunteer.

Hoenig smiles at his audience and begins: “This is a support-the-Fed rally, right?”

Dead silence. Then the room erupts in laughter. Disarmed, the Tea Partiers listen politely as Hoenig defends the Federal Reserve as an indispensible institution, even if at the moment, he says, it happens to be heading in the wrong direction.

And, by the way, if it were up to him (though it’s not, really) he would break up the biggest Wall Street banks.

This is Tom Hoenig’s moment, and it’s a strange one. In Washington, he is the burr in Fed Chairman Bernanke’s saddle: the rogue heartland banker who keeps dissenting alone -- for the sixth straight time on Sept. 21 -- to protest the Fed’s rock- bottom interest-rate policy. Hoenig warns that the Bernanke majority is setting the country up for an as-yet-unknown asset bubble: the next dot-com or subprime craze. He can’t tell yet where the boom-and-bust will materialize, but he can feel it coming, like a Missouri wheat farmer senses in his bones the storm that’s just over the horizon.

In abundant speeches and articles, Hoenig has condemned the political influence of the financial elite. “We’ve had a Treasury Secretary from Goldman Sachs under a Democratic President and a Treasury Secretary from Goldman Sachs under a Republican President. The outcomes were not good,” Hoenig says while being driven to a luncheon talk at an affordable housing conference in Topeka, Kan.

Hoenig harbors powerful misgivings over not dissenting more often and more forcefully during the Greenspan years. “He regrets going along with the votes when Alan Greenspan was chairman to get rates so low and keeping them so low so long,” says his friend Fisher.
There is much more in the article including a discussion of the open debate between Krugman and Hoenig.

Philadelphia Fed president Charles Plosser joins Hoenig

Please consider Economic Outlook Charles I. Plosser's speech to The Greater Vineland Chamber of Commerce September 29, 2010.
My basic message is this: I believe we are in the midst of an economic recovery – a modest one, but a recovery nonetheless. Over the last few months, we have experienced something like the summer doldrums. The tail winds that helped propel the economy earlier in the year have waned. Yet such a slowdown is not unusual in the early phases of recovery, and we should not overreact to data that can be volatile and may be revised over time. My assessment of the recent data leads me to expect that the recovery will continue at a moderate pace over the next several quarters.

Inflation and Monetary Policy

On the inflation front, recent data indicate some deceleration, which has led some observers to voice concerns about sustained deflation – that is, a prolonged decline in the level of prices. In my view, inflation will remain subdued in the near term, but I do not see a significant risk of sustained deflation. I anticipate that inflation expectations will remain relatively stable and core inflation will run in the 1 to 1-1/2 percent range this year and accelerate toward 2 percent in 2011.

Inflation in this range is not a problem – indeed, low inflation is desirable. Most people forget, or are too young to know, that from 1953 to 1965, the average inflation rate measured by the consumer price index (CPI) was just 1.3 percent. For the last 15 years, Switzerland’s average inflation rate has been less than 1 percent. In neither of these episodes did low inflation lead to economic stagnation or fears of deflation.

Were deflationary expectations to materialize – and let me repeat, I do not see much risk of this – I would support appropriate steps to raise expectations of inflation, including, perhaps, aggressive asset purchases coupled with clear communication that our goal is to combat deflationary expectations. But for such a strategy to be successful, the public must believe that the Fed can and will act to combat those expectations.

The Fed must be credible. Protecting that credibility is why, based on my current outlook, I do not support further asset purchases of any size at this time. As I said earlier, asset purchases in our current economic environment can do little if anything to speed up the return to full employment. But if the public believes that they can and is disappointed, it may have less confidence that the Fed will act to raise inflationary expectations if needed. Because I see little gain at this point, and some costs, I would prefer not to engage in further asset purchases at this time.
There is much to blast Plosser for. For starters, Quantitative Easing does not work as noted in Sure Thing?!

Moreover, inflation targeting is pure idiocy. For some explanations as to why please see Fallacy of Inflation Targeting.

For further discussion, please see Does Inflation Targeting Make Any Sense?

Finally, it is perfectly clear that Plosser does not even know what inflation is. Yet, even if one did think inflation was about prices, the idea that the Fed can control prices in a global economy is sheer lunacy.

Nonetheless, it is interesting to see multiple dissents regarding Fed policy. Hopefully that dissent continues to mount.

Mike "Mish" Shedlock
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4:26 AM

Why the Statistical "Recovery" Feels Bad

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Inquiring minds might be interested in charts of GDP minus the effect of increased government spending. The charts are from reader Tim Wallace who writes ...

Dear Mish -

Take a look at the following spreadsheets of GDP from 2001 to 2010, in chained 2005 dollars to account for [price] inflation.

U.S. GDP and Net GDP (subtracting government spending)

click on chart for sharper image

The above chart clearly demonstrates that there really is no recovery, just increased federal spending and debt.

Here are the GDP numbers chained to 2005 dollars (Millions):

YearGDPGov't SpendingNet GDP

Note that the chained GDP number less the federal spending nets out to a number less than the GDP of 2004. So basically, our economy is back where it was seven years ago.

Private Sector GDP

click on chart for sharper image

Private sector GDP continues to shrink as the above chart and following table shows.

YearPrivate GDP%

Moreover, over 40% of government spending is deficit spending. That increase in deficit spending accounts for the alleged rebound in GDP. Clearly that deficit spending is unsustainable.

How much of that increased government spending made it into your pocket or benefited you in any way? While your are pondering that, remember that all government spending adds to GDP whether or not anything is actually produced.

The "Feels Bad" Recovery

These charts help explain Good News: The Great Recession is Over; Bad News: It Doesn't Feel Like It.
So far, we do not even have an admission by the President, by Congress, or by most economists as to what the problems are. Instead everyone wants to "stimulate" something, typically by throwing money at problems.

This is why the problems are unlikely to be fixed, and this is why we are likely to remain in a stagnant economy that produces few jobs for the remainder of the decade.

While the recession is over, it certainly does not feel like it. Moreover, because we fail to address the structural issues, the odds of slipping back into another recession are exceptionally high.
Keynesian and Monetarist Stimulus Both Failures

Neither Keynesian stimulus (deficit spending) nor monetary stimulus (Quantitative Easing) have done anything to speed up the recovery. In regards to the latter, the QE Engine Revs, but the Car Goes Nowhere.

Just as happened in Japan, all we have to show for our stimulus is bigger and bigger deficits with a corresponding increase in the percentage of revenues needed to finance that debt.

All this talk of a "recovery" is nonsensical. Careful analysis shows the alleged recovery is nothing more than an illusion caused by unsustainable deficit spending. Meanwhile, the real economy is mired at the 2004 level. Simply put, the recovery "feels bad" because there is no recovery in the first place, only a statistical illusion of one.

Mike "Mish" Shedlock
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Tuesday, September 28, 2010 10:30 PM

Governor Christie to Test Teachers in Reading and Math

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If you can't read, write, or do basic math, you sure can't teach it. That is the logic behind Governor Chris Christie's reform package that will require teachers in kindergarten through fifth grade pass tests in reading and math in order to be certified.

Everyone but the teachers' unions and incompetent teachers should be happy with Sweeping N.J. Education Reform

Christie is turning his take-no-prisoner’s style to the classroom, demanding a top to bottom overhaul of how New Jersey students learn and teachers teach. And that means undoing tenure, seniority and other union work rules.

“We cannot wait. Your children are sitting in these classrooms today. We cannot wait to make it better,” Christie told CBS 2’s Marcia Kramer.

The governor wants to turn the old seniority system inside out and put quality teaching ahead of lack-luster performance. He will:

  • Prohibit salary scales based on seniority
  • Grant raises based on classroom performance
  • Give tenure based on classroom performance

Educational experts applauded the governor’s actions.

The governor needs the state Legislature to approve the changes to seniority and tenure. The rest of the things he did by signing executive orders.
Fancy that, teachers have to be able to read and write. The only thing that puzzles me is why only kindergarten through fifth grade teachers need certification tests.

Bear in mind this is hardly an ideal approach. In a free market there would not be teachers' unions in the first place and schools would easily get rid of incompetent teachers at will.

However, pragmatically speaking, it is extremely difficult to get to where we need to go in a single step. Changing seniority and tenure rules is a welcome step in the right direction.

Moreover, unless you are a union member, you have to adore Christie's willingness to play hardball. We need Christie in the Whitehouse, not a state capitol.

Mike "Mish" Shedlock
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2:24 PM

QE Engine Revs, Car Goes Nowhere

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The economy is stuck in neutral so stepping on the QE gas pedal is highly unlikely to accomplish much except increase the noise level. Yet, the philosophy at the Fed seems to be, if gas doesn't work, give the engine more gas.

So the engine continues to rev louder and louder, and treasury yields drop, but that does not and will not put Americans back to work.

5-Year Treasury Yields at All-Time Low

Curve Watcher's Anonymous notes Treasury Five-Year Yields Near Lowest Since 2008 Before Auction

Treasuries rose, pushing five-year note yields to the lowest level in almost two years before today’s auction, as a drop in consumer confidence spurred bets that the Federal Reserve will increase debt purchases.

Bonds also advanced as an official said the Bank of England should step up quantitative easing and Standard & Poor’s said the price of bailing out nationalized lender Anglo Irish Bank Corp. could exceed $47 billion

“The engine is revving, but the car is going nowhere,” said Thomas L. di Galoma, head of U.S. rates trading in New York at Guggenheim Capital Markets LLC, a brokerage for institutional investors. “It’s the combination of QE and a possible QE2 in England. You’ve got some sovereign-debt problems, which is also sending a safe-haven bid into Treasuries.”
Yield Curve Weekly Close

Providing unneeded liquidity may or may not help asset prices (please see Sure Thing?! for a discussion) but if quantitative easing helped the real economy, at some point yields would stop falling.

Clearly the Fed has no clue as to what to do, but it wants to "do something". The only thing the Fed can think of doing (or is willing to do) is have another round of quantitative easing, so the Fed eases whether it makes any sense or not.

The amazing thing here is talk of "Sure Things" regarding equities, with treasuries universally despised.

Of course it is no "Sure Thing" for treasury yields to drop either, but arguably it is more likely given the economic engine is stuck in neutral.

The simple fact of the matter is increased borrowing power or lower interest will not cause business businesses to expand. I have discussed this point at length in

Here are a few charts from NFIB Small Business Trends for September.

Prices Received

Actual Price Changes

Single Most Important Problem

The single most important problem is lack of customers. Access to credit is not even on the list. Small businesses don't want loans because they don't have any customers and prices they receive are falling like a rock.

This is deflation in action, and it is crucifying small businesses.

Floods Everywhere

The response from the Fed is to provide more liquidity. Hell, water is everywhere already. The action in corporate bonds alone proves it. Some think that liquidity will continue to flow into equities.

However, with junk bonds already at parity, it seems to me that gold and treasuries are a better bet.

Regardless, please note how Bernanke's policies have robbed those living on fixed income, now earning 0% on their savings.

Bernanke to those on Fixed Income

The above cartoon is actually in reference to Amazing Arrogance, Gall, Chutzpa, and Unmitigated Effrontery from Berkshire Hathaway but the same can be said about the policies of Bernanke that destroy the middle class and those living on fixed income.

Yet, here we go again, with another round of QE, another round that cannot possibly do anything positive for the real economy, but try we must because Bernanke does not want to appear like the powerless charlatan that he is.

Mike "Mish" Shedlock
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6:27 AM

Sure Thing?!

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Last week, David Tepper, a billionaire hedge fund titan and president of Appaloosa Management remarked on CNBC ...

Two things are happening. It's that easy sometimes. Either the economy is going to get better by itself, in the next 3 months and what assets are going to do well? You can guess what assets will do well - stocks are going to do well, bonds won't do so well, gold won't do as well. OR The economy is not going to pick up in the next three months and the Fed is going to come in with QE. Right? Then what's going to do well? Everything! In the near term - Everything!


Earnings vs. Share Prices

One might not be able to argue with Tepper's past performance, but one sure can argue with his current logic. Stocks do not necessarily go up because earnings go up. Stocks rise or fall primarily based on sentiment.

Right now, sentiment is so bullish and earnings estimates so lofty there is room for hefty earnings expansion that falls short or estimates. Buying stocks that miss wildly optimistic earnings estimates is not likely to work out well.

Furthermore, even if earnings do come in on target, there is no historic guarantee that stock prices follow. For example, on March 31, 1973 the S& P was at 111.52 with trailing earnings of $6.80. Seven years later, on March 31, 1980 the S&P was at 102.09 with trailing earnings of $15.27.

Thus, over a span of seven years, earning rose 125% while stock prices fell 8.5%!

What happened? The PE ratio on the S&P fell from 16.40 to 6.68, that's what.

Moreover, those were real earnings then. Now, corporations hide garbage in SIVs with the blessing of the Fed and analysts cite pro-forma earnings that throw out "one-time" charges that occur with increasing regularity.

Thus, anyone who says stock prices will go up because earnings go up, does not understand history. This does not make Tepper wrong, but it does make his argument fallacious.

What About Quantitative Easing?

Tepper also argues that everything will be good if the Fed falls back on quantitative easing. Really?

The Cleveland Fed has a series of nice charts on Japan’s Quantitative Easing Policy
Japan’s Quantitative Easing vs. Price Inflation

Japan’s Quantitative Easing in Trillions of Yen

After a series of fairly ineffectual policy actions, the Bank of Japan undertook its famous quantitative easing policy from March 19, 2001, to March 9, 2006. Under this policy, the Bank shifted its day–to–day operating target from the overnight, call–money rate to the level of current–account balances (reserves) at banks. Over the five years that the program was in place, the Bank of Japan raised its current–account target nine times. In implementing the quantitative easing policy, the Bank of Japan also increased its outright purchases of longer-dated Japanese government securities. The objective was to flood banks with excess reserves, which, of course, would keep the call-money rate at zero.

Although deflation ended in 2006, along with the quantitative easing policy, it returned after a very short hiatus in 2007, and continued until the recent commodity price boom.
Nikkei Monthly Chart

For the Japanese Nikkei Index it has been two lost decades going on three.

Japan started QE on March 19, 2001. The stock market fell for two more years before staging a magnificent rally that collapsed to a new all time low in the great recession.

No Lesson Learned

Amazingly, the Cleveland Fed article concludes "The Japanese experience suggests that when inflation and short–term interest rates approach zero, central banks should act aggressively, giving greater than normal weight to downside risks. Moreover, they should commit to an inflation target and clearly explain their actions in terms of that target."

That nonsense was written in 2008. It is still nonsense today. Yet it seems to be the nonsense the Fed is about to try. Amazingly, nearly everyone believes it will work.

If quantitative easing worked, we sure would not need another round of it. Would we?

However, here were are with unemployment close to 10% (and I believe new all time highs are coming). Here we are with treasury yields in the gutter and with mortgage rates at all time lows, yet home sales are at record lows. To top it off, and in spite of trillions of dollars of Keynesian stimulus from Congress, on top of trillions of quantitative easing from the Fed, and GDP is likely to go negative this quarter or next!

Indeed, quantitative easing was so much of a success that Bernanke needs to do it again.

The Greatest Head-Fake of All-Time?

Todd Harrison, founder of Minyanville is pondering the question The Greatest Market Head-Fake of All-Time?
One of the first adages I learned on Wall Street was that nobody is bigger than the market. That theory is being put to the test.

"Don't fight the Fed" has been taken to an entirely new level. It's no longer about rate cuts -- that bullet blasted long ago -- it's about massive "intervention,” intricate acronyms, and the full faith and credibility of our government. For those who point to the past -- The Depression, the 70's, Y2K -- I would offer that this time is indeed different. Never before has the world been so interconnected and leveraged. FDR didn’t know what a derivative was.

I've said it before and I'll say it again, I want to see an economic recovery as I stand to benefit as much as the next guy. Despite what we hear -- the recession is over, the upside is easy -- let me tell you something you already know: it's not easy and it ain't over. I consider myself an optimistic realist, meaning I hope for the best but will call it like I see it. Before we put the final toe tag on the legacy of this Great Recession, I foresee more pain, perhaps a lot of it.

There are drugs that mask the symptoms and medicine that cures the disease. The drugs -- giving the drunk another drink with hopes he sobers up -- will carry us for only so long before social mood sours to the point of deterioration either domestically, internationally, or both. The medicine -- debt destruction or reorganization -- would be a bitter pill for asset classes but a strong step towards true globalization.

The government bought time, literally, by reflating markets and allowing corporate America to roll out debt and issue stock. Risk wasn't destroyed, it simply changed shape. It migrated from one perception to another, from one balance sheet to the next. I don't know how to be any clearer; we can run but we cannot indefinitely hide. Sometimes I feel like I'm taking crazy pills. The imbalances are cumulative still and the lessons learned from the previous crisis have been squandered.

Could we rally in the intermediate term? Sure, just as nobody is bigger than the market, nobody is smarter than it either... least of all me. I respect David Tepper -- his track record and the attendant compensation are eye-poppers -- but would caution Minyans that if a trade looks too easy, it probably is.
Could We Be Missing Something?

Last week, right after this Tepper story appeared, I was asked by a fund manager I highly respect "Could we be missing something?"

This was my answer.....
It's always possible to miss something.

In spite of what I think the next Congress will do (be far more conservative), perhaps I am wrong. Perhaps Congress starts sending checks, the dollar drops and stocks soar. It's quite a long shot, but it could happen, at least in theory.

Can it be that the real economy just does not matter? I don’t think so, but can it not matter for longer than we thought?

Perhaps the market is going up for reasons none of us can see, even the bulls.

Perhaps the market rolled 6 straight (4’s, 5’s, 9’s, and 10’s) with no 7’s. The odds are against it, but it can happen. Long shots do come in from time to time. Indeed long-shots must, by definition pay off at times. Otherwise they would be zero-shots not long-shots.

Judging from the technical action, I believe there is an increasing chance we have one more swoon down to say 900, with the market going sideways then for 5 years. There is also an increasing chance we do not have another collapse, just a slow drift down for a long time similar to what happened in the 1970's.

If either of those scenarios plays out, valuations can catch up with share prices. The result will not be pretty, and such a path would crucify pension plans and frustrate the heck out of bulls and bears alike. Arguably that is the path of maximum frustration. No one would be happy.

Finally, there is always a chance we did not miss anything major and the simple explanation is that there are (or at least were) far too many bears. Indeed, that may be the most likely explanation. After all, the arguments presented by the bulls are fatally flawed. Yet flawed or not, if most of the key players acted on those beliefs, the market was at least bound to rise temporarily on those misguided beliefs.
Reflections on Confidence

Please consider the Zero Hedge article Why QE2 + QE Lite Mean The Fed Will Purchase Almost $3 Trillion In Treasurys And Set The Stage For The Monetary Endgame
[The following snip is from Bank of America's Jeffrey Rosenberg, who analyzes the costs of QE2]

The costs of QE 2 in our view however go beyond the cost benefit analysis Chairman Bernanke highlighted in his Jackson Hole speech. There, the Chairman highlighted two key risks to additional purchases of longer-term securities. First, that they do not know with precision the effect of changes in Fed holdings of securities on financial conditions. On this point we have emphasized on numerous occasions that the main consequences of QE1 to date have been financial asset inflation. Further purchases under QE2 hence in our view would likely be limited in impact to furthering this process of asset inflation.

The second risk highlighted in Jackson Hole by the Chairman concerns the confidence effects of Fed’s ability to exit accommodative policy and shrink the size of its balance sheet.

Bernanke acknowledged that fiscal policy needs to be part of the policy response and that “Central bankers alone cannot solve the world’s economic problems.” In our assessment, further liquidity injection beyond some additional marginal transmission mechanism into mortgage refinancing or housing affordability would achieve little impact on the real economy.

For smaller corporates or small business, QE1 did little to expand lending, though QE1 likely did prevent even further declines in lending. However, QE alone appears incapable of leading to expanding lending as the problems today shift from one of supply to one of demand.

Even as banks have eased underwriting standards, the demand for loans remains low.

And this leads to our final cost analysis on QE2. Where confidence stands as the key issue for the economy, expanding QE2 may end up doing more damage than good as the confidence loss from a Fed indicating its fears of deflation through expansion of QE2 as well as the follow on loss of confidence from the diminishing impact of further QE leads to a loss in confidence whose costs outweigh those of the benefits of further reductions in long term rates.
Uncharted Territory with Risks to the Downside

Tepper seems to have more confidence in Bernanke than Bernanke has in Bernanke. Even Bernanke seems to understand we are in uncharted territory with uncharted risks.

One such risk is that confidence could severely erode in financial assets (such as equities) denominated in dollars and unsupported by Fed buying. That risk is both significant and heavily skewed to the downside. After all, equities are subject to earnings shock and PE compression, as noted earlier.

Also note that the lift in equities in 2009 was a directly related to the lift in corporate bonds. Arguably, Bernanke's one success was unlocking the corporate bond market. Companies priced for bankruptcy on expectation they would not be able to roll over their debt got a new lease on life.

Now junk bonds are back at par. So where to from here? At best, QE2 can maintain that liquidity. At worst, confidence collapses in spite of, or perhaps because of QE2.

Conversely, commodities, especially gold, may be beneficiaries of a loss of confidence in equities, junk bonds, or the dollar. Thus, from a risk/reward perspective, stocks are quite far down on the list of places to be, hoping for QE2.

A month ago everyone was focused on a "Hindenburg Omen". Now everyone is focused on a "sure thing" by the Fed. That is how quickly sentiment can change, and sentiment can just as easily turn again.

Caution, not "sure things" seems like a better bet to me.

Mike "Mish" Shedlock
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Monday, September 27, 2010 10:38 PM

UAW Workers Vote 457 to 96 to Close Plant Instead of Reducing Salaries

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With Indiana unemployment rate at 10.1% one might think that jobs that pay more than double the minimum wage would be in demand. Actually, such jobs are in demand, but ironically not from some of those who have them.

Let's take a look at an offer Illinois businessman Justin Norman made last August to UAW members in a plant in Indianapolis scheduled to close in 2011. The offer was rejected today.

Illinois Businessman Proposes to Save 650 UAW Jobs

August 29, 2010: Norman talks pay with GM workers

Illinois businessman Justin Norman continued his effort to win over GM Indianapolis stamping plant workers, telling a gathering Sunday that skilled trades employees at his Chicago-area plant will earn nearly $100,000 this year.

GM executives three years ago scheduled the shutdown of the 2.1-million-square-foot metal plant in 2011 if no buyer appeared. This spring, JD Norman Industries agreed to take over the factory if UAW Local 23 accepted a new contract that cuts costs.

The new contract would include a lower base wage of $15.50 per hour, down from $29 per hour, and pare the wage for skilled trades workers to $24 per hour from about $33.

Autoworkers who stay with JD Norman would receive lump sum bonuses, in some cases up to $35,000 over two years, and retain the right to transfer to open GM plants. They could keep the bonus if they did transfer.
UAW Prefers No Jobs to Jobs

September 27, 2010: UAW turns down contract offer to keep Indy stamping plant open
General Motors autoworkers have rejected the contract offer from JD Norman Industries to continue operating an Indianapolis stamping plant, said Maurice Davison, a UAW official in Indianapolis.

According to retired GM autoworker Gregg Shotwell, publisher of the UAW dissident newsletter Live Bait & Ammo, the final tally included 457 "no" and 96 "yes" votes.

The rejection means that General Motors will proceed with plans to remove machinery and close the plant in 2011, Davison said.

The plant employs 650 workers.
How is it that people can be so destructive to their own well being?

Lines would be 5 miles long for jobs that pay $15-$24 per hour with a $35,000 bonus after two years if such an offer could be made to the general public.

I do not know the nature of their existing contract or how long severance benefits might last, but I strongly suspect many of those rejecting the offer will start looking for minimum-wage jobs at Walmart when their benefits expire. Few if any of them will blame themselves for their situation.

Mike "Mish" Shedlock
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2:36 PM

Pied Piper Politics; Krugman and Candle Makers Complain about the Sun; Global Trade Wars

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The odds of a global trade wars took yet another step forward today.

Brazil’s finance minister went on the warpath complaining about the "international currency war" upset that the Brazilian Real appreciated 25% against the US dollar in less than two years.

Guido Mantega, Brazil’s finance minister, said on Monday the world was in an “international currency war”, in a further sign that Brazil is preparing measures to prevent further appreciation of its currency, the real.

“We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness,” he said, according to Reuters.

The US dollar has fallen by about 25 per cent against the real since the beginning of last year, making the real the strongest performing currency in the world, according to Bloomberg.

Mr Mantega recently said Brazil’s sovereign wealth fund was preparing to make “unlimited” dollar purchases to prevent the real appreciating any more.
Currency Intervention Doesn't Work

Currency intervention does not work but that never stops any country from trying.

Worse yet, with increasingly harsh rhetoric from China, Japan, the US, and now Brazil, I am starting to wonder if anything can stop the trade war that is shaping up.

This is now my third consecutive article touching on the subject of trade wars. See also ...

Krugman Favors Protectionism

Would the Yuan rise if China floated it, resulting in more jobs in the US and a better balance of trade? That's what Krugman thinks, but I have stated many times it's not even clear the Yuan would rise. Moreover, Krugman never looks at the unseen effects of what he suggests.

The Acting Man Austrian blog agrees while noting China Bashing in High Gear Again
It began with a NYT editorial by Paul Krugman, who appears to have a number of hobby horses that occupy most of his efforts – demanding more deficit spending, more money printing, raising taxes and bashing China for currency manipulation.

Now, don't get us wrong – we also tend to think that China's exchange rate policies are harmful – alas, they are mostly harmful for China.

Krugman asserts that the yuan's exchange rate would increase if it were allowed to float as though that were an incontestable given (he does not explicitly demand a floating, fully convertible yuan however – he just wants China to keep 'manipulating' it, albeit in an upward direction):

If discussion of Chinese currency policy seems confusing, it’s only because many people don’t want to face up to the stark, simple reality — namely, that China is deliberately keeping its currency artificially weak.

How do we know whether the yuan is 'artificially weak'? As a matter of fact, we do not know that, and there are many arguments in favor of the yuan weakening if it were allowed to float. ....

In addition to these considerations, think about the fact that China's citizens had to live with a closed capital account for an eternity. How would they react if it were to be opened? We tend to think that citizens with large savings who have heretofore been forced to invest those savings within China – a major force in driving China's real estate bubble to absurd heights – would begin to divert a lot of capital to investments abroad. While we can not be certain how big a flood of money would leave China in the event, it's a good bet the markets are not prepared for it. The consensus is after all congruent with Krugman's assertion that the yuan is too weak.

Let us however step back for a moment from this discussion and for argument's sake accept the notion that the yuan's exchange rate is too low and would rise if left to float. How can that harm the US? Krugman asserts that a trade deficit is 'negative', but why should that be so? Trade is after all a voluntary economic activity. When people engage in trade, they do so because both parties to the trade deem it to their economic advantage. It follows that there can be nothing 'negative' about this. China's merchants wouldn't sell their goods for dollars if they did not prefer these dollars over their merchandise, and conversely US consumers would not trade their dollars for Chinese merchandise if they thought the trade harmful to their economic well-being. Just because there is a national border between these sets of traders this basic economic fact is not magically suspended. If trade deficits were worth worrying about, why not also worry about the trade deficit between, say, New York and Philadelphia?

The fact that Krugman does not even mention this basic facet of trade anywhere in his articles is tantamount to a red alert. Frederic Bastiat lampooned protectionism back in 1845 when he penned his 'Petition of the Candle Makers'. The candle makers are incensed that the light of the sun can be had for free. The sun's 'unfair trade advantage' surely needs to be curtailed somehow!

We are suffering from the ruinous competition of a rival who apparently works under conditions so far superior to our own for the production of light that he is flooding the domestic market with it at an incredibly low price; for the moment he appears, our sales cease, all the consumers turn to him, and a branch of French industry whose ramifications are innumerable is all at once reduced to complete stagnation. This rival, which is none other than the sun, is waging war on us so mercilessly we suspect he is being stirred up against us by perfidious Albion (excellent diplomacy nowadays!), particularly because he has for that haughty island a respect that he does not show for us.”

Replace 'perfidious Albion' with China, and you have Krugman. Krugman makes the same mistake he always makes – the one mark of a truly bad economist if you will – he neglects the 'unseen' effects of his policy advice. It may well be true that a small group of domestic producers would benefit from a higher yuan (which ones? We're not quite sure, actually…). Alas, every single consumer would suffer for their betterment by having to pay higher prices. This in turn means that consumers will either have to cut back on their consumption, or lower their rate of saving. It seems obvious that this entails a lower standard of living for everyone but the favored few. Since less money will be available for either consumption or saving, there will also be less money available for investment. Capital formation is thus likely to slow, further impinging on future growth.
Who is Harmed by Low Prices?

From Prepare for Currency/Trade Wars; How Might China Respond to US Tariffs?
Assume for a second that everyone is selling us stuff for far less than it's worth. Who is harmed by this, us or them? The overwhelming percentage of the population (everyone but the handful of jobs we would save by tariffs) comes out ahead. How is this not a good thing?
Pied Piper Politics

Those who believe tariffs will solve our problems effectively argue along with Krugman and the candle makers against the sun. Yet, the parade of protectionists, led by Pied Piper (Paul Krugman), grows with each passing day.

The Pied Piper and his followers all scream for higher prices as if tariffs are the magic elixir that will restore the US to fiscal health. It won't. Trade wars never solve anything.

The US is in a mess of its own making. Screaming about "fair trade" is a scapegoat for preposterous US economic policies on military spending, entitlements, policing the world, public sector pensions, Fannie Mae and Freddie Mac, too big to fail, and numerous other disasters at the state and federal level.

Giving into the Pied Piper, will do nothing but make the problem worse.

Mike "Mish" Shedlock
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10:54 AM

Eurozone Recovery Slows; Contraction Evident Except Germany, France

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Robust growth in Q3 will soon give way in Europe. Markit reports Eurozone recovery slows as renewed contraction is evident outside of French-German core

Contracting periphery

Outside of the two largest euro member states, a renewed contraction of economic activity was evident in September. The Composite Output Index for the rest of the Eurozone1 has fallen steadily since peaking at 54.2 in March, dropping from 51.7 in August to 49.4 to thereby slip below the 50.0 no-change level for the first time since last November.

Employment growth disappoints

One of the more disappointing aspects of the recovery has been weak job creation. The Composite PMI Employment Index fell slightly in September, down from its weak post-recession peak in August, and is consistent with only very modest employment growth of perhaps 0.2% per quarter.

Furthermore, the jobs growth is largely confined to France and Germany. The former saw jobs created at a rate only just below August’s 28-month high, while the latter saw the sharpest rise in employment since May 2008. In contrast, outside of these countries, PMI data signalled an accelerating rate of job losses in September, with the rate of decline reaching the highest since February.
How long Germany and France can keep Europe from slipping back into recession remains to be seen, but if contraction of economic activity in the rest of Europe continues, I would suggest another quarter or two at most.

One big advantage German exporters had earlier in the year was the Euro collapsed to 1.18. The Euro is now approaching 1.35.

Meanwhile, Japan's intervention in the Yen has failed to produce any lasting results, as expected.

Trade Friction Increases

Congress and Geithner are on the warpath over currencies already. Moreover, the House is set to vote on Tariff legislation this week, as discussed in Prepare for Currency/Trade Wars; How Might China Respond to US Tariffs?

Yet, without waiting to see whether or not the House and Senate pass a bill, China has fired off a preemptive warning. MarketWatch reports China raises antidumping duties on U.S. chicken
China’s Commerce Ministry has decided to increase an antidumping duty on U.S. chicken products, months after the punitive measures were first introduced, in a sign of continuing trade frictions between the two economic superpowers.

China will raise the minimum chicken duty to 50.3% on chicken products imported from the U.S., compared with minimum duties of 43.1% that were introduced in February, the ministry reportedly said in a statement on Sunday. The maximum antidumping tariff for the chicken products will remain at 105.4%, reports said.
Global Trade War Risks Increase

With US and China openly bickering, and with the US House of Representatives prepared to act, risk of a global trade war is increasing by the day. I do not think China's chicken move will help any.

Every country wants its currency to weaken to stimulate exports. However, that's mathematically impossible except against gold, and rising gold prices will not do exporters any good.

Hopefully cooler heads will prevail, but now that Geithner has stirred up a hornet's nest, anything can happen.

Mike "Mish" Shedlock
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Sunday, September 26, 2010 8:21 PM

Prepare for Currency/Trade Wars; How Might China Respond to US Tariffs?

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Patience of US legislators regarding the value of the Yuan has finally given out. Last Friday, Congress jumped into the fray after exceptionally harsh statements from Treasury Secretary Tim Geithner, who up until now had always preached diplomacy. Here is a brief sequence of events.

Patience Runs Out

MarketWatch reports Patience runs out on quiet diplomacy on China currency.

Sept. 15, 2010
Patience appears to have run out in Washington for the standard White House approach that favors quiet diplomacy for dealing with China over the dispute over the value of its currency.

In testimony to the House Ways and Means Committee, a wide array of experts said that quiet diplomacy has essentially been a failure. The only debate at the hearing was what new approach should be tried.
Geithner Enters the Battle

One day later Geithner calls for faster yuan appreciation
Sept. 16, 2010
“China needs to allow significant, sustained appreciation over time to correct this undervaluation and allow the exchange rate to fully reflect market forces,” Geithner said in testimony prepared for the Senate Banking Committee. Geithner will also talk about the yuan with the House Ways and Means Committee this afternoon.

“It is past time for China to move,” Geithner said.

An undervalued yuan has helped China to boost exports and encouraged U.S. companies to outsource manufacturing to China from the U.S., Geithner said. He added that the yuan is held at a undervalued level by “heavy intervention” even as Chinese officials have pledged to allow the yuan’s value to be guided more by market forces.
China Rebuffs Geithner

Responding to Geithner China says it won’t repeat Japan’s mistake
Sept. 20, 2010
China pledged not to repeat Japan’s mistake and allow its currency to rise in response to foreign pressure, countering criticism from U.S. lawmakers that the yuan is undervalued amid a growing cross-Pacific row over Beijing’s currency regime.

“China will not go down the path that Japan did and give in to foreign pressure on the yuan’s exchange rate,” Li Daokui, an economist and member of the monetary policy committee of the People’s Bank of China, was cited as saying in a report by the state-run China Daily.

Li’s comments appeared to reference to the 1985 Plaza Accord that resulted in coordinated government intervention in the currency markets to bring down the value of the U.S. dollar amid concerns over a ballooning trade deficits with its most important trading partners.

There’s growing concern in Beijing that the strong-yen agreement doomed Japan’s economy.

Attracted by the appreciating yen, cash flowed into Japan in the late 1980s, resulting in loose monetary conditions that helped fuel a bull market in stocks and real estate. The resulting asset bubble burst in 1990, followed by two decades of economic stagnation in Japan.

“But what has the US done to reduce its trade deficit?” Li said. “The US should pay much more attention to its own problems.”
Congress Risks Trade War

Geithner's sounding off and the rebuke from China were all it took to spur Congress into action.

The Financial Times reports US Congress to attack renminbi valuation
Sept. 23, 2010
Democratic leaders in the House of Representatives will move ahead with a bill allowing the US to retaliate against China for manipulating its currency, a significant escalation of the dispute between Washington and Beijing.

Sander Levin, chairman of the ways and means committee in the House of Representatives, said on Wednesday the bill would be compatible with World Trade Organisation rules.

But in a largely untested area of trade law the measure will evoke opposition from Beijing and could lead to a legal challenge in the WTO. The bill will go to committee on Friday and could be voted on by the full House as early as next week.

“This bill is being advanced in the absence of effective action on a multilateral basis,” Mr Levin said.

Hours later, Wen Jiabao, the Chinese premier, told business leaders in New York that pressure on Beijing was unwarranted.

“The conditions for a major appreciation of the renminbi do not exist,” he said. If the renminbi were suddenly to rise by a large degree against the dollar, “we cannot imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs, and how many migrant workers will return to the countryside... China would suffer major social upheaval”.
Risk of Trade Wars Looms

The Telegraph reports Risk of trade war rises as key US committee backs tariffs on China
The adoption of the measure by the Ways and Means Committee on Friday means it will now be voted on by the House of Representatives on Wednesday.

"China's exchange-rate policy has a major impact on American businesses, and Americans jobs, which is what this is all about," said Sander Levin, a Democrat from Michigan and chairman of the committee.

China's determination to shackle the strength of its currency helped turn the country into the world's manufacturing hub for everything from iPods to T-shirts and, until the recession bit, attracted few critics. But an unemployment rate of 9.6pc in the US, as well as upcoming Congressional elections, is spreading anger across Capitol Hill.

According to the bill's supporters, a properly valued yuan would move jobs back to the US as exports from China become more expensive. The Peterson Institute for International Economics in Washington argues up to 500,000 American jobs could be created.

Not every US company shares the committee's view. Wal-Mart and Citigroup are among companies lobbying against the Bill, fearing it will provoke retaliation in China. If the bill passes next week, the Senate will still need to vote on it.
House Vote Set

Bloomberg reports China Currency Measure Set for Vote in U.S. House
Legislation pressing China to raise the value of its currency is set for a vote in the U.S. House next week, as Republicans joined Democrats in expressing frustration that the yuan is appreciating too slowly.

“We cannot wait any longer to level the playing field for U.S. businesses and protect American manufacturing jobs,” Democratic Leader Steny Hoyer of Maryland said yesterday after the Ways and Means Committee sent the bill to the full House.

The committee adopted the measure by voice vote after the panel’s top Republican, Dave Camp of Michigan, voted with Democrats to back the bill. The full House will vote Sept. 29, said committee Chairman Sander Levin of Michigan, a Democrat.

The measure would let companies petition for higher duties on imports from China to compensate for the effect of a weak currency. President Barack Obama’s administration hasn’t taken a position on the bill, said Natalie Wyeth, a Treasury Department spokeswoman.

The currency dispute “is a proxy for the state of the overall U.S.-China commercial relationship,” William Reinsch, president of the Washington-based National Foreign Trade Council, said Sept. 23 on Bloomberg Television. “I don’t think it will have that big of an impact on the American economy.”

Lawmakers fended off warnings from lobbyists representing companies such as Caterpillar Inc., Wal-Mart Stores Inc. and Citigroup Inc., who said the measure may lead to retaliation against U.S. companies operating in China and curb exports to the country. China may retaliate if the House passes the legislation, said Reinsch, who represents multinational companies such as Caterpillar.

Forty-four Republicans had already signed on as sponsors of the original bill, and with Camp’s support, lobbyists said they expect additional Republicans to vote with Democrats next week.

“Provoking tension with our trading partners doesn’t come without costs, and we should choose our battles carefully,” Stephanie Lester, vice president of the Retail Industry Leaders Association, which represents Wal-Mart, said in a statement. “It makes little sense to enact harmful policies that will spark a bilateral conflict over currency with one of our largest trading partners and fastest growing markets for American exports.”
Impact on Jobs

I certainly disagree with C. Fred Bergsten, director of the Peterson Institute for International Economics in Washington who says "Forcing China to raise the value of its currency may create 500,000 jobs in the U.S."

I do not think it will create any jobs. In fact, I think it will cost jobs. Manufacturing is not going to return to the US just because we pass tariffs on China. Wage differentials are too great. Instead, imports will simply come from some other country and rising prices will hurt sales.

Of course we could pass tariffs on the whole world, but who then buy our stuff? The most likely thing to happen if we pass massive numbers of tariffs is global trade will collapse.

How Might China Respond?

Assuming we do pass a bill and the President signs it, China will respond.

Some might argue this would prompt China to dump treasuries. I find that unlikely. However, China would certainly buy less of them.

Here are a few things to consider.

On June 27 China announced it would buy 20 Boeing 777-800 airplanes for $1.4 billion to be delivered between 2013 to 2015. On August 31, Air China announced it would buy 15 Boeing 787-9 aircraft.

Might not China cancel those orders or give all future orders to Airbus? Might not China decide to put a tariff on US agricultural imports?

There are all kinds of ways China could retaliate without dumping treasuries, and we would not like any of them.

Pray tell what if China shuts off all rare earth exports? Please see Rare Earth Diplomacy: Japan Holds Chinese Boat Captain;China Blocks Rare Earth Exports to Japan;China Holds 4 Japanese on Spy Charges;Captain Set Free for a discussion as to what that would mean to US military.

No-Win Situation for Obama

Anti-China sentiment is at a fever pitch in Congress.

If Congress passes a bill, the president will be in a no-win situation, with either his reelection chances or the economy at huge risk.

For example, if the president vetoed a bill he would be attacked from members of both political parties.

If he signed a bill and numerous import tariffs placed, global trade would collapse and the US would soon be back in a deep recession, assuming you believe Good News: The Great Recession is Over

Regardless, trade wars will make matters much worse. Does anyone remember Smoot-Hawley?

First Things First

We still do not know if the Senate will take up the measure before the election, what the Senate version will look like, whether the president will sign the bill if the measure passes, and whether or not the final version of the bill mandates action instead of noise.

Lots of things can happen. Hopefully cooler heads prevail. One final point: Trade wars like these are hallmarks of deflationary times.

Addendum - Fair Trade or Free Trade?

I was asked "Mish, what if we adopted a 'fair trade' policy where we only traded with countries that meet certain standards. Ie.) they need a EPA equivalent, UI, etc. This would seemingly stimulate jobs here while raising the global standard of living no?"

That may sound good but what constitutes "fair trade?
Who gets to define "fair"? Us or them?

Assume for a second that everyone is selling us stuff for far less than its worth. Who is harmed by this, us or them? The overwhelming percentage of the population (everyone but the handful of jobs we would save by tariffs) comes out ahead. How is this not a good thing?

Imagine going into Walmart and demanding to pay higher prices. They would think you were nuts, and so would I. Go into a small business and demand to pay more and they will probably accommodate you. People shop at Walmart, Target, Kohls, Best Buy or wherever because they like low prices.

The only people who don't like low prices are those who think (incorrectly) that higher prices will bring back jobs. But they won't.

The irony in this "fair trade" argument is the US is arguably one of the biggest abusers of "fair trade" around, especially on agricultural products. The EU is second.

Even Canada bitches at us regarding agricultural goods and lumber. Year in and year out trade agreements die on US and EU agricultural subsidies.

I maintain the first country that practices free trade regardless of what anyone else does will be a winner.

Mike "Mish" Shedlock
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