Debt downgrade inevitable - even helpful

The downgrade of US debt to AA+, was inevitable. It could be describe it as the "tea party downgrade" because it was the debt ceiling brinksmanship line that really stood out in the S&P report. Consider if you were China's central bank and your largest debtor just said "maybe we won't pay" - you'd expect a downgrade and to collect higher interest rates based on that risk - especially since the value of the debt is decreasing as a result of QE. Substantively, the US is still AAA. It is the ultimate safe haven asset, nothing is more secure. It is just a sign of the times that the most secure assets are being downgraded.

However, this can be a helpful downgrade if the result is the same as what followed Canada and Sweden's downgrades in the 1990s. This is a major psychological blow (probably why markets are tanking), which can be a wake-up call to voters that the US is not immune to similar troubles as Europe and so the country's leaders may look to improve credit rating to AAA again by making the tough and correct decisions about future spending. Canada's experience was of large deficit reduction, sustainable government debt loads and a longer-term fiscal outlook. This will be more challenging for the US as they do not have positive economic momentum right now, but it can still be done.

The US needs a 2% VAT (value-added tax), and this would begin to address the systemic issues affecting the long-term solvency of the country.

Immigration: Growth in population equals economic growth

With the economy in stagnation and growth an uncertain prospect, one idea that isn't being floated, but is an immediate boost to growth, is immigration.

Americans are underwater on mortgages, have high debt and are using more and more of their disposable incomes to pay off those debts - the messy process of de-leveraging. If a family earning $50,000/yr can find $360/mo. for debt repayment from disposable income it will take 2 years to pay off $8000 in credit card debt (at 8% interest).

The average credit card debt in the US (2010) was $15,799 - if you apply the same formula that is 47 months. If you take an interest rate of 22% it is 53 months. That is $108 billion that consumers do not have to buy goods. That is taking off 0.77% from annual GDP growth. The debt ceiling deal passed by Congress is also taking almost $200 billion/year - another 1.4% off growth.

What does this mean? It means that the US economy needs to grow at 2.2% just to stay stagnant.

To grow the economy there needs to be more people, more people with needs. Immigration is the quintessential American value. The Statue of Liberty is not to glorify the US, it is not for military triumph. Lady Liberty represents freedom to "the huddles masses yearning to breathe free". It says whoever you are, wherever you're from, you can work hard and make something of yourself in America.

Comprehensive immigration reform should be the most important economic stimulus that gets passed. It would bring millions of undocumented immigrants into the fold and paying taxes. It would create wage growth as employees demand minimum wage. Immigrants, usually being lower income, would spend their earnings on essentials - household goods, food, toys for kids.

If 20 million undocumented immigrants in the country earning $20,000/yr would add $200 billion to the economy (assuming they contribute $10,000/yr now in the shadow economy today). Eclipsing the damage of de-leveraging or government austerity. As the economy grows, these immigrants will want iPads and stainless steel fridges and new cars as the family units mature. There is also supporting evidence to show 2nd and 3rd generation Americans earn at the national average ($54, 283 in 2009).

The US is facing a demographic challenge. The Millennial Generation - the children of the Baby Boomers, cannot pay for the retirement of their parents by themselves; the Medicare and Social Security tax burden would cripple their standard of living. New immigrants are what is needed to grow the population base, which will grow the economy and tax revenues and help fix this current problem.

We are all the children of immigrants.

Next post: How Baby Boomers lived high and squandered the wealth

Post from 1994 - Courtesy of NYT "Confidence Dip Imperils Stocks And Clinton"

THE American economy is growing at a nice clip. But public confidence is not. And because many do not think the future will be better than the present, both investors and Democrats may be in for disappointments.

The lack of optimism may seem puzzling. Since President Clinton's election, the number of people with jobs has grown by 4.7 million, or 4.2 percent. Not since Jimmy Carter has a presidential term begun by producing so many jobs.

The problem is that Americans are not at all confident that the recent past is prologue. On the job front, they are far less optimistic than they were just after the election. In December 1992, the Conference Board's monthly survey of consumer confidence found that 21 percent thought there would be more jobs available in six months. Now the figure is 13 percent.

Why the change? "A lot of the gains in employment have been in jobs at the low end of the pay spectrum or that don't have as much security," says Jason Bram, an economist at the Conference Board.

At a similar point in the first Reagan Administration, the economy was in recession, and employment was down 1.4 million since the election. But the three forecast questions asked by the Conference Board -- whether there would be more jobs and better business conditions in the economy, and whether the respondent expected higher earnings in six months -- got more positive replies then than they do now. Even in recession, the middle class then felt confident. Now, with white collar layoffs continuing, the Government deadlocked on health care reform and GATT ratification in jeopardy, the future seems less certain.

It is not just consumers who are fretting. Many on Wall Street see signs the economy is slowing. Those concerns probably are misplaced -- David Shulman, the chief equity strategist at Salomon Brothers, notes that the seers wrongly feared weak fourth quarters in both 1992 and 1993 -- but for some purposes perception is reality.

The Conference Board has been surveying consumer sentiment since 1969, and has developed two indexes, one reflecting consumer views of the present situation, and one reflecting the future outlook. In forecasting, what matters is the relationship of the two indexes.

In August, for the first time since 1990, the future index slipped to a point where it is just under the current index. Historically, if it falls to at least a nine-point difference, the stock market suffers. That happened, for example, in September 1987.

In addition, the relationship of the two indexes at the time of mid-term elections has forecast the coming presidential race. If the future looked better than the present, the incumbent party kept the presidency. And vice versa.

If those historic relationships are believed, it poses an interesting dilemma for Wall Street Republicans, which is to say most of those on Wall Street. Should they hope that the mood will improve, providing a positive sign for stocks? Or that it won't, providing a negative sign for President Clinton?

Graphs showing the Dow industrial average for the past week, conference board consumer confidence survey index of present situation and expectations from 1992 to 1994.

US Chronic Problems

Optimists argue that the global economy has merely hit a “soft patch.” Firms and consumers reacted to this year’s shocks by “temporarily” slowing consumption, capital spending, and job creation. As long as the shocks don’t worsen (and as some become less acute), confidence and growth will recover in the second half of the year, and stock markets will rally again.

Factors slowing US growth are chronic. These include slow but persistent private and public-sector deleveraging; rising oil prices; weak job creation; another downturn in the housing market; severe fiscal problems at the state and local level; and an unsustainable deficit and debt burden at the federal level.*

The financial crisis was driven by the multi-TRILLION dollar housing bust - until that is resolved (i.e. prices start increasing); this process of de-leveraging cannot complete. Banks must keep taking write downs (I would avoid bank stocks completely); the Fannie Mae/Freddie Mac issue needs to be addressed (billions/qtr in loses, still); and US consumers need to pay off their debts (a problem exacerbated by short sales).

Looking at post-housing bust Japan; the US is looking at the same medium-term issues that caused the Lost Decades. While the US stock market has recovered much more quickly and US banks were forced to write-down loses much, much sooner the comparison is still fair. We cannot rebuild trillions of dollars in lost wealth overnight.

With a $14 trillion GDP and 3% growth, we are adding $420 billion in wealth a year. Estimates vary, but loses from the financial crisis near $4.5 trillion, so even at 3% growth (higher than 1.8% in Q1 2011), it will take 10 years to rebuild the lost wealth.

The US economy is now larger than pre-crisis, which is a positive sign, but factoring in growth in the labour supply and population we are still well away from producing enough wealth to reduce the unemployment rate. We also need to understand that the debt, even at 2.96% rate, is a skim off the economy. Those interest payments (on $14 trillion), essentially wipe out the wealth creation and transfer to the foreign lenders. This is the danger of large deficits - it can turn into a vicious cycle.

*Credit to Nouriel Roubini for the initial insight.

"Reckless Endangerment" - researched evidence that government-sponsored banking is a bad idea

Watch the video from Yahoo! Daily Ticker

Money is power, and the big banks know it

It was many years ago that modern Western civilization crossed the Rubicon and developed a system of banking that lent more power to bankers than to the people. This is how modern money mechanics work - and it's not all bad.

With trillions of dollars on balance sheets at banks - big and small - it is important to have banks that ensure the proper flow of capital to resources that are in demand. It is the backbone of the capitalist system - the "profit motive" that built the Modern Era.

Politicians are prone to "pet projects" and support for unproductive industries, because they have constituents who would suffer without political support. This is planned economics - and it's not all bad either (unless you start forcing your plan on people). This helps mitigate shocks - and allows steady growth to proceed without the short-term vacillations of market forces that can be devastating to individual lives and families.

Since the 2008 financial crisis and the subsequent Great Recession, the interdependency of bankers and politicians has created a new form of state-sponsored capitalism - a hybrid of both ideas. The secret to the Great Recession that no one likes to talk about is this transition was irrevocably accelerated and has led to a much greater than advertised bailout to the banks.

With AIG and the Big Banks having paid off (mostly) the $700 billion that the government granted them in 2008. We need to look at the continuing bailout that is creating new global imbalances and will likely be described as the cause of the next big crisis. With 0.5% interest to banks, that are lending to consumers at 4.5% - they are minting a profit. This is doing two things:

1) Giving banks a government subsidy by inflating the money supply. This is great for them because: it makes their debts smallers; and improves their capital. But, 2% inflation to everyone but central bankers means making 98% of last year's earning. This makes paying bills more difficult and has a negative affect on consumer spending and investment (the real economy). This process is likely to accelerate into 2013-2015 as the deflationary spiral that was averted by Ben Bernanke (by printing money), turns hyper-inflationary as real growth begins. Consumers will start hurting more and more as inflation ticks up to 4-6%.

2) Increased leverage rates at banks

Investment banking is the "shadow economy" - it creates massive wealth by making nothing. It is the process of taking A, giving it to B and making money on the transaction. Modern banking was founded on this, it was the toll that the real economy paid to ensure that capital was able to move freely and seek out profit.

This traditional view has changed as speculative bubbles are running amok (at the behest of the Fed). Banks are no longer looking for "investments" - a small company with a great idea that will grow; or the real estate company that needs money to build homes, but will sell at the end for a profit - those do not make return in a quarter, they are long-term. So banks have turned to financial instruments - derivatives, CDOs - because they can make quick profit.

This is the real danger of the state-sponsored capitalist model (currently being experimented with in China as well). The government is subsidizing massive gambles on pieces of paper. A derivative is a bet - a bet that something will happen (you don't buy a stock in a company, thinking it will go up, you buy a piece of paper that pays out if the company stock goes up - the investor owns nothing). It is not investing - it is gambling.

The central banks of the world are controlled by the Big Banks - and have complete control of the money supply. They have now - following a financial collapse that the majority of law makers still don't understand - convinced the political system to provide unneeded support. Support that hurts consumers.