Central Perk: Mish's Global Economic Trend Analysis

joi, 30 septembrie 2010

Posted: 30 Sep 2010 04:38 PM PDT

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

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

Danny writes ...

Mish:

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

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

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

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

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

Danny
Austin, Texas

Retired Teacher Supports Christie

Joan, a retired teacher writes ...

Hello Mish

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

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

Joan

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

Thanks Joan and Danny.

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

Huge Flaw in Municipal Bond Assumptions

Posted: 30 Sep 2010 08:52 AM PDT

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

Please consider The Great Contraction Coming in State Finances

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

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

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

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

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

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

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

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

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

Financial Reform Act Impacts

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

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

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

Harrisburg, Pennsylvania Explores Bankruptcy

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

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

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

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

"I'm not going to have that $210 million payment on the backs of taxpayers," he said in an interview after the vote. "Bankruptcy, I don't think, would kill our city. I think the tax increases would kill our city."

Certainly Councilor Brad Koplinski understands the situation properly.

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

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

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

Posted: 30 Sep 2010 02:29 AM PDT

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

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

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

But this is only true if trade is "price-elastic," with other countries able to produce similar goods of their own at only marginally different prices. This is less and less the case as the United States and Europe de-industrialize and as their capital investment shrinks as a result of their expanding financial overhead ends in a wave of negative equity. To assume that higher exchange rates automatically reduce rather than increase a nation's trade surplus is Junk Economics Error #4. It is a tenet of the free market fundamentalism that Prof. Krugman usually criticizes, except where China is concerned.

Mish Comment: Another Krugman flaw is that he seldom if ever looks at the consequences of what he proposes. Even IF manufacturing jobs returned to the US after tariff hikes, it would be at the expense of dock workers unloading ships, truckers hauling goods from coast to coast, and most importantly higher prices for consumers everywhere. Higher prices are not good thing. Higher prices would benefit the few whose jobs were saved, at the expense of everyone else. Higher prices also benefit governments that take a sales tax bite out of every transaction and squander it on needless projects.

Michael Hudson: Chinese currency appreciation would let speculators and arbitrageurs make a killing on the currency shift. Its exports would cost more – but is it believable that America would rebuild its factories and re-employ the workforce that has been downsized and outsourced? To imagine that long-term investment responds to immediately is Junk Economics Error #5.

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

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

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

The House Ways and Means Committee is demanding that China raise its exchange rate by 20%. This would enable speculators to put down 1% equity – say, $1 million to borrow $99 million and buy Chinese renminbi forward. The revaluation being demanded would produce a 20,000% profit, turning the $100 million bet (and just $1 million "serious money") into making $2 billion. It also would bankrupt Chinese exporters who had signed dollarized contracts with U.S. retailers.

Mish Comment: I am not sure how Hudson arrives at $2 billion. 20% of $100 million is $20 million. Making $19 million on $1 million is 1,900% not 20,000%. Otherwise, his point is accurate and well expressed.

Michael Hudson: This is a compendium of the kind of propaganda Americans are being subjected to these days. There is little acknowledgment that the United States is as guilty of "managing the dollar" by its policy of quantitative easing that depresses the exchange rate below what would be normal for any other economy suffering so gigantic and chronic payments deficits. It is the United States that is out of line with every other economy.

Mish Comment: Does Hudson mean "depresses the exchange rate" or "depresses interest rates"? In context, the latter would seem to fit better. Certainly the goal is to bring back jobs by depressing the exchange rate, but it has not done so, nor will it do so for reasons cited. Otherwise, I agree with what seems to be the central idea of the paragraph, that the US is as guilty of manipulation as China.

Michael Hudson: Wall Street's idea of "equilibrium" is that if only foreign countries would commit financial suicide along the lines that the United States is doing, then global equilibrium could be restored. But the most successful economies have kept their FIRE-sector costs of living and doing business within reasonable bounds, and are not remotely as debt-leveraged as the United States. German workers pay only about 20% of their income for housing – about half the rate of their U.S. counterparts. German practice is not to make 100% mortgage loans, but to require down payments in the range of 30% such as still characterized the United States as recently as the 1980s.

The FIRE sector's business plan has priced U.S. labor out of world markets. There seems little likelihood of making Chinese and German workers pay rents or mortgage interest as high as the United States? How can American economic strategists force them to raise the price of their college and university tuition so that they must take on the enormous student loans of the magnitude that Americans have to take on? How can they be persuaded to follow the high-cost U.S. practice of adding FICA-type wage withholding to the cost of living to save up pensions, Social Security and medical insurance in advance, instead of the pay-as-you-go basis that Germany quite rightly follows?

Mish Comment: The preceding two paragraphs get straight to the heart of the matter. They are consistent with something I have said 100 times. It is not the wage that matters, but rather how far wages go that matters. All this talk about "fair wages" and "fair trade" is nonsense. If the US stopped being the world's policeman, slashed military expenditures by 65%, paid government workers what they were worth, and killed defined benefit pension plans for government employees along the way, the dollar would soar, prices would drop, and we would not be in this big of a mess. Instead, we push the envelope between the "haves" and the "have-nots"

Michael Hudson: China is trying to help by voluntarily cutting back its rare earth exports. It has almost a monopoly, accounting for 97% of global trade in these 17 metallic elements. They are used in military and other high-technology applications, from guided missile steering systems and computer hard drives to hybrid electric automobile batteries. This has prompted China to recently cut back its exports to save its land from depletion (and also environmental pollution), and build up its own stockpile for future use.

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

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

Look on the Bright Side

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

The Bright Side

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

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

Laughter, the Best Medicine

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

Dear Mish:

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

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

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

I am still chuckling
Danny

Defending Free Trade

Inquiring minds are reading Biography of Frederic Bastiat on Mises.

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

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

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

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

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

Proper Perspective

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

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

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

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

A "What If?" Thought Test

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

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

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

Would any jobs return to the US in either scenario?

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

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

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

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

joi, 30 septembrie 2010

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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joi, 30 septembrie 2010

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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