Do These Idiots Realize How Stupid They Sound?

Just how idiotic is it to seek to prevent what has already occurred? I suggest that is blatantly idiotic. Here is a case in point.

Earlier this evening, I noted ECB Seeks to Avert What Has Already Happened

I cannot help but laugh out loud at some of the headlines this evening. By any rational measure, confidence has collapsed, yet G-7 Seeks to Avert Collapse in Confidence

That the ECB needs to take these actions is a 100% sure-fire sign that investors have lost confidence.

That is ridiculous enough, but the height of absurdity is found in the G-7 Statement on Renewed Strains

We reaffirmed our shared interest in a strong and stable international financial system, and our support for market-determined exchange rates.

Today the G-7 advocated both currency and and bond-market interventions "whatever it takes" yet sings the praises of "market-determined exchange rates".

I really do have to ask "Do These Idiots Realize How Stupid They Sound?"

Definition of Idiot

The above question is more complicated than it seems at first glance. In typical usage, "idiots" by definition do not realize what they are saying.

However, let's throw out a definition as follows: Idiot - Someone devoid of common sense who lives in the shelter of academia or politics, with no real-world experience. Also included in this definition is someone with real-world experiences yet ignores the real world in favor of academics, politics, or desires.

Bernanke with a PhD, and Krugman with a Noble Prize both qualify as potential idiots under the above definition. Bear in mind that sometimes (when it suits their goals) both may say things that make perfect sense. I agree with Krugman about 20% of the time. Such is the problem with this definition of idiocy.

Common Sense vs. Purposeful Idiocy

On grounds of common sense, anyone simultaneously praising free markets and intervention on the exact same issue is an idiot.

But Wait! What if the statement was a lie on purpose, hoping that idiots in mainstream media would not catch the lie?

Recall that Jean-Claude Juncker, Luxembourg PM and Head Euro-Zone Finance Minister says "When it becomes serious, you have to lie"

Is the support for free markets just another purposeful lie?

One cannot easily determine the truth in these instances. However, in accordance with Occam's Razor, the simplest explanation is likely the best.

One case suggests that potential idiots are telling lies on purpose. The simple case suggests that idiots can be expected to behave like idiots.

Thus, I come to the conclusion that "These Idiots Do Not Realize How Stupid They Sound".

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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ECB Seeks to Avert What Has Already Happened; Raspberries and Gold

I cannot help but laugh out loud at some of the headlines this evening. By any rational measure, confidence has collapsed, yet G-7 Seeks to Avert Collapse in Confidence

Group of Seven nations sought to head off a collapse in global investor confidence after the U.S. sovereign-rating downgrade and a sell-off in Italian and Spanish debt intensified threats to the world economic recovery.

The G-7 will take “all necessary measures to support financial stability and growth,” the nation’s finance ministers and central bankers said in a statement today. Members agreed to inject liquidity and act against disorderly currency moves if necessary.

The European Central Bank indicated separately that it will buy Italian and Spanish bonds and Japan signaled further dollar purchases in a sign of concern that prices are becoming unhooked from fundamentals. Stocks extended last week’s decline, the biggest since 2008, adding to risks for a global rebound already burdened by European fiscal cuts and elevated U.S. unemployment.

That the ECB needs to take these actions is a 100% sure-fire sign that investors have lost confidence.

Raspberries and Gold

“The G-7 just gave a raspberry to S&P and basically said its analysis is irrelevant,” said Diane Swonk, chief economist at Mesirow Financial Inc. in Chicago.

I can top that. The futures so far have given the raspberry to the ECB and the G-7. Moreover, gold has given the raspberry to nearly everything else. Grain, energy, and equity futures are all trading lower. However Gold is up $34 to $1684 and silver is up $1.18 to $39.39.

Addendum:

The feed on Zero Hedge has been messed up all evening. It has been both duplicated and not working. I am not sure if this is universal or not. However, links are now working (at least for me) but some of them may still be duplicated.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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S&P Futures Open Down 30 Points, -2.6%; ECB to "Actively Implement" Bond Purchases

What started out as an extremely poor idea has now turned into a bet the bank bond-buying strategy as ECB Signals Purchases of Italian, Spanish Bonds.

The European Central Bank said it will “actively implement” its bond-purchase program, signaling it is ready to start buying Italian and Spanish securities to counter the sovereign debt crisis.

In a statement issued in the name of President Jean-Claude Trichet after an emergency teleconference meeting of policy makers, the Frankfurt-based ECB welcomed Italy and Spain’s efforts to reduce their budget deficits. It also called on all euro-area governments to follow through on the measures agreed at a July 21 summit, including allowing the European Financial Stability Facility to purchase bonds on the secondary market.

“It is on the basis of the above assessments that the ECB will actively implement its Securities Markets Program,” the central bank said. “This program has been designed to help restoring a better transmission of our monetary policy decisions -- taking account of dysfunctional market segments -- and therefore to ensure price stability in the euro area.”

Buying Italian and Spanish debt may open the ECB to accusations it is bailing out profligate nations, breaching a key principle in the euro zone’s founding treaty and eroding its credibility. Germany’s Bundesbank opposes the move.

“The ECB is once again intervening as the last line of defense,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland in London. “The intervention will put a halt to the bond market crash that some member states faced. However, the ECB is now in for the long haul and will potentially have to buy up to half of the Italian and Spanish traded debt, the biggest risk-pulling effort ever engineered in Europe.”

The initial reaction from the market was swift and severe. S&P futures opened up 30 points in the red, Nasdaq futures 47 points in the red.

The night is still young and the intervention in Italian bonds begins tomorrow.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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France AAA Rating on the Line; S&P Says 1 in 3 Chance of Further US Downgrades; Contagion in Downgrades? Currency Crisis Escalates; Euro Endgame

With the US AAA rating gone, how long can France hold its AAA rating? I suspect not long. So where will that leave the ECB attempting to put a circle around Italy? Will Germany have to backstop all of Europe?

Those are the new key questions and notice how the key question list keeps growing larger in size and significance.

France Vulnerable to Rating Cuts

Bloomberg reports AAA France May Be Vulnerable After U.S. Cut

The decision by Standard & Poor’s to downgrade the U.S. credit rating leaves France as the AAA country most likely to lose its top grade, some investors and economists say.

France is more expensive to insure against default than lower-rated governments including Malaysia, Thailand, Japan, Mexico, Czech Republic, the State of Texas and the U.S.

“France is not, in my view, a AAA country,” said Paul Donovan, London-based deputy head of global economics at UBS AG. “France can’t print its own money, a critical distinction from the U.S. It is not treated as AAA by the markets.”

“If Italy and Spain have difficulties, are we sure that, for instance, France can still be considered a ‘core’ country?” said Marco Valli, chief euro-area economist at UniCredit Global ‘Core’ is becoming a narrower group of countries.”

While France’s debt of 84.7 percent of gross domestic product is less than Italy’s 120.3 percent, as a percentage of economic output it has risen twice as fast as Italy’s since 2007. French government debt totaled 1.59 trillion euros ($2.3 trillion) at the end of 2010, according to the European Union; Italy's was about 1.8 trillion euros. France has had a larger budget deficit than Italy every year since 2006. S&P rates Italy A+, four levels below France.

“If French authorities do not follow through with their reform of the pension system, make additional changes to the social-security system and consolidate the current budgetary position in the face of rising spending pressure on health care and pensions, Standard & Poor’s will unlikely maintain its AAA rating,” S&P said in a June 10 report.

The S&P warned the US, now it has warned France. Notice how the rating agencies want austerity. I asked some tough questions above, here is a cream-puff question: Short-term, what will all these austerity measures do to global growth?

Japan Threatens More Yen Intervention

Adding to the global tension, Japan Official Warns of More Yen Selling

A Japanese Finance Ministry official said the government is ready to sell yen again following last week’s move if it sees speculative trades driving the currency higher.

Further intervention would “maintain the effect and warn those who make unusual moves” in the currency market, Vice Finance Minister Fumihiko Igarashi said on a television program of public broadcaster NHK yesterday.

Japan acted alone in selling the yen last week, in contrast with a previous intervention in March that was coordinated among the G-7. The Bank of Japan added 10 trillion yen of monetary stimulus on Aug. 4, hours after the Finance Ministry’s move.

Baba and Lee at Goldman Sachs said that Japan has been buying U.S. Treasuries when it sells yen, leaving it with more than 30 trillion yen in unrealized losses that will test the government’s “true determination” to combat the currency’s rise.

Japan maintains its trust in the ability of the U.S. to pay its debts and expects Treasuries to remain an attractive investment, a government official from the Asian nation said yesterday on condition of anonymity. Japan is the second-largest international investor in Treasuries, behind China.

Countries do not care much about losses on treasury holdings. They care about exports. Notice how even amidst the S&P downgrade of US debt Japan's reaction is to buy more.

I covered this topic at length on Friday in Reserve Currency Curse: Idea China to Stop Buying Treasuries After S&P Downgrade is Fallacious; US Would Welcome China Not Buying US Treasuries!.

Global Currency Wars

In spite of its stated "strong dollar" policy, clearly the US wants a lower dollar. It is equally clear (and stated) that Japan wants a lower Yen, Brazil wants a lower Real, Switzerland wants a lower Swiss Franc, and China does not want the Yuan to rise.

Yet every month, someone talks about China or Japan or some other country dumping treasuries or dumping the dollar.

In case you missed it, please consider Global Currency Wars Enter New Stage; Brazil Calls Off Truce, South Korea Reviews "All Possibilities", Philippines Threatens "Prudential Limits".

When does this madness blow sky high in a global currency crisis? I will tell you it is going to happen, I just cannot tell you when.

Europe's Structural Problems

Structurally the only way to resolve the European mess is

1. Adoption of a European nanny state complete with common bonds and common fiscal policies
2. Partial breakup of the Eurozone

Euro Endgame

Would Germany go along with the former? How difficult is the latter?

I cannot answer the former but the latter is easier said than done. Greece for example would immediately blow up in hyperinflation if it was forced to immediately go back on the Drachma. No one would want that. Capital and human capital would both flee Greece. The same might apply to Portugal and Spain.

Germany could leave. Otherwise, slowly but surely the European Nanny State solution will be forced down the throats of screaming German taxpayers.

The endgame is not clear, and both option 1 and 2 involve huge unresolved issues with global consequences. What is clear is the current path is unsustainable. There has never been a successful currency union in history that did not also involve a fiscal union as well. This time will not be different.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Israel, Dubai, Saudi Arabia Shares Plunge in Wake of S&P Downgrade; Israel Drops 7%, Dubai 3.7%, Saudi 5.5%; Is S&P Downgrade to Blame?

The Mideast markets typically run Sunday to Thursday. However, the Saudi Arabia market is open on Saturday. The global selloff hit Saudi on Saturday and spread to Israel and Dubai on Sunday.

Israel Drops 7 Percent, 19.9% Since April 21

Israeli Stock Index Tumbles Most Since 2008

Israel’s benchmark stock index plunged the most in almost 11 years after Standard & Poor’s lowered the U.S. credit rating and amid concern the widening sovereign debt crisis in Europe will stall global growth.

Israel Discount Bank Ltd. (DSCT), the country’s third-largest lender, skidded 10 percent. Nice Systems Ltd. (NICE) slumped the most since November 2008. All 25 shares in the TA-25 Index tumbled, pushing the gauge down 7 percent, the biggest decline since October 2000, to 1,074.27 at the 4:30 p.m. close in Tel Aviv. The index is near the so-called bear-market territory after retreating 19.9 percent from a record high of 1,341.89 on April 21.

Dubai Shares Drop 3.7 Percent

Dubai Shares Drop Most Since February

Emaar Properties PJSC (EMAAR), developer of the world’s tallest tower, slumped 5.3 percent. Arabtec Holding Co. (ARTC) dropped the most since March after it said second-quarter profit fell 74 percent. The DFM General Index (DFMGI) lost 3.7 percent, the most since Feb. 28, to 1,484.31 at the 2 p.m. close in Dubai. The measure has plunged 12 percent from this year’s high in April, entering a so-called correction.

Saudi Shares Plunge 5.5%

Saudi Shares Plunge as U.S. Downgrade Fuels Concern Over Global Economy

Saudi Arabian shares tumbled for a third day, sending the benchmark index to its largest intraday drop since March, amid rising concerns about the global economy after Standard & Poor’s cut the U.S.’s credit rating for the first time.

Saudi Basic Industries Corp. (SABIC), or Sabic, the world’s biggest petrochemicals maker, fell the most in five months. Al Rajhi Bank (RJHI), the kingdom’s largest publicly traded lender by market value, reached its lowest price since March.

The 147-company Tadawul All Share Index (SASEIDX) slumped 5.5 percent to 6,073.44, the steepest decline since March 1, at the 3:30 p.m. close in Riyadh. All 15 industry groups fell. The gauge has fallen 10.5 percent from the year-high of 6,788.42 on Jan. 16.

“The Saudi market is reacting to the steep declines in global markets over the weekend,” said Asim Bukhtiar, an equity analyst at Riyad Capital. “Growing concerns of the U.S. relapsing into recession are driving sentiment.”

S&P Downgrade Did Not Cause This

Analysts worded all these reports as if the S&P downgrade was to blame or partially to blame. The facts of the matter are these.

1. The global economy is slowing
2. European debt crisis has escalated
3. A global currency war is underway
4. The US is headed for recession if not in recession now
5. Europe is already in a recession in my estimation

The downgrade itself is not the problem. Rather the S&P downgrade (long overdue) is one of many symptom of a much larger global financial crisis. Nonetheless, expect many demagogues to make S&P the scapegoat if the decline escalates this week.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Decade of Stimulus Yields Nothing But Mountain of Debt; What to Do About It?

Is there any kind of stimulus the US did not try in the last 10 years?

1. We had 1% interest rates from Greenspan fueling housing.
2. We had wars from Bush and Obama fueling defense industry employment.
3. We had two rounds of Quantitative easing from the Fed.
4. We had cash-for-clunkers.
5. We had two housing tax credit packages.
6. We had an $800 billion stimulus package from Congress for "shovel-ready" projects.
7. We had stimulus kickbacks to states.
8. We had HAMP (Home Affordable Mortgage Program).
9. We had bank bailouts out the wazoo to stimulate lending.
10. We had Small Business lending programs.
11. We had central bank liquidity swaps.
12. We had Maiden Lane, Maiden Lane II, and Maiden Lane III
13. We had Single Tranche Repurchase agreements
14. We had the Citi Asset Guarantee
15. We had TALF, TARP, TAF, CPFF, TSLF, MMIFF, TLGP, AMLF, PPIP, and PDCF
16. We had so many programs the Fed must have run out of letters because they were not given an acronym.

That is a partial list. Other than bailing out bondholders what exactly do we have to show for any of it? The one-word answer is "debt".

Decade of Stimulus Yields Nothing But Debt

Bloomberg's Caroline Baum wrote an excellent article on this theme. It was so good I asked if I could reproduce it in entirety.

With permission please consider Decade of Stimulus Yields Nothing but Debt: Caroline Baum

When George W. Bush took up residence in the White House in January 2001, total U.S. debt stood at $5.95 trillion. Last week it was $14.3 trillion, with $2.4 trillion freshly authorized by Congress Tuesday.

Ten years and $8.35 trillion later, what do we have to show for this decade of deficit spending? A glut of unoccupied homes, unemployment exceeding 9 percent, a stalled economy and a huge mountain of debt. Real gross domestic product growth averaged 1.6 percent from the first quarter of 2001 through the second quarter of 2011.

It doesn’t sound like a very good trade-off. And now Keynesians are whining about discretionary spending cuts of $21 billion next year? That’s one-half of one percent. And it qualifies as a “cut” only in the fanciful world of government accounting.

The Budget Control Act of 2011 will save $917 billion over 10 years relative to the Congressional Budget Office’s baseline. It leaves the tough work to a bipartisan congressional committee of 12, to be appointed by the leadership in each house. If this supercommittee fails to agree on a minimum of $1.2 trillion of additional savings over 10 years, automatic spending cuts -- evenly divided between defense and nondefense -- will kick in.

Is there any reason to think the same folks who couldn’t agree on a grand bargain this past month will join hands and find commonality in the next three, with one month off for vacation?

Rosy Scenario

Even if the committee agrees on the prescribed savings by Nov. 23 and Congress enacts them by Dec. 23, as required, laws passed today aren’t binding on future congresses.

Throw in the fact that revenue and budget forecasts tend to be overly optimistic, and there’s even less reason to think Congress has put the U.S. on a sound fiscal path.

In a July 2011 working paper for the National Bureau of Economic Research, Harvard economist Jeffrey Frankel identified a pattern of over-optimism in official forecasts, a bias that gets bigger in outer years. (Who can forget the CBO’s 2001 estimate of a 10-year, $5.7 trillion budget surplus?) A fixed budget rule, such as the euro area’s Stability and Growth Pact with its mandated deficit-to-GDP ratios, only exacerbates the tendency.

“Political leaders meet their target by adjusting their forecasts rather than by adjusting their policies,” Frankel writes.

First Installment

The deal hashed out in Washington at the eleventh hour this week does nothing to curb the unsustainable growth of entitlement spending -- on programs such as Medicare, Medicaid and Social Security. Medicare outlays have risen 9 percent a year for the last 30 years in a period of stable demographics, according to Steven Wieting, U.S. economist at Citigroup Inc. The automatic spending cuts outlined in the budget act would limit reductions in Medicare expenditures to no more than 2 percent a year.

By the end of 2012 or start of 2013, the federal government will be back at the trough with a request for additional borrowing authority. The debt will keep rising, and the ratio of publicly held debt to GDP will increase from 62 percent last year to as much as 90 percent in 2021, according to some private estimates, depending on what Congress does about the expiring tax cuts, the Medicare “doc fix” and the alternative minimum tax.

The CBO’s estimate of $2.1 trillion in savings over 10 years is well short of the $4 trillion Standard & Poor’s says is necessary to stabilize the debt and avoid a rating downgrade.

‘Architectural Change’

No matter. Some prominent Keynesians are advocating more spending now for an economy that is sputtering. Alas, there is little appetite in this country, and less in Congress, for more spending in light of the questionable results. A lost decade doesn’t seem like a good return on an $8.35 trillion investment. (For purists, only $6 trillion of the increase was in marketable debt, the kind of good old deficit spending Keynesians love.)

Maybe it’s time to try something new and different. In 2002 I wrote a column titled, “How About Some Tax Reform Along With Tax Relief?”

How about it? Get rid of the loopholes. Better yet, scrap the entire tax code, which would decimate the lobbying industry. Implement a flat tax or a national sales tax. The time has come for what former Treasury Secretary Paul O’Neill calls “architectural change.”

Can the Code

The current tax code is burdensome, inefficient and costly to administer. O’Neill says it costs the Treasury an estimated $800 billion annually, divided equally between administrative costs and uncollected revenue.

Eliminate the corporate and individual income tax, he says, and replace them with a value-added or consumption tax, with tax refundability for lower-income households.

“We should focus the tax system on raising revenue for the things we as a society need,” O’Neill says.

Of course, what society needs is a matter of opinion. Without strong economic growth, the options are more limited, the choices more difficult. Fiscal stimulus can have only a short-term impact. The government taxes or borrows from Peter to pay Paul, reflecting a temporary transfer of resources, nothing more.

What does the nation have to show for chronic short-term thinking and policies like these? Long-term problems and a mountain of debt.

Keynesians Always Want More Stimulus

Baum wrote "Some prominent Keynesians are advocating more spending now for an economy that is sputtering."

She is too polite, but to follow suit I will not name-drop either.

Keynesians always want more stimulus. They claim they don't, but there is never a time any of them ever wanted to run surpluses or even a balanced budget out of fear of ending a nascent recovery or starting a "recession of choice" as one Keynesian clown put it.

More to the point, the idea that government or the Fed can micro-manage the economy stepping in as needed is absurd. Heck the Fed could not even see a housing bubble or a recession and it is supposed to manage the economy?

Look at the supporters of Fannie Mae in Congress. Look at Democrats whining about cutbacks in social programs 100% of the time. They are supposed to run a surplus?

Lesson of Japan

For over 20 years Japan tried Monetarist (various QE and interest rate) stimulus as well as Keynesian (fiscal) stimulus and all it has to show for it is the highest debt-to-GDP ratio of any major country in the word. Rest assured that is going to matter sometime within the next 5 years.

Right now we are following their path and it clearly is not working.

How About We Try Something Different?

I am with Caroline here, how about trying something different like scrapping the tax code?

I will add my standard three ideas 100% guaranteed to help cities and states.

1. Scrap Davis and all prevailing wage laws
2. Eliminate collective bargaining of public unions
3. Institute national right-to-work laws

If you want to try something really radical (yet perfectly sensible), here is an idea that is also guaranteed to help: get rid of the Fed and its perpetual bubble-blowing, moral-hazard, bail-out-the-bondholder policies.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Euro-Area Central Banks to Hold Crisis Call; G-7 Officials to Discuss Coordinated Action; Ratings of UK, France in Jeopardy; Meeting Agenda

In "secret" meetings (that everyone knows about) Euro-Area Central Banks to Hold Crisis Call

Euro-region central bank governors will hold emergency talks tomorrow aimed at stopping Spain and Italy from becoming the next victims of the sovereign debt crisis and limiting the market fallout from the first U.S. rating downgrade in history.

The central bank heads will hold a conference call at 6 p.m. Paris time, said a euro-area central bank official who declined to be identified because the talks are confidential. An spokesman for the European Central Bank declined to comment.

Coordinated Action

The Trend Letter reports AP source: G-7 finance officials to discuss co-ordinated central bank action

Financial officials from the Group of Seven industrialized nations will discuss how to co-ordinate action among their countries' central banks, a person familiar with the matter said Saturday, following several days of market panic and a downgrade of the U.S. credit rating.

The person spoke on condition of anonymity because the level and timing of the contacts had yet to be confirmed.

French Finance Minister Francois Baroin, whose country currently holds the G-7 presidency, said he had been in close contact with his G-7 counterparts "throughout the previous days and also this very morning."

"We'll be carefully watching the evolution of what might happen on Monday," Baroin told France's RTL radio, without providing details on the contacts. The G-7 members are Britain, Canada, France, Germany, Italy, Japan and the U.S.

The G-7 contacts come after one of the worst weeks in global financial markets since the collapse of U.S. investment bank Lehman Brothers in 2008.

Stabilizing Italy and Spain is set to be the biggest test for the 17-country eurozone, since their large economies are likely too big to support with full-blown bailouts.

Because of that, eurozone leaders last month decided to give their bailout fund new pre-emptive powers, such as the ability to buy distressed government bonds on the open market like the ECB, extend short-term credit lines or help re-capitalize struggling banks.

However, those new powers have not been implemented yet — a process that may take until early September unless national parliaments are called back from their summer recess. Analysts also warn that at the moment, the bailout fund is too small to successfully use its new tools.

Mansoor Mohi-uddin, a managing director at UBS, warned that besides undermining investor confidence in the U.S., S&P's downgrade may herald similar action from rating agencies on other top-rated countries.

"The sovereign ratings of other AAA rated countries like the U.K. and France are likely to come under question," Mohi-uddin said in a note.

Summary of Meeting Agenda

Few details have been released on the "secret" meetings but I have a list of agenda items in advance.

1. How to kick the can down the road
2. How to make it look like we are not kicking the can down the road
3. How to get Germany to agree to kick the can down the road
4. How to silence Germany if Germany refuses to kick the can down the road

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Reserve Currency Curse: Idea China to Stop Buying Treasuries After S&P Downgrade is Fallacious; US Would Welcome China Not Buying US Treasuries!

Comments abound on the significance of the S&P downgrade of US debt. Some think it will affect the stock market open on Monday. I don't, but if it does, I suggest it will last at most a day.

In "On the S&P ratings move" Bruce Krasting said essentially the same thing on the lasting effect, however he expects "interesting market action come Sunday night as this news is digested."

Moreover, if there is "interesting action" Sunday evening, it may not have anything to do with the rating cut at all. Rather, I suspect it will be in relation to the ECB confirming it will buy Italian debt.

What got my attention in Krasting's article was a fallacious, yet widely repeated set of statements "I don’t expect to see some big headline that says, 'China to sell'. That’s not going to happen. The critical issue is, 'Will they buy more?' I doubt they will."

The first sentence is true. However, the idea China will stop buying US debt is complete silliness.

Trade Deficit Math

The rationale for my statement is a simple mathematical identity. There can be no dispute of it. Yet, people dispute it all the time. I have a brilliant writeup from Michael Pettis on this very issue that I received a few days ago via email.

The timing is perfect. Michael Pettis writes ....

Foreign capital, go home!

Is the PBoC going to stop buying USG bonds? Once again we are hearing worried noises from various sectors about the possibility of a reduction in Chinese purchases of USG bonds.

The threat of a looming US default seems to be driving this renewed concern, although I am not sure that the PBoC really is worried about not getting its money back. After all if the US defaults, it will be mainly a technical default that will certainly be made good one way or the other. Since the PBoC doesn’t have to worry about mark-to-market losses, unlike mutual funds, I think for China this is largely an economic non-event (not that there isn’t good mileage in pointing to the sheer silliness of the US political process). Still, for domestic political reasons it needs to be seen huffing and puffing over American irresponsibility.

Xia Bin, an adviser to the central bank, told reporters earlier this month that China should speed up reserve diversification away from dollars to hedge against risks of the US currency’s possible long-term decline.

Let’s leave aside the fact that every six months we have heard the same thing for the past several years, and nothing has happened, shouldn’t we nonetheless be worried? Won’t reduced PBoC purchases be disruptive to the US economy and to the US Treasury markets?

No, they won’t, and anyway they aren’t going to happen.

Muddled Thinking

There is so much muddled thinking on the issue, even from economists who should know better, that I thought I would try to address what it would mean if the PBoC were actually serious and not simply making noises aimed at domestic political constituents.

First of all, remember that the PBoC does not purchase huge amounts of USG bonds because it has a lot of money lying around and doesn’t know what to do with it. Its purchase of USG bonds is simply a function of its trade policy.

You cannot run a current account surplus unless you are also a net exporter of capital, and since the rest of China is actually a net importer of capital (inward FDI and hot money inflows overwhelm capital flight and outward FDI), the PBoC must export huge amounts of capital in order to maintain China’s trade surplus. In order the keep the RMB from appreciating, in other words, the PBoC must be willing to purchase as many dollars as the market offers at the price it sets. It pays for those dollars in RMB.

What does the PBoC do with the dollars it purchases? Because it is such a large buyer of dollars, it must put them in a market that is large enough to absorb the money and – and this is the crucial point – whose economy is willing and able to run a large enough trade deficit.

Simple Math

This last point is what everyone seems to forget when discussing Chinese purchases of foreign bonds. Remember that when Country A exports huge amounts of money to Country B, Country A must run a current account surplus and Country B must run the corresponding current account deficit. In practice, only the US fulfills those two requirements – large and flexible financial markets, and the ability and willingness to run large trade deficits – which is why the PBoC owns huge amounts of USG bonds.

If the PBoC decides that it no longer wants to hold USG bonds, it must do something else. There are only four possible paths that the PBoC can follow if it decides to purchase fewer USG bonds.

1. The PBoC can buy fewer USG bonds and purchase more other USD assets.
2. The PBoC can buy fewer USG bonds and purchase more non-US dollar assets, most likely foreign government bonds.
3. The PBoC can buy fewer USG bonds and purchase more hard commodities.
4. The PBoC can buy fewer USG bonds by intervening less in the currency, in which case it does not need to buy anything else.

Since these are the only ways that the PBoC can reduce its purchases of USG bonds, we can go through each of these scenarios to see what would happen and what the impact might be on China, the US, and the world. We will quickly see that none of them imply calamity. On the contrary, every outcome is neutral or positive for the US.

To make the explanation easier, let’s simply assume that the PBoC sells $100 of USG bonds. Since the balance of payments must balance, this immediately implies that there must be corresponding changes elsewhere in trade and capital flows.

1. The PBoC can sell $100 of USG bonds and purchase $100 of other USD assets.

In this case there has been no change in the balance of payments and basically nothing else would change. The pool of US dollar savings available to buy USG bonds would remain unchanged (the seller of USD assets to China would now have $100 which he would have to invest, directly or indirectly, in USG bonds), China’s trade surplus would remain unchanged, and the US trade deficit would remain unchanged. The only difference might be that the yields on USG bonds will be higher by a tiny amount while credit spreads on risky assets would be lower by the same amount.

2. The PBoC can sell $100 of USG bonds and purchase $100 of non-US dollar assets, most likely foreign government bonds.

Since in principle the only market big enough is Europe, let’s just assume that the only alternative is to buy $100 equivalent of euro bonds issued by European governments. The analysis doesn’t change if we include other smaller markets.

There are two ways the Europeans can respond to the Chinese switch from USG bonds to European bonds. On the one hand they can turn around and purchase $100 of USD assets. In this case there is no difference to the USG bond market, except that now Europeans instead of Chinese own the bonds. What’s more, the US trade deficit will remain unchanged and the Chinese trade surplus also unchanged.

But Europe might be unhappy with this strategy. Since there is no reason for Europeans to buy an additional $100 of US assets simply because China bought euro bonds, the purchase will probably occur through the ECB, in which case Europe will be forced to accept an unwanted $100 increase in its money supply (the ECB must create or borrow euros to buy the dollars).

On the other hand, and for this reason, the ECB might decide not to purchase $100 of US assets. In that case there must be an additional impact. The amount of capital the US is importing must go down by $100 and the net amount that Europe is importing must go up by that amount.

Will this reduction in US capital imports make it more difficult to fund the US deficit? Not at all. On the contrary – it might make it easier. If US capital imports drop by $100, by definition the US current account deficit will also drop by $100, almost certainly because of a $100 contraction in the trade deficit (the US dollar will decline against the euro, making US exports more competitive and European imports less competitive).

A contraction in the US trade deficit is of course expansionary for the US economy. Since the purpose of the US fiscal deficit is to create jobs, and a $100 contraction in the trade deficit will also create jobs, the US fiscal deficit will contract by $100 for the same level of job creation – perhaps even more if you believe, as most of us do, that increased trade is a more efficient creator of productive jobs than increased government spending.

In other words although there is $100 less demand for USG bonds, there is also $100 (or more) less supply of USG bonds, in which case there is no need for a price adjustment.

This is the key point. If foreigners buy fewer USD assets, the US trade deficit must decline. This is almost certainly good for the US economy and for US employment. When analysts worry that China might buy fewer USG bonds, they are actually worrying that the US trade deficit might contract. This is something the US should welcome, not deplore.

But the story doesn’t end there. What about Europe? Since China is still exporting the $100 by buying European government bonds instead of USG bonds, its trade surplus doesn’t change, but of course as the US trade deficit declines, the European trade surplus must decline, and even possibly go into deficit. This is because by selling dollars and buying euro, China is forcing the euro to appreciate against the dollar.

This deterioration in the trade account will force Europeans either into raising their fiscal deficits to counteract the impact of fewer exports or letting domestic unemployment rise. Under these conditions it is hard to imagine they would tolerate much Chinese purchase of European assets without responding eventually with anger and even trade protection.

3. The PBoC can sell $100 of USG bonds and purchase $100 of hard commodities.

This is no different than the above scenario except now that the exporters of those hard commodities must face the choice Europe faced above.

Stockpiling commodities, by the way, is a bad strategy for China but one that it seems nonetheless to be following to some extent. Commodity prices are very volatile, and unfortunately this volatility is inversely correlated with Chinese needs.

Since China is the largest or second largest purchaser of most commodities, stockpiling commodities is a good investment only if China continues growing rapidly, and a bad investment if its growth slows. This is the wrong kind of balance sheet position any country should engineer. It simply exacerbates underlying conditions and increases economic volatility – never a good thing, especially for a very poor and undeveloped economy like China’s.

4. The PBoC can sell $100 of USG bonds by intervening less in the currency, in which case it does not need to buy anything else.

In this case, which is the simplest of all to explain, China’s trade surplus declines by $100 and the US trade deficit declines by $100 as the RMB rises.

The net impact on US financing costs is unchanged for the reasons discussed above (a lower trade deficit permits a lower fiscal deficit). Chinese unemployment will rise because of the reduction in its trade surplus unless it increases its own fiscal deficit. Beijing, of course, is in no hurry to try out this scenario.

It’s about trade, not capital

This may sound counterintuitive to all except those who understand the way the global balance of payments work, but countries that export capital are not doing anyone favors unless incomes in the recipient country are so low that savings are impossible or unless the capital export comes with needed technology, and countries that import capital might be doing so mainly at the expense of domestic jobs.

China's Worry, Not US

For this reason it is absurd for Americans to worry that China might stop buying USG bonds. This is what the Chinese worry about.

In fact the whole US-China trade dispute is indirectly about China’s insistence on purchasing USG bonds and the US insistence that they stop. Because remember, if the Chinese trade surplus declines, and the US trade deficit declines too, by definition China is directly or indirectly buying fewer US dollar assets, which in principle means fewer USG bonds.

And contrary to much of what you might read, this reduction in USG bond purchases will not cause US interest rate to rise at all. For those who insist that it will, it is the equivalent of saying that the higher a country’s trade deficit, the lower its domestic interest rates. This statement is patently untrue.

US Would Welcome China Not Buying US Treasuries

Pettis makes an irrefutable mathematical analysis that shows the idea the US should fear the day foreigners especially China would stop buying US treasuries is silliness.

Let's look at this from another point of view. Congress, the president, Bernanke, and many others all want the RMB (Yaun) to rise.

If the Yuan rises in value vs. the US dollar, the other side of the mathematical equation says the US trade deficit with China will shrink and China's unemployment rate will rise.

China, fearing unrest does not rising unemployment. Thus, in spite of all the misguided huffing and puffing of numerous analysts, it is China who fears not buying US debt. Otherwise, they would not buy it!

Curse of Global Reserve Currency

The benefit (if one can call it a benefit) to having the world's reserve currency is the ability to finance endless wars and live beyond one's means. The mathematical counterpart is being at the mercy of foreigners on trade wars, outsourcing, and unemployment.

What's the Solution?

I have pointed out the solution several times, but this is a good time to repeat it.

Global Trade Solution: Hugo Salinas Price and Michael Pettis on the Trade Imbalance Dilemma; Gold's Honest Discipline Revisited

Bear in mind Pettis does not agree with a return to the gold standard.

Please see Michael Pettis Warns of "Virulent Political Turn Against Euro", Adds Clarification to "Gold's Honest Discipline" for additional comments from Michael Pettis.

Why China Will Not Stop Buying US Assets Recap

• China's unemployment would rise and so would its social problems. There are counterbalancing benefits but the former is what has China's attention now. Eventually the market will force China's hand, but when that happens it will be good for the US, exactly the opposite of what most think.
  


• China will not stockpile commodities as a solution because that is pro-cyclical. China has too much infrastructure building already and will cut back. Moreover, stockpiling commodities would add to China's massive price inflation problem. Thus, stockpiling of commodities is the last thing China needs to do.


• The US and possibly European markets are the only ones big enough and liquid enough to park reserves. Buying European assets would just transfer the problem to Europe. Moreover, Europe would resit far more forcefully than the US has.

Those are the hard realities of what is essentially a mathematical identity. One can debate what China should do and the consequences of proposed actions, but the math is not in question.

Pettis is formulating a non-gold-based solution and when it is finalized, I will get a look. I do not have a timeline on that.

In the meantime, the US worry is not that China will stop buying US treasuries, but rather the exact opposite.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Surprising Optimism in Face of Weekly Global Equity Carnage; Foolish Comments of the Day; "Beat the Street" Bullsweet

Wall Street is unwavering in its outlook that the S&P will hit 1400 this year. That is nearly a 17% rally from here.

Please consider Strategists Sticking With 17% S&P 500 Rally by Year-End on Rising Profit

Wall Street has never been more sure that the Standard & Poor’s 500 Index will rally in 2011, even after speculation the U.S. economy is heading for a recession prompted the biggest plunge since the bull market began.

Chief strategists at 13 banks from Barclays Plc (BARC) to UBS AG (UBSN) see the benchmark measure of American equity surging 17 percent through Dec. 31, the average estimate in a Bloomberg survey. Their projection that the index will reach 1,401 hasn’t budged in four weeks, while mounting concern U.S. growth is slowing drove the S&P 500 down 11 percent since July 22, including yesterday’s 4.8 percent tumble.

Strategists say earnings growth will fuel gains. S&P 500 profit will rise 18 percent in 2011 and 14 percent in 2012, according to the average per-share analyst estimates in a Bloomberg survey. More than 75 percent of corporations in the index have exceeded earnings estimates for the second quarter, with total income topping projections by 5.2 percent.

Credit Suisse Group AG (CSGN) and HSBC Holdings Plc (HSBA) advised investors to buy equities today. Andrew Garthwaite, a London- based strategist at Credit Suisse, reiterated an “overweight” recommendation on stocks even as he cut his year-end forecast for the S&P 500 to 1,350.

“Our economists are not forecasting a recession and, indeed, are looking for U.S. growth to accelerate in the second half,” Garry Evans, global head of equity strategy at HSBC in Hong Kong, wrote in a note today. “Investors should look to raise equity risk gradually over the summer.”

Foolish Comments of the Day

The foolish comment of the day award is a tossup.

Garry Evans, global head of equity strategy at HSBC in Hong Kong, said "Our economists are not forecasting a recession and, indeed, are looking for U.S. growth to accelerate in the second half".

Even if that preposterous statement was true, stocks are priced for perfection here.

Jonathan Golub, the chief U.S. market strategist at UBS in New York said: “I’m reluctant to overreact to some shorter-term weakness, no matter how real it is, because the market has proven to be unbelievably resilient. If you would have been acting that way for the last two years, you would have gotten killed by this market.”

Wonderful. That same ridiculous philosophy would have gotten you killed in 2008.

"Beat the Street" Bullsweet

I mock the statement "more than 75 percent of corporations in the index have exceeded earnings estimates for the second quarter". Quite frankly it is total bullsweet.

Nearly every quarter, even in 2008 and 2009 the majority of firms beat estimates. Here is the way the process works:

• Corporations give analysts "tips" regarding profit expectations.
• Those profit expectations are purposely low.
• Wall Street analysts lower estimates, if necessary, as the quarter progresses such that corporations can "beat the street".
• If corporations are going to miss and need an extra penny, they change tax assumption or make other "one time" adjustments as necessary.
  
• Corporations beat the street by a penny with "pro-forma" (after adjustment) reporting.
  

When they miss they often miss big, throwing everything but the kitchen sink into the open so they can handily "beat the street" the next quarter.

That is not true with every corporation and every analyst but it is true in general. Thus most corporations, no matter what the market, recession or not, "beat the street".

Optimism in the Face of Market Plunges is Seldom Rewarded

Wall Street analysts sticks with targets that make no fundamental sense. They also call for second-half recoveries instead of recessions.

If you are a bull, optimism in the face of a sinking market is the last thing you want to see. Such optimism is seldom rewarded.

Markets rally after people throw in the towel and there are few bulls left. Judging from this group, there is much more decline to come.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Stocks Rally on News ECB to Buy Italian Bonds; Italy Seeks Constitutional Amendment to Require Balanced Budget; Ball in Germany's Court

Stocks surged in a mid-morning to early-afternoon ramp on news the ECB will step in to buy Italian bonds and that Italy has agreed to balance its budget by 2013.

Please consider Italy pledges to balance budget by 2013, make balanced budget a constitutional requirement

Italy is pledging to work for a constitutional amendment requiring the government to balance its budget as Rome feverishly tries to assure domestic and foreign investors its finances are sound and calm nervous market.

Finance Minister Giulio Tremonti also told a hastily convened news conference Friday night that Italy aims to balance its budget in 2013, a year before previously scheduled. Premier Silvio Berlusconi, saying he conferred with world leaders, announced that G-7 finance ministers will meet "within days" of the exploding financial crisis.

Analysts at Rabobank International called the current fund "hugely inadequate" to cover Italy and Spain, not least because it would lose the pro-rated contributions those countries make if they needed to be bailed out with loans.

They calculated the fund would need euro665 billion ($941 billion) to cover Italy's funding needs for three years.

The EU's Monetary Affairs Commissioner Olli Rehn returned to Brussels in an attempt to shore up investor confidence following the recent spike up in the two countries' borrowing costs.

"Such dramatic changes in the markets are incomprehensible," Rehn said. "It is not as if the fundamentals of the Italian or Spanish economies have changed overnight."

He reiterated previous calls to increase the capacity of the bailout fund and said recently agreed changes to the fund's powers should be ratified by all governments by early September.

Dissent at ECB Wider than Reported

Via email from Barclays Capital Research

ECB round-up: reports suggest that there could have been as many as four dissenters to re-opening SMP purchases

Since yesterday's disclosure by ECB President Trichet that the decision to re-activate sovereign debt purchases (the SMP) had not been "unanimous", various reports have emerged concerning the likely dissenters, with reports this morning from Reuters, the FT and Dow Jones suggesting that there were three (or even four, based on the Reuters report), out of the 23 member Governing Council.

A Dow Jones report this morning cited "a person familiar with the matter" as saying that ECB Executive Board member J Stark had also opposed reactivating the SMP. This is interesting, for the usual procedure is for the ECB's six person Board to agree a common line by a majority vote in advance of the Council meeting, and so it has been our understanding that dissent from officials on the Board is highly unusual. As well, the DJ report said that there was "at least one central bank from the Benelux region [who] also opposed restarting the SMP".

I commented on the feud yesterday in Another Major Feud Between the German Central Bank and the ECB Over Resumption of Bond Purchases; Will Germany Leave the Euro?

Today we see the feud was wider than initially reported. We also see Trichet is going to do what he wants and a majority of the puppets are willing to go along. The key point is there is seldom as much dissent as we now see.

Questions Abound

1. Will Mario Draghi, head of the central bank of Italy, carry as much influence over the board when he takes over from Jean-Claude Trichet in October?
2. Can Italy really balance the budget?
3. Will all the governments ratify the proposed changes to the Maastricht Treaty?
4. What is the potential cost of this backstop?
5. How many pledged has Trichet broken in the past 2 years? Does anyone have a count?
   

That is more questions than I have answers. Moreover, please note that changes to the Maastricht Treaty must be unanimous. Germany and Finland will be very reluctant at best. Germany's constitution may need modification first. This is far messier than it looks, and it looks quite messy.

German Taxpayers on the Hook

Zero Hedge does a good job at question 4 in his post Explaining How The Just Announced ECB Market Rescue Pledged 133% Of German GDP To Cover All Of Europe's Bad Debt

Basically what just happened an hour ago, is that the ECB gave a green light to use the SMP program to buy Italian and Spanish bonds. The problem is that the SMP's unsterilized purchasing capacity is de-minimis and it is merely a stopgap until the sterilized EFSF is enacted in its final form.

The question is precisely what this final form will be: will it be €1.5 or €3.5 trillion? Nobody knows yet which is why Rehn refused to answer the question twice already today.

And here is where Germans get angry, because explicitly they end up backstopping everyone in Europe! And the cost to them becomes 133% of their entire economy in a worst case scenario, which of course in this centrally planned world, is now guaranteed.

So the ball is now basically in Germany's court.

Ball in Germany's Court

Without saying so explicitly, ZeroHedge just asked the question I asked yesterday: "Does Germany accept the monetization of foreign bonds at German taxpayer expense or does Germany leave the Euro?"

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

ISM and Recessions - Is there any Predictive Value? Can the US already be in Recession?

Reader Jamie at the research department of the University of California asks an interesting question about the predictive capability of ISM data.

Hi Mish,

I'm wondering what a 3-mo rolling average of the ISM reports would look like, plotted against the quarterly GDP report of annualized growth. If there is any predictive value in the ISM reports, I'd expect GDP to roll over into negative territory, and the Q2 number to be revised down a bit. How much noise is there in the ISM? Does these reports work as coincident indicators with any degree of accuracy? Just thinking this might make for an interesting post.

Jamie

Thanks Jamie, let's take a look.

Manufacturing ISM Noise



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There are many false signals on manufacturing ISM, where a contraction does not imply a recession. Other manufacturing ISM charts show the same noise.

Let's turn our attention to the services ISM. Unfortunately, the series only dates to 1997.

Service ISM New Orders



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Service ISM Business Activity



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14 years is not a lot of data. Moreover, there is even less data for the index than the components, at least on FRED where I picked up the charts. However, the pattern for the data we do have is somewhat clear.

A dip in 2003 did not precede a recession, but that dip was short-lived.

There are 73 charts in the ISM series so inquiring minds may wish to take a closer look.

I commented on the services ISM Business Activity number on Wednesday in ISM says "Business Conditions Flattening Out"; Why Services Number Worse Than It Looks; Unsustainable Conditions.

Unsustainable Conditions

Production [business activity] is +2.7 while new orders, employment, and deliveries are down. Also note that backlog of orders has plunged over the past two months. Meanwhile new export orders is not only in a free-fall, but also in contraction for the first month as the global economy cools.

Supplier deliveries are on the verge of contraction, and inventories were +3 points to 56.5.

In short, one of these numbers does not make sense in relation to the others, in relation to the manufacturing ISM, in relation to the financial industry, and in relation to the global economy.

That 56.1 production reading at +2.7 simply does not fit in, and is not sustainable if the other conditions remain in current "slowing" condition.

The possibility of a much bigger decline next month seems very real. In fact, that is my call in advance.

Real GDP Percent Change From Year Ago

There is plenty of recession predictive or coincident capability in "Real" GDP (inflation adjusted GDP)



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Nearly every time Real GDP dips below 2%, the economy was either in recession or headed for recession.

Services ISM confirms as do many other data points including consumer spending and jobs. This chart suggests we are headed for recession if not already in one.

More Than Meets the Eye

I wrote the above several days ago. There was so much other immediate news that I never got around to publishing it. Since then I read an article by John Hussman essentially saying essentially same thing.

Please give Hussman's post More Than Meets the Eye a well-deserved look.

The components of our recession warning composite might be called "weak learners" in that none of them, individually, has a particularly notable record in anticipating recessions. The full syndrome of conditions, however, captures a critical "signature" of recessions. That signature of "early warning" conditions is based on financial market indicators including credit spreads, equity prices and yield curve behavior, coupled with slowing in measures of employment and business activity. Every historical instance of this full syndrome has been associated with an ongoing or immediately impending recession.

The components (which I've reordered for simplicity) are:

1: Widening credit spreads: An increase over the past 6 months in either the spread between commercial paper and 3-month Treasury yields, or between the Dow Corporate Bond Index yield and 10-year Treasury yields.

2: Falling stock prices: S&P 500 below its level of 6 months earlier. This is not terribly unusual by itself, which is why people say that market declines have called 11 of the past 6 recessions, but falling stock prices are very important as part of the broader syndrome.

3: Weak ISM Purchasing Managers Index: PMI below 50, or,

3: (alternate): Moderating ISM and employment growth: PMI below 54, coupled with slowing employment growth: either total nonfarm employment growth below 1.3% over the preceding year (this is a figure that Marty Zweig noted in a Barron's piece many years ago), or an unemployment rate up 0.4% or more from its 12-month low.

4: Moderate or flat yield curve: 10-year Treasury yield no more than 2.5% above 3-month Treasury yields if condition 3 is in effect, or any difference of less than 3.1% if 3(alternate) is in effect (again, this criterion doesn't create a strong risk of recession in and of itself).

At present, both measures of credit spreads in condition 1 are widening, the S&P 500 is within about one percent of its level 6 months ago, the Purchasing Managers Index is at 55.3%, total nonfarm payrolls have grown by only 0.8% over the past year, the unemployment rate is up 0.4% from its March 2011 low, and the Treasury yield spread is just 2.7%. From the standpoint of this composite, we would require only modest deterioration in stock prices and the ISM index to produce serious recession concerns.

Wells Fargo's senior economist Mark Vitner reiterated the point last week, noting that since 1950, year-over-year growth in real GDP has dipped below 2% on 12 occasions. In 10 of those instances, the economy was already in recession or quickly entered one. The exceptions were 1956 and 2003.

For our part, we've always believed that the strongest evidence is obtained by combining multiple data points into a single "gestalt." So I have difficulty concluding that the U.S. is on the verge of recession simply because the year-over-year growth rate has stalled. At the same time, we are closely monitoring a much broader set of data, because the deterioration has been very rapid. I should be clear - the evidence is not yet convincing that a recession is imminent, but it is also important to recognize that the developing risks are greater than most investors seem to assume at present.

Definition of Recession

The NBER, which is the official arbiter of recessions describes recessions this way.

The NBER does not define a recession in terms of two consecutive quarters of decline in real GDP. Rather, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

"Sufficient" Does Not Mean "Necessary"

Two declining quarters of GDP is a "sufficient" recession condition, however, not even one quarter of declining real GDP is a "necessary" condition.

The recession that started in November of 2007 did not have one full quarter of declining Real GDP growth.

Real GDP



Notice that chart shows declining "growth". GDP was actually rising at the time the recession started.

Real GDP Percent Change vs. Year Ago



Those waiting for contraction before they concede the US is in recession may wake up one day and discover, just as happened in 2008, that the recession was 1/3 over before they saw it "coming". Indeed, some recessions may not be spotted until they are already over.

Might the US be in recession now?

One thing is for sure: At a minimum, the US is certainly on the border of one. Economist Dave Rosenberg raised his odds of recession this week from 99% to 100%. That is how certain he is.

For the average guy on the street out of work and unable to find any job, the last recession never ended.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Another Gap-and-Crap on Payroll Report - Jobs +117,000, Unemployment Rate 9.1% - Actual number of Employed (by Household Survey) declines by 156,000

Thoughts on the Jobs Report

European stock market rallied from a potential bloodbath on news of a "good" US jobs report. What passes for "good" decreases with time.

US futures were solidly in the green at the open but it was an immediate "sell the news" reaction.

Here is an overview of today's numbers.

• US Payrolls +117,000
• US Unemployment Rate -.1 to 9.1%
• Participation Rate -.2 to 63.9% accounting for drop in unemployment rate
• Actual number of Employed (by Household Survey) fell by 38,000
• Unemployment rose by 156,000
  
• Those dropping out of the labor force rose by 374,000
• Civilian population rose by 182,000, Labor Force declined by 193,000
  
• Average Weekly Workweek was unchanged at 34.3 hours
  
• Average Private Hourly Earnings Increased by 10 Cents
• Government employment decreased by 37,000 - a genuine bright-spot
  

Recall that the unemployment rate varies in accordance with the Household Survey not the reported headline jobs number, and not in accordance with the weekly claims data.

Many of those millions who dropped out of the workforce would start looking if they thought jobs were available. Indeed, in a 2-year old recovery, the labor force should be rising sharply as those who stopped looking for jobs, once again started looking. Instead, the labor force is not expanding at all.

Were it not for people dropping out of the labor force for the past two years, the unemployment rate would be well over 11%.

June 2011 Jobs Report

Please consider the Bureau of Labor Statistics (BLS) July 2011 Employment Report.

Total nonfarm payroll employment rose by 117,000 in July, and the unemployment rate was little changed at 9.1 percent, the U.S. Bureau of Labor Statistics reported today. Job gains occurred in health care, retail trade, manufacturing, and mining. Government employment continued to trend down.

Unemployment Rate - Seasonally Adjusted



Nonfarm Employment - Payroll Survey - Annual Look - Seasonally Adjusted

Notice that employment is lower than it was 10 years ago.

Nonfarm Employment - Payroll Survey - Monthly Look - Seasonally Adjusted



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Between January 2008 and February 2010, the U.S. economy lost 8.8 million jobs.

Ignoring the effects of the census, in the last 10 months of a recovery 2+ years old, the economy is averaging about 129,000 jobs a month. That is very poor as recoveries go.

Statistically, 127,000 jobs a month is enough to keep the unemployment rate flat.

Nonfarm Employment - Payroll Survey Details - Seasonally Adjusted



Average Weekly Hours



Index of Aggregate Weekly Hours



Average Hourly Earnings vs. CPI



"Success" of QE2

Over the past 12 months, average hourly earnings have increased by 2.3 percent. The consumer price index for all urban consumers (CPI-U) was up 3.4 percent over the year ending in June.

Not only are wages rising slower than the CPI, there is also a concern as to how those wage gains are distributed.

BLS Birth-Death Model Black Box

The BLS Birth/Death Model is an estimation by the BLS as to how many jobs the economy created that were not picked up in the payroll survey.

The BLS has moved to quarterly rather than annual adjustments to smooth out the numbers.

For more details please see Introduction of Quarterly Birth/Death Model Updates in the Establishment Survey

In recent years Birth/Death methodology has been so screwed up and there have been so many revisions that it has been painful to watch.

The Birth-Death numbers are not seasonally adjusted while the reported headline number is. In the black box the BLS combines the two coming out with a total.

The Birth Death number influences the overall totals, but the math is not as simple as it appears. Moreover, the effect is nowhere near as big as it might logically appear at first glance.

Do not add or subtract the Birth-Death numbers from the reported headline totals. It does not work that way.

Birth/Death assumptions are supposedly made according to estimates of where the BLS thinks we are in the economic cycle. Theory is one thing. Practice is clearly another as noted by numerous recent revisions.

Birth Death Model Adjustments For 2011



BLS Back in Outer-Space

Do NOT subtract the Birth-Death number from the reported headline number. That is statistically invalid. However, in my estimation the BLS is back in outer-space.

It is clear the economy is slowing and the BLS model has not picked it up. The model is horrendously wrong at economic turns.

-18,000 may look reasonable but bear in mind that January and July are revision months where the BLS adjusts for prior errors. I believe the BLS has missed another economic turn, and the BLS is terribly wrong following turns.

Household Data



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In the last year, the civilian population rose by 1,781,000. Yet the labor force dropped by 400,000. Those not in the labor force rose by 2181,000.

Were it not for people dropping out of the labor force, the unemployment rate would be well over 11%.

Table A-8 Part Time Status



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There has been almost no improvement in part-time employment in a full year. 8.4+ million workers want a full time job and cannot find one.

Table A-15

Table A-15 is where one can find a better approximation of what the unemployment rate really is.



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Distorted Statistics

Given the total distortions of reality with respect to not counting people who allegedly dropped out of the work force, it is hard to discuss the numbers.

The official unemployment rate is 9.1%. However, if you start counting all the people that want a job but gave up, all the people with part-time jobs that want a full-time job, all the people who dropped off the unemployment rolls because their unemployment benefits ran out, etc., you get a closer picture of what the unemployment rate is. That number is in the last row labeled U-6.

While the "official" unemployment rate is an unacceptable 9.1%, U-6 is much higher at 16.1%.

Things are much worse than the reported numbers would have you believe. Moreover, the unemployment rate is barely better than it was a year ago. It would actually be worse than a year ago were it not for people dropping out of the labor force.

Mass Layoffs Rise, Robots to Replace Workers

In case you missed it, please see Mass Layoffs Rise; One Million Robots to Replace Workers; Looking Ahead: Dismal Job Situation No Matter What Job Report Shows for why this payroll report may be as good as it gets for a while.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Bloodbath in Europe Follows Bloodbath in Asia; Don't Worry, It's Orderly; First Rule of Panic

Bond yields of Italy, Spain, and Belgium continue their relentless march higher. Yields are at record or near-record highs in all three countries relative to Germany.

Italy 10 Year Government Bonds



Spain 10 Year Government Bonds



Belgium 10 Year Government Bonds



Italy debt yields nearly touched Spain debt yields at the highs near 6.41%

Sarkozy Meets With Merkel, Zapatero

Bloomberg reports Sarkozy to Discuss Debt Crisis With Merkel, Zapatero After Markets Roiled

French President Nicolas Sarkozy and German Chancellor Angela Merkel will discuss the euro region’s debt crisis today after concerns that it will spread to Italy and Spain helped trigger a global market rout.

Sarkozy will also speak with Spanish Prime Minister Jose Luis Rodriguez Zapatero, according to an official at the French president’s office in Paris. Sarkozy spoke with European Central Bank President Jean-Claude Trichet yesterday and the previous day, said the person, who cannot be identified under government policy. The official wouldn’t give details on the timing of the calls.

European officials are now trying to prod leaders into announcing new measures such as increasing the size of the bailout fund to put a firewall around Italy and Spain, the euro region’s third and fourth-largest economies. Parliaments may also be pushed to speed up the ratification of new measures designed to empower it to buy government bonds.

The meeting was useless. There is nothing they can do or say.

European Equities Rout



click on chart for sharper image

Many of the numbers are fluctuating wildly. Difficult to predict the close.
Eyes are now on the US jobs Report.

Don't Worry, It's Orderly

Bloomberg reports Stock Plunge Erasing $780 Billion Seen as ‘Orderly’ as Brokers Keep Bids

The rout that erased about $780 billion from U.S. share values yesterday reflected orderly selling by institutional investors, unlike the crash of May 2010, traders said.

The Standard & Poor’s 500 Index fell 4.8 percent to an eight-month low, the biggest drop since February 2009. The tumble that became known by traders as the flash crash on May 6, 2010, wiped out $862 billion in less than 20 minutes and briefly sent the S&P 500 down 8.6 percent.

While 497 stocks in the S&P 500 fell yesterday, declines were smaller than in the 2010 crash. So-called circuit breakers that halt trading when shares rise or fall 10 percent in five minutes were triggered once yesterday. The swings on May 6 were so wide that the curbs would have been set off more than 600 times had they existed, according to data compiled by Ana Avramovic, a New York-based analyst at Credit Suisse Group AG.

“Liquidity is fine,” Dave Lutz, head of ETF trading and strategy at Stifel Nicolaus & Co. in Baltimore, wrote in an e- mail. “I have not heard any chatter of brokers pulling in bids, and I don’t see any ‘panic’-type selling from our clients. The market is operating just fine -- this is a bad sell-off, but very orderly.”

Please remember the first rule of panic: If you are going to panic, do so before everyone else does.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Mass Layoffs Rise; One Million Robots to Replace Workers; Looking Ahead: Dismal Job Situation No Matter What Job Report Shows

A good jobs report on Friday (if we get one) is now meaningless. Looking ahead, the jobs situation is bleak globally, not just in the US. Here is supporting evidence for my statement.

Planned Layoffs Surge In July

Challenger says Planned Layoffs Surge In July

August 3, 2011: For the past three months, American companies have been cutting their workforce in increasing numbers, according to a new report from Challenger, Gray & Christmas, an outplacement consultancy group in Chicago. In July, the number of planned job cuts surged to a 16-month high of 66,414 — a 60 percent increase from June.

“We’re beginning to see patterns that are disconcerting, and the really troubling part is this: Nothing is happening in the economy which is going to boost job growth,” said Christine L. Owens, executive director of the National Employment Law Project.

With the exception of slight improvement last week, new weekly unemployment claims have topped 400,000 a week for more than three months — the level generally considered the dividing line between an improving labor market and a stagnant one. Likewise, the number of job openings dropped in June and July, according a firm that tracks online job postings. Another telling piece of the puzzle: The number of temporary workers — whose fortunes are closely watched as an indicator of employers’ future hiring intentions – dipped between May and June, according to the Bureau of Labor Statistics.

For the record, last week's dip below 400K initial claims was revised up. It has been 17 consecutive week of +400K initial claims.

40,000 European Bank Positions Targeted

Marketwatch reports 40,000 positions are targeted; Swiss firms hit by soaring franc

A running tally of planned job cuts by European banks reached around 40,000 Tuesday, little more than halfway though earnings season, as firms that failed to control costs or were over-optimistic about growth make the deepest cuts.

Most of those cuts are in Europe but a slowdown in Europe means a slowdown in US exports. Moreover, one can expect similar cuts in the US as soon as banks are forced to mark assets to market.

HBSC, Credit Suisse, Goldman Sachs, Morgan Stanley Announce Cuts

The New York Times reports HSBC to Trim 30,000 Jobs in Cost-Cutting Move

August 1, 2011: HSBC, the big European bank, said Monday that it was cutting 30,000 jobs, as part of a wide-ranging cost-cutting program to improve profitability.

HSBC is the latest bank to announce job cuts amid regulatory uncertainty and global economic weakness. Credit Suisse said last week that it planned to eliminate 2,000 positions, or 4 percent of its jobs. Goldman Sachs and Morgan Stanley are also reducing their head counts.

That 30,000 is part of the 40,000 reported above.

Merck To Cut Up To 13,000 Jobs

The Wall Street Journal reports 2nd UPDATE: Merck To Cut Up To 13,000 Jobs, Reports 2Q Net Gain

Merck & Co. (MRK) said Friday that it would widen its cost-cutting measures by eliminating up to 13,000 jobs--on top of the 17,000 layoffs in prior actions--as the drug maker responds to generic competition and other challenges by shifting resources to emerging markets.

I would be very surprised to see this "contained" to Merck. Should Congress do something rational, such as allow drug imports from Canada, there could be a bloodbath in pharmaceuticals.

Mexicans Return Home

The jobs situation in the US is so bleak in California, Mexican economy draws undocumented immigrants home

There are fewer undocumented immigrants in California – and the Sacramento region – because many are now finding the American dream south of the border.

"It's now easier to buy homes on credit, find a job and access higher education in Mexico," Sacramento's Mexican consul general, Carlos González Gutiérrez, said Wednesday. "We have become a middle-class country."

Mexico's unemployment rate is now 4.9 percent, compared with 9.4 percent joblessness in the United States.

An estimated 300,000 undocumented immigrants have left California since 2008, though the remaining 2.6 million still make up 7 percent of the population and 9 percent of the labor force, according to the Public Policy Institute of California.

Mexican citizens returning home is a good thing. That they are returning home because of exceptionally poor economic conditions in the US is not.

One Million Robots to Replace Workers

Please consider Foxconn to replace workers with 1 million robots in 3 years

Taiwanese technology giant Foxconn will replace some of its workers with 1 million robots in three years to cut rising labor expenses and improve efficiency, said Terry Gou, founder and chairman of the company, late Friday.

The robots will be used to do simple and routine work such as spraying, welding and assembling which are now mainly conducted by workers, said Gou at a workers' dance party Friday night.

The company currently has 10,000 robots and the number will be increased to 300,000 next year and 1 million in three years, according to Gou.

Foxconn, the world's largest maker of computer components which assembles products for Apple, Sony and Nokia, is in the spotlight after a string of suicides of workers at its massive Chinese plants, which some blamed on tough working conditions.

The company currently employs 1.2 million people, with about 1 million of them based on the Chinese mainland.

Manufacturing Jobs Vanish in "Creative Destruction"

People blame China for stealing jobs. While that is partially true, the bigger picture is "creative destruction".

Many manufacturing jobs are simply vanishing period. They no longer exist. Robots and technology do the work.

Flashback August 27, 2009: Creative Destruction

[My friend] BC writes:

See chart 5 illustrating the conditions persisting during Japan's slow-motion, deflationary, debt-deleveraging depression from the mid-to-late '90s when the Japanese Boomer demographic drag and persistent price deflation took hold. I strongly suspect that we will experience a similar pattern between private and public debt/GDP.

We could see bank lending/GDP return to the 30% long-term average area from today's peak of 50-51% (and bank real estate loans/GDP of 27% vs. the long-term average 10-11%).

If so, we are likely to see little or no bank lending growth, which in a debt-money economy means little or no GDP growth and further mass-consolidation of capacity and debt defaults or gradual pay down.

Instead of "recovery" or "expansion", we should think in terms of a Schumpeterian Depression phase of the Long Wave trough, characterized as a debt-deflationary, deleveraging, demographics-induced no-growth regime.

Long-term 3.3% real GDP growth has decelerated to ~1.5%, and I expect average growth from the '00 peak to the mid- to late '10s to decelerate further to 1% or below.

The bottom line is that private debt-based growth is simply not possible, whereas any "growth" we do experience will be as a result of incremental government borrowing and spending, most of which will be in the form of war spending, bailouts, and social service transfers at very low GDP multiplier.

Schumpeterian Depression

Inquiring minds might be interested in concepts like Creative Destruction.

The economic concept of creative destruction was first introduced by the Austrian School economist Joseph Schumpeter.

Theory and Examples

Companies that once revolutionized and dominated new industries – for example, Xerox in copiers or Polaroid in instant photography – have seen their profits fall and their dominance vanish as rivals launched improved designs or cut manufacturing costs. Wal-Mart is a recent example of a company that has achieved a strong position in many markets, through its use of new inventory-management, marketing, and personnel-management techniques, using its resulting lower prices to compete with older or smaller companies in the offering of retail consumer products.

Just as older behemoths perceived to be juggernauts by their contemporaries (e.g., Montgomery Ward, FedMart, Woolworths) were eventually undone by nimbler and more innovative competitors, Wal-Mart faces the same threat. Just as the cassette tape replaced the 8-track, only to be replaced in turn by the compact disc, itself being undercut by MP3 players, the seemingly dominant Wal-Mart may well find itself an antiquated company of the past. This is the process of creative destruction.

Other examples are the way in which online free newspaper sites such as The Huffington Post and the National Review Online are leading to creative destruction of the traditional paper newspaper. The Christian Science Monitor announced in January 2009 that it would no longer continue to publish a daily paper edition, but would be available online daily and provide a weekly print edition.

The Seattle Post-Intelligencer became online-only in March 2009. Traditional French alumni networks, which typically charge their students to network online or through paper directories, are in danger of creative destruction from free social networking sites such as Linkedin and Viadeo.

In fact, successful innovation is normally a source of temporary market power, eroding the profits and position of old firms, yet ultimately succumbing to the pressure of new inventions commercialized by competing entrants. Creative destruction is a powerful economic concept because it can explain many of the dynamics of industrial change: the transition from a competitive to a monopolistic market, and back again.

Creative destruction can hurt. Layoffs of workers with obsolete working skills can be one price of new innovations valued by consumers. Though a continually innovating economy generates new opportunities for workers to participate in more creative and productive enterprises (provided they can acquire the necessary skills), creative destruction can cause severe hardship in the short term, and in the long term for those who cannot acquire the skills and work experience.

I do not know what Friday's jobs number will bring, but at this point, assuming it is good, it is more likely to be a last hurrah than anything else. My guess is for jobs to be under 100,000 and for unemployment to "unexpectedly" rise .2%.

Regardless, consumers have tossed in the towel, most of Europe is in an outright recession right now, and the US is headed for a recession if not in one now. Global stimulus has worn out. It always does.

No structural problems have been fixed by central bankers, they just bailed out the banks and the bondholders at the expense of taxpayers, sending taxpayers deeper into the hole.

There is no reason at all for businesses to want to expand in this environment, so they won't. That's all you need to know.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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