THE BARRICADE

California - And by Extension the U.S. - Headed for Permanently Smaller Economy (Gregor Macdonald)

The June issue of Gregor.us Monthly, The Scholarship of Collapse, addresses several views of economic and systemic collapse from the works of Jared Diamond to Joseph Tainter, and then goes on to apply these views to the United States–and to its biggest state, California. Frankly, it’s not much fun to suggest that another leg down in housing is on the way. Or, that California is unlikely to see its GDP exceed its previous peak for quite some time. But without the two industries that characterized post-war growth in the US, housing and automobiles (and the financial industry that squatted on top of these) it’s hard to see how California–and the US by extension–does not become a permanently smaller economy.

Recession? No, Its a “D-Process,” and It Will Be Long (Barron’s)

Let’s call it a “D-process,” which is different than a recession, and the only reason that people really don’t understand this process is because it happens rarely. Everybody should, at this point, try to understand the depression process by reading about the Great Depression or the Latin American debt crisis or the Japanese experience so that it becomes part of their frame of reference. Most people didn’t live through any of those experiences, and what they have gotten used to is the recession dynamic, and so they are quick to presume the recession dynamic. It is very clear to me that we are in a D-process.

Taibbi’s Latest is Finally Online, “The Great Bubble Machine,” (Rolling Stone)

In Rolling Stone Issue 1082-83, Matt Taibbi takes on “the Wall Street Bubble Mafia” — investment bank Goldman Sachs. The piece has generated controversy, with Goldman Sachs firing back that Taibbi’s piece is “an hysterical compilation of conspiracy theories” and a spokesman adding, “We reject the assertion that we are inflators of bubbles and profiteers in busts, and we are painfully conscious of the importance in being a force for good.” Taibbi shot back: “Goldman has its alumni pushing its views from the pulpit of the U.S. Treasury, the NYSE, the World Bank, and numerous other important posts; it also has former players fronting major TV shows. They have the ear of the president if they want it.” Here, now, are excerpts from Matt Taibbi’s piece and video of Taibbi exploring the key issues.

The Banking Industry: How to Buy Friends and Alienate People (Baseline)

It is the changing nature and power of the largest financial institutions – banks of various kinds – that has damaged our system since the 1980s; the rise in financial services compensation is part symptom and part pathogen.  Big banks present the major risk going forward – to both the economy in general and to smaller banks in particular.

Unemployment Rate and Part-Time Employees (Calculated Risk)

“When the economy turns around if you have so many people that are in slack work, you’ll say, ‘I don’t need to hire anybody new. I need to work my existing workers more.’ It’s going to be a lot harder to bring the unemployment rate down.’

The New Homeowner Hallucination (Clusterstock)

Mark thinks the next segment of the market to crash will be the mid- to high-end, where many smug homeowners are now telling themselves they’ll just rent their houses for a year while they wait for the market to “come back.” Needless to say, Mark thinks these folks are dreaming.

Embrace Deflation–its the cure, not the problem (Mish)

The idea that “Falling prices are a blow to households who borrow money because it makes it harder to repay debt” is preposterous. When prices fall, consumers have more money and they can pay off debts faster, provided of course they have a job. Falling prices reward the fiscally prudent, which is the way it should be.

Falling home prices do encourage more mortgage walk-aways which is another matter. However, home prices must drop to the point of affordability before a recovery in housing can begin, so even falling home prices are desirable. The sooner home prices fall to the point of affordability, the better of everyone will be.

from Barricade contributor Ground Control:

On June 19th, WSJ ran “Too Big to Fail, or Succeed: Everyone will want to become big enough to enjoy ’systemic risk’ protection.”

Here’s the excerpt that got me going:

“The same pattern with regard to competitive markets can be seen in the Justice Department’s new antitrust policy. Christine Varney, the new assistant attorney general in charge of antitrust policy, has said that U.S. policy should be more like Europe’s. Until now, U.S. antitrust policy has tried to protect competition. Europe attempts to protect competitors. Protecting competitors means blunting the skills of superior players, allowing inferior managers and business models to remain in business and thus preventing better managements and business models from emerging. Again, stability wins out over change and progress.”

There’s certainly a lot wrong with Obama’s proposals, which makes it all the more disappointing when his critics get it wrong. Once again, someone writing in the Journal doesn’t get it, that vigorous antitrust enforcement is absolutely essential to promoting and ensuring competitive, innovative, healthy markets.

The simplest observation is that monopoly profits are clearly in the interests of shareholders, and company executives are obligated to maximize profits. At the same time, monopolies are clearly against the interests of consumers, as they underproduce, overcharge, and have a (sometimes greatly) decreased incentive to innovate. Without vigorous antitrust enforcement, especially merger review (which is ex ante), virtually every market would wind up monopolized. The extra profits enjoyed by the shareholders of each monopolist would be dramatically outweighed by the losses they suffer from all the other markets in which they consume. Ex post enforcement is also critical, because not all anticompetitive effects arise from mergers, nor can all such effects be predicted in advance.

While I prefer the Republican policy prescriptions, the prior administration really fell down on the job in the area of antitrust enforcment. The Bush DOJ (much more political than the FTC, which has less political turnover) failed to challenge a single merger in eight years. Then, lo and behold, you have companies that are too big to fail and, moreover, were not forced to behave competitively in the meantime. It was a serious lapse. Anyway, I still fail to get it, why so many conservatives are opposed to antitrust enforcement, as it is a decidedly conservative principle, that markets should be kept free.

Lastly, while it is certainly true that antitrust exists to protect competition for the benefit of consumers, and not competitors per se, competitors are nevertheless a proxy for healthy competition. What this statement is supposed to mean, generally, is that a competitor should be afforded the opportunity to compete on price and quality without facing artificial barriers to entry and/or expansion. Thus an equally efficient rival should be able to compete, but that there should be no sympathy for a competitor with a bad product or costs that are too high. But what most of these ideologues continue to ignore are the tremendous advances in pricing theory and strategy that have been shown, and been mathematically proven, to empower a dominant firm to erect just such artificial barriers. Good for individual shareholder, but bad for everyone else, and a net loss in total consumer surplus/welfare.

Market chatter over green shoots and rising prices has fueled a bear market rally that won’t last, despite policymaker ‘noise.’

By Andy Xie, guest economist to Caijing and a board member of Rosetta Stone Advisors Ltd.

(Caijing Magazine) A combination of growth optimism and inflation fear has catapulted asset markets in the past few weeks. These two concerns should drive markets in different directions: Inflation fear, for example, should limit room for stimulus and prompt stock markets to retreat. But the investment camps expressing these opposite concerns go separate ways, each pumping up what seems believable. As a result, stock and commodity markets are mirroring the behavior seen during the giddy days of 2007.

Regardless of what investors or speculators say to justify their punting, the real driving force is the return of animal spirit. After living in fear for more than a year, they just couldn’t sit around any longer. So they decided to inch back. The resulting market appreciation emboldened more people. All sorts of theories began to surface to justify the market trend. Now that the rising trend has been around for three months globally and seven months in China, even the most timid have been unable to resist. They’re jumping in, in droves.

When the least informed and most credulous get into the market, the market is usually peaking. A rising economy and growing income produces more funds to fuel the market. But the global economy is now stuck with years of slow growth. Strong economic growth won’t follow the current stock market surge. This is a bear market rally. People who jump in now will lose big.

Over the past three weeks, the dollar dove while oil and treasury yields surged. These price movements exhibited typical symptoms of inflation fear, which is complicating policymaking around the world. The United States, in particular, could be bottled in. The federal government’s fiscal stimulus and liquidity pumping by the Federal Reserve are twin instruments for propping up the bursting U.S. economy. The fiscal deficit could top US$ 2 trillion (15 percent of GDP) in 2009. That would increase by one-third the total stock of federal government debt outstanding. Such a massive amount of federal debt paper needs a buoyant Treasury to absorb. If the Treasury market is a bear market, absorption becomes a huge problem.

U.S. Treasury Secretary Timothy Geithner recently visited China to, among other things, persuade China to buy more Treasuries. According to a Brookings Institution estimate, China holds US$ 1.7 trillion in U.S. Treasuries and GSE paper (about 15 percent of the total stock). If China stops buying, it could plunge the Treasury market into deep bear territory. If China does not buy, the Treasury market will get worse. But China can’t prop up the market by buying.

In the past few years, purchases by central banks around the world have dominated demand for Treasuries. Central banks have been buying because their currencies are linked to the dollar. Hence, such demand is not price sensitive. The demand level is proportionate to the U.S. current account deficit, which determines the amount of dollars held by foreign central banks. The bigger the U.S. current account deficit, the greater the demand for Treasuries. This is why the Treasury yield was trending down during the bulging U.S. current account deficit period 2001-’08.

This dynamic in the Treasury market was changed by the bursting of the U.S. credit-cum-property bubble. It is decreasing U.S. consumption and the U.S. current account deficit. The 2009 deficit is probably under US$ 400 billion, halved from the peak. That means non-U.S. central banks have much less money to buy, while the supply is surging. It means central banks no longer determine Treasury pricing. American institutions and families are now marginal buyers. This switch in who determines price is shifting Treasury yields significantly higher.

The 10-year Treasury yield historically averages about 6 percent, with about 3.5 percent inflation and a real yield of 2.5 percent. This reflects the preferences of marginal buyers in the United States. Foreign central banks have pushed down the yield requirement substantially over the past seven years. If marginal buyers become American again, as I believe, Treasury yields will surge even higher from current levels. Future inflation will average more than 3.5 percent, I believe. Some policy thinkers in the United States believe the Fed should target inflation between 5 and 6 percent. The Treasury yield could rise to between 7.5 and 8.5 percent from the current 3.5 percent.

A massive supply of Treasuries would only worsen the market. The Federal Reserve has been trying to prop the Treasury market by buying more than US$ 300 billion – a purchase that’s backfired. Treasury investors are terrified by the inflation implication of the Fed action. It is equivalent to monetizing national debt. As the federal deficit will remain sky-high for years to come, the monetization could become much larger, which might lead to hyperinflation. This is why the Treasury yield has surged in the past three weeks.

One possible response is to finance the U.S. budget deficit with short-term financing. As the Fed controls short-term interest rates, such a strategy could avoid the pain of high interest rates. But this strategy could crash the dollar.

The dollar index-DXY has fallen 10 percent from the March level, even though the U.S. trade deficit has declined substantially. It reflects the market’s expectations that the Fed’s monetary policy will lead to inflation and a dollar crash. The cause of dollar weakness is the outflow of U.S. money, in my view. It is the primary cause of a surge in emerging markets and commodities. Most U.S. analysts think the dollar’s weakness is due to foreigners buying less of it. This is probably incorrect.

The dollar’s weakness can limit Fed policy options. It heightens inflation risks; a weak dollar imports inflation and, more importantly, increases inflation expectations, which can be self-fulfilling in today’s environment. The Fed has released and committed US$ 12 trillion (83 percent of GDP) for bailing out the financial system. This massive overhang in money supply could cause hyperinflation if not withdrawn in time. So far, the market is still giving the Fed the benefit of the doubt, believing it will indeed withdraw the money. Dollar weakness reflects the market’s wavering confidence in the Fed. If the wavering continues, it could lead to a dollar collapse and make inflation self-fulfilling.

The Fed may have to change its stance, even using token gestures, to assure the market it won’t release too much money. For example, signaling rate hikes would soothe the market. But the economy is still in terrible shape; unemployment may surpass 10 percent this year. Any suggestion of hiking interest rates would dampen growth expectations. The Fed is caught between a rock and a hard place.

Oil prices have doubled since a March low, even though global demand continues to decline. The driving forces again are expectations of inflation and a weaker dollar. As U.S.-based funds flee, some of the money has flowed into oil ETFs. This initially impacted futures prices, creating a huge gap between cash and futures prices. The gap increased inventory demand as investors tried to profit from the gap. Rising inventory demand caused spot prices to reach parity with futures prices. Rising oil prices, though, lead to inflation and depress growth. It is a stagflation factor. If the Fed doesn’t rein in weak dollar expectations, stagflation will arrive sooner than I previously expected.

Stagflation in the 1970s spawned the development of rational expectation theory in economics. Monetary stimulus works by fooling people into believing in money’s value while the central bank cheapens it. This perception gap stimulates the economy by fooling people into demanding more money than they should. Rational expectation theory clarified the underpinning for Keynesian liquidity theory. However, as they say, people can’t be fooled three times. Central banks that tried to use stimuli to solve structural problems in the ’70s saw their stimuli didn’t work. People saw through what they tried again and again, and began behaving accordingly, which translated monetary stimulus straight into inflation without stimulating economic growth.

Rational expectation theory discredited Keynesian theory and laid the foundation for Paul Volker’s tough love policy, which jagged up interest rates and triggered a recession. The recession convinced people that the central bank was serious about cooling inflation, so they adjusted their behavior accordingly. Inflation expectations fell sharply afterward. The credibility that Volker brought to the Fed was exploited by Alan Greenspan, who kept pumping money to solve economic problems. As I have argued before, special factors made Greenspan’s approach effective at the same. Its byproduct was asset bubbles. As the environment has changed, rational expectation theory will again exert force on the impact of monetary policy.

Movements in Treasury yields, oil and the dollar underscore the return of rational expectation. Policymakers have to take actions to dent the speed of its returning. Otherwise, the stimulus will lose traction everywhere, and the global economy will slump. I expect at least gestures from U.S. policymakers to assuage market concerns about rampant fiscal and monetary expansion. The noise would be to emphasize the “temporary” nature of the stimulus. The market will probably be fooled again. It will fully wake up only in 2010. The United States has no way out but to print money. As a rational country, it will do what it has to, regardless of its rhetoric. This is why I expect a second dip for the global economy in 2010.

While inflation expectations are causing some in the investor community to act, the rest are betting on strong economic recovery. Massive amounts of money have flowed into emerging markets, making it look like a runaway train. Many bystanders can’t take it any longer and are jumping in. Markets, after trending up for three months, are gapping up. Unfortunately for the last-minute bulls, current market movements suggest peaking. If you buy now, you have a 90 percent chance of losing money when you try to get out.

Contrary to all the market noise, there are no signs of a significant economic recovery. So-called green shoots in the global economy are mostly due to inventory cycles. Stimuli might juice up growth a bit in the second half 2009. Nothing, however, suggests a lasting recovery. Markets are trading on imagination.

The return of funds flowing into property is even more ridiculous.  A property burst usually lasts for more than three years. The current burst is larger than usual. The property market is likely to remain in bear territory for much longer. The bulls are talking about inflation as the bullish factor for property. Unfortunately, property prices have risen already and need to come down even as CPI rises. Then the two can reach parity.

While rational expectation is returning to part of the investment community, most investors are still trapped by institutional weakness, which makes them behave irrationally. The Greenspan era has nurtured a vast financial sector. All the people in this business need something to do. Since they invest other people’s money, they are biased toward bullish sentiment. Otherwise, if they say it’s all bad, their investors will take back the money, and they will lose their jobs. Governments know that, and create noise to give them excuses to be bullish.

This institutional weakness has been a catastrophe for people who trust investment professionals. In the past two decades, equity investors have done worse than those who held U.S. market bonds, and who lost big in Japan and emerging markets in general. It is astonishing that a value-destroying industry has lasted so long. The greater irony is that salaries in this industry have been two to three times above what’s paid in other sector. The key to its survival is volatility. As markets collapse and surge, possibilities for getting rich quickly are created. Unfortunately, most people don’t get out when markets are high, as they are now. They only take a ride.

Indeed, most people who invest in the stock market get poorer. Look at Japan, Korea and Taiwan: Even though their per capita incomes have risen enormously over the past three decades, investors in these stock markets lost money. Economic growth is a necessary but not sufficient condition for investors to make money in the stock market. Most countries, unfortunately, don’t possess the conditions for stock markets to reflect economic growth. The key is good corporate governance. It requires rule of law and good morality. Neither is apparent in most markets.

It’s a widely accepted notion that long term stock investors make money. Actually, this is not true. Most companies don’t last for more than 20 years. How can long term investment make money for you? The bankruptcy of General Motors should remind people that this notion is ridiculous. General Motors was a symbol of the U.S. economy, a century-old company that succumbed to bankruptcy. In the long run, all companies go bankrupt.

Property on the surface is better than the stock market. It is something physical that investors can touch. However, it doesn’t hold much value in the long run either. Look at Japan: Its property prices are lower than they were three decades ago. U.S. property prices will likely bottom below levels of 20 years ago, after adjusting for inflation.

China’s property market holds even less value in the long run. Chinese properties are sitting on land leased for 70 years for residential properties and 50 years for commercial properties. Their residual values are zero at the end. The hope for perpetual appreciation is a joke. If you accept zero value at the end of 70 years, the property value should only be the use value during those 70 years. The use value is fully reflected in rental yield. The current rental yield is half the mortgage interest rate. How could properties not be overvalued? The bulls want buyers to ignore rental yield and focus on appreciation. But appreciation in the long run isn’t possible. Depreciation is, as the end value is zero.

The world is setting up for a big crash, again. Since the last bubble burst, governments around the world have not been focusing on reforms. They are trying to pump a new bubble to solve existing problems. Before inflation appears, this strategy works. As inflation expectation rises, its effectiveness is threatened. When inflation appears in 2010, another crash will come.

If you are a speculator and confident you can get out before it crashes, this is your market. If you think this market is for real, you are making a mistake and should get out as soon as possible. If you lost money during your last three market entries, stay away from this one – as far as you can.

A Look at the Tehran Situation from Around the Web:

NAIC: Beltway insights for the Iranian-American community, live blogging the events of the election protests.

From the Young Turks

Zerohedge tracking events in Tehran by Twitter:

Posted by Tyler Durden at 3:36 PM

For all curious about events in Iran who have access to Twitter, especially now that western journalists have all been deported, please follow persiankiwi

Some of his most recent tweets below:
khamenei website is back online - waas hacked before - #Iranelection
2 minutes ago from web

were attacked in streets by mob on motorbikes with batons - firing guns into air - streetfires all over town - roads closed; #Iranelection
4 minutes ago from web

http://twitpic.com/7h41m pictures of killings in tehran today. #Iranelection
about 2 hours ago from web

unconfirmed - Karroubi is heading to Tajreesh sq now. #Iranelection
about 2 hours ago from web

we are hearing that large numbers gathering in Tajreesh sq, north tehran, now. rumour that there will be another speech. #Iranelection
about 2 hours ago from web

we honour and thank the people of Iran and especially the hackers. Baseej have guns we have brains. #Iranelection
about 2 hours ago from web

NOTE to HACKERS - attack www.farhang.gov.ir - pls try to hack all iran gov wesites. very difficult for us. #Iranelection
about 2 hours ago from web

www.ahmadinejad.ir - hacked - hacked - hacked - afareen - javeed bad mellat Iran. #Iranelection
about 2 hours ago from web

confirmed - ahmadinejad website hacked off net. #Iranelection
about 2 hours ago from web

trying to access ANejad website - appears to be hacked. whoever did this ‘peerooz’. #Iranelection
about 2 hours ago from web

Activists Launch Hack Attacks on Tehran Regime (Wired)

Yes there is a lot of money being printed out there, and the inflation genie will more than likely de-bottle one day, but looking around and holding a finger up to the winds of real estate, bankruptcy, and unemployment indicates that the “real world” is still deflating, despite what commodities bulls would like you to think.   Consider David Rosenberg’s last missive:

Consumers Paying Down Debt in Record Amounts
Ever heard of a plastic-burning party? Americans are cutting back on their credit cards and other forms of debt at a record rate — paying down $15.7 billion of their obligations in April on top of $16.5 billion in March and $10.9 billion in February. In total, this three-month slide amounts to a credit contraction (not including mortgages) of $172 billion, which is truly historic and deflationary too.

Secular Labour Market Headwinds
It was quite an experience sitting down and reading the assessment of Friday’s employment data in the morning papers this past weekend: Hints of Hope in Jobless Data Even as Rate Jumps to 9.4% (NYT), Slower Jobless Lift Hopes (Wall Street Journal), Jobs Data Fuel Hopes Worst of Recession is Over (Financial Times).

All this excitement over a 345,000 payroll decline tells us that we have been in a recession for so long now that we have all forgotten what an economic expansion looks like. A 345,000 job slide is double what we were experiencing before the Lehman collapse and is worse than the worst months in each of the last two recessions. Admittedly, with the help of a 220,000 boost from the Birth-Death model (compared with 174,000 in May 2007 — at the peak of the cycle), the nonfarm data was better than consensus estimates and not nearly as bad as what we had been seeing through most of this year when the declines were hovering around 700,000 per month. Then again, the economy is no longer contracting at a 6% annual rate, so why should anyone really be expecting detonating job losses any more? The fact that the employment data are “less bad” than a depression-style experience misses the point. Beneath the veneer, there are secular deflationary headwinds in the labour market that the bond market has a right to know before building on the knee-jerk reaction to Friday’s headline data because we are concerned that the data are being misdiagnosed.

Of course, Jim Rogers and the other commodities hawks are right that we are ripe for a currency crisis and it can happen scary-quick.  But that very real dangers doesn’t mean that assets and prices are coming down Other signposts out there:

Schiller’s good peice on why housing may (will) keep falling (NYT)

But something is definitely different about real estate. Long declines do happen with some regularity. And despite the uptick last week in pending home sales and recent improvement in consumer confidence, we still appear to be in a continuing price decline.

There are many historical examples. After the bursting of the Japanese housing bubble in 1991, land prices in Japan’s major cities fell every single year for 15 consecutive years.

Pigpen sent this great site: youwalkaway.com. I love this as it empowers debtors and undercut’s the power of financial institutions. Finally, and relatedly, as predicted more and more folks are giving the big “F You” to the financial oligarchs by filing for bankruptcy. I hope this portends a conscious move away from middle class debt slavery mindset that demands you protect your credit-score in order to keep consuming.  Wake up, folks–if you need credit to buy it, you don’t need it and you can’t afford it.

Deflation hurts the creditors, the large holders of financial capital that have largely co-opted the political system.  Deflation is good for the little guy.  Deflation is good for democracy. Cheer deflation.