There Must Be Some Way Out Of Here

THE ECONOMIST
July 18th 2002 | WASHINGTON, DC From The Economist print edition

Americans are losing confidence in the economy. Can George Bush stem the slide?

THESE are not happy times for the White House. Share prices are tumbling, consumer confidence has fallen sharply and George Bush's own approval ratings seem to be heading down. For an administration haunted by the ghost of George Bush senior, whose defeat in 1992 was blamed on a sluggish economy, the parallels are becoming painful, not least because the current president's efforts to reassure Americans are also falling flat.

Mr Bush's trip to Wall Street to preach about corporate ethics was widely derided as too little, too late. This week's follow-up, a hastily-arranged pep talk on the economy in Alabama, proved another embarrassment. “This economy is coming back,” boomed Mr Bush. “That's the fact.” Meanwhile, in one of Wall Street's more dramatic days, stockmarkets slumped (though they recovered somewhat after he finished). It was all too close to Herbert Hoover, who famously proclaimed America's economy to be on a “sound and prosperous basis” in October 1929.

Judging Mr Bush's words by short-term movements in share prices is, of course, neither fair nor useful. The real questions are whether the White House has correctly diagnosed what ails the American economy, and whether its policies are right.

Mr Bush's basic contention is that the fundamentals of the American economy are in good shape. This was also the message of Alan Greenspan, chairman of the Federal Reserve, in congressional testimony the following day. At first blush, they have a point. Inflation is low and productivity growth remains surprisingly robust. Much of the excess investment that firms had built up during the boom has been worked off. Consumer spending remains surprisingly solid. Retail sales, for instance, rose 1.1% in June, far faster than analysts were expecting. The Fed has raised its forecast for economic growth in 2002 to 3.5-3.75%.

Yet despite these apparently good fundamentals, consumers are worried. The University of Michigan's consumer-confidence index fell sharply in July, to levels last seen in November. The main reason, of course, is the stockmarket slide (see article). Over the past two weeks alone the Dow Jones Industrial Average has fallen by 6%. The S&P 500 has dropped to levels not seen since October 1997. The technology-laden Nasdaq index is 72% below its peak in March 2000.

In large measure, this slide is the deflation of the 1990s bubble, a point Mr Bush himself hinted at: “America must get rid of the hangover that we now have as a result of the binge...we just went through,” he said in Alabama. But it has clearly been aggravated by the slew of corporate scandals and the loss of investor confidence.

Sliding equity prices could begin to hurt those fundamentals, promoted so assiduously by Messrs Bush and Greenspan. Household saving, in particular, may be found wanting as Americans re-evaluate what they can expect from their retirement portfolios. That suggests a protracted spell of sluggish, rather than buoyant, consumer spending. Capital investment could also suffer, if firms become more cautious about borrowing.

Unfortunately, there are scant signs that the administration will help counter this. In his Alabama speech, Mr Bush promised an “agenda for long-term growth”. This encompassed: fiscal policy (he wants to make his tax cut permanent, whilst forcing Congress to hold the line on spending); trade policy (he urged Congress to grant him “fast-track” authority to negotiate trade agreements); corporate reform (he touted his new Corporate Fraud Task Force, promised more money for the Securities and Exchange Commission, and urged Congress to send him an accounting-reform bill before August); boosting accountability in schools; and terrorism-risk insurance.

This grab-bag of assorted policies hardly constitutes a post-bubble economic agenda. Even if you thought it did, once you start going through the individual bits, the progress is patchy. For instance, the Senate certainly passed a tough corporate-reform bill on July 15th, and Mr Bush welcomed it. The next day Republicans in the House of Representatives promised to dilute many of the measures in the Senate bill (though they did agree to stiffer sentences for corporate criminals).

Nor do the prospects for trade policy look good. The Bush team has been pushing Congress for fast-track authority for 18 months. Legislation squeaked past the House of Representatives last December and the Senate in May. But reconciling the two bills has been difficult. If Congress does not get round to voting on fast-track by the August recess, the proximity of the mid-term elections in November suggests that the politically sensitive trade bill has little hope.

The biggest and most intractable problems, however, concern fiscal policy. Nobody seems to have absorbed how a post-bubble environment might influence the budget. On July 12th, the Bush administration announced that the federal government would run a deficit of $165 billion this year, compared with an earlier forecast of $106 billion made in February 2002. Although the economy has grown faster than expected since February, tax revenues have plummeted. Much of this revenue drop is due to the stockmarket, as individuals' capital gains have turned into losses. If the bear market lasts, so too will those revenue shortfalls.

In these conditions, Mr Bush's main fiscal policy—that his 2001 tax cuts, ostensibly to be reversed in 2010, should be made permanent—is hard to justify. If demand weakens substantially, there may be a case for more tax cuts (or spending) today. But it is hard to see the fiscal wisdom in making future tax cuts permanent at a time when revenues are so uncertain.

On spending, blame needs to be divided between the White House and Congress. Mr Bush talks tough on spending. He has threatened to veto a $27 billion supplemental budget bill that Congress has larded up to $31 billion. However, by agreeing to far larger, and permanent, expenditures (such as the massive farm bill) Mr Bush has lost the moral high ground. Congress, in turn, is closely divided, and short on any procedural systems for fiscal discipline. Finger-pointing and partisan bickering are far more likely in Washington than the confidence-inspiring policies that America's economy needs.

Repeal the 16th amendment and abolish the income tax. Abolish the IRS and take away the citizenship of senior IRS officials and send them to Russia where they'll feel at home. Obliterate federal spending, and start to pay off the national debt in large chunks. Abolish "static scoring" with regards to taxation of any kind. Reinstate and restore the Constitution and Bill of Rights and abolish all laws, treaties, emergency orders and executive orders that have rendered it useless and return to the Constitutional boundaries of our constitutional Republic our founding fathers gave us. Importantly, repeal the Emergency and War Powers Acts. Repeal all laws created by unconstitutional and extraconstitutional devices, such as Executive Order or Presidential Directive. Repeal and abolish all unconstitutional federal involvement in states issues such as: crime, health, education, welfare and the environment, and only God knows how many other intrusions. Social programs such as Social Security, welfare and Medicare must be repealed. So too, do most federal subsidies. Rescind all treaties and International Agreements which are not in perfect agreement with the Constitution. Tell the United Nations to stuff it! The U.S. should disassociate itself from the U.N. and the U.N. should be forced to leave the United States. Destroy all documentation that links the U.S. with the U.N. See Arthur Andersen for details. Alger Hiss, screw you. Furthermore, demand that the federal government refrain from meddling in the business and squabbles of foreign nations, unless there is an imminent threat to the people of the United States. PROTECT OUR BORDERS!! Elect a real small government candidate for President, and the same for Congress. Take memory loss drug to try to forget that most Americans love socialism in about every way and that politicans are simply a reflection of themselves, and, none of the above is going to happen. Now, returning back to reality. Terrorism, shadow government, Stock market crash, federal government crash, Police State, Martial Law, gun-confiscation, FEMA, FBI, CIA, Dictatorship, T.I.P.S., Carnivore, Operation Magic Lantern, Echelon, The Patriot Act, Executive orders too numerous to count, slavery, death, One World Government. It could never happen here. For those of you not just interested in Medicare Part B.

FINANCIAL SENSE ONLINE
Weekday Commentary from Jim Puplava
Market Wrapup
Wednesday, September 4, 2002
SOURCE

^{Wednesday September 4, 2002 Market WrapUp}

The Daily Spin
It is always interesting to hear the daily spin as to why stocks rose or fell. The days stocks fall are usually accompanied by some piece of news relating to the economy or corporate profits. With weak economic numbers and declining profits it would make sense for stocks to fall. Valuations at today’s level make stocks grossly overpriced, so in order to sell investors stocks, various spin cycles have been resurrected to keep John Q. fully invested in his shares. If there is a good economic report, it is spun way out of proportion. When it is later revised lower, the number is kept quiet. A good example was the government’s revisions of the GDP numbers from 1999-2001. Those revisions not only showed lower productivity, but also the fact that the economy grew at a much lower rate, and that the recession of last year was much more severe than originally reported. This fact alone would warrant much more attention then it received given the rosy scenarios projected for the second half of this year.

When it comes to financial or economic numbers today, there isn’t much you can put faith in anymore. The economic numbers are seasonally adjusted, massaged, manipulated and restated so frequently that you never know the real story. When it comes to earnings, we are still dealing with fictional numbers. The bottom line reported to the SEC, which reflects earnings according to GAAP, is no longer discussed. In its place we now have operating earnings or some other variation of pro forma earnings, which don’t reflect reality. What goes on today in the financial field is a farce, if not fraud. Wall Street knows it, and so does Washington. The problem is that the economy is much more dependent on bubbles today than in the past. If the stock market bubble was to fully deflate, along with the mortgage and housing market, the US economy would be in deep trouble. It is now necessary to maintain the illusion that all is well, when in fact the patient is terminally ill.

The simple fact is that the American economy is requiring more and more doses of cheap credit to finance its day-to-day functioning. Without massive daily infusions of credit, the economy would implode. In order to postpone the day of reckoning it has been necessary to use every means of artificial stimulus available. All this has done is to postpone judgment day, and nothing more. Analysts and commentators can talk all they can about how this market has bottomed, but this talk is meaningless in light of stock market valuations. I hate to keep harping on this fact, but valuations do matter when you are in a bear market. The only time they don’t matter is when you are in the midst of a bubble as we saw in the late 90’s. However, with the S&P 500 trading at 32 times trailing earnings and dividend yield of only 1.73%, the S&P 500 would have to drop in half from here just to get back to normal, much less become cheap. This talk about market bottoms, or for that matter, brokerage analysts and fund managers talking about stocks as cheap, is based on no sense of reality. A stock that has dropped 75% may be cheaper than it was before it fell, but it doesn’t make the stock a value if it still trades at 35 times earnings. A dividend yield of less than 2% only looks cheap if you compare that dividend to t-bills, which are offering yields slightly less than that. One should point out that t-bill yields are considerably safer than a stock dividend.

There are other measures of valuation other than dividends and P/E multiples. Price/book and price/sales ratios also indicate that stocks are grossly overvalued. The price-to-book ratio is an interesting one to look at since book value has been destroyed by the merger and acquisition binge of the last decade. In order to inflate stock prices in an effort to capitalize on stock options, CEO’s went on a buying spree overbuying and overpaying for companies through the issuance of stock. Now those companies have to write off those assets by big writedowns, which are decimating book value. This is one reason, in my opinion, why analysts and anchors don’t talk about earnings according to GAAP, because the GAAP numbers reflect these massive write-offs.

The book value of a company is the shareholder’s bank account. That book value is supposed to reflect assets that were invested in to produce higher returns for shareholders, rather than returned to shareholders in the form of a dividend. When money is retained by management, instead of distributed to shareholders as owners of the enterprise, shareholders have the right to ask of management how well they have done as stewards of that money. The answer is very clear by looking at what has happened to book value over the last two years. It has been destroyed by reckless acquisitions and diluted through the aggressive use of stock options to reward CEO’s and top management. As stewards of shareholder value, most management teams would have received an ‘F’ for failure to do their duty, an ‘F’ for fraud, and an ‘F’ for free-wheeling with shareholder money.

In today’s markets, the reason given for stock prices rising was that investors now believe the July lows were the final bottom of this bear market. The markets veered between losses and gains early in the day. Stocks supposedly rose after a report that zero-percent loans helped to lift sales at Ford, which is hemorrhaging from red ink, and GM. Between discounts and zero-percent loans, the auto companies are giving cars away. This concept has spread to other industries that have seen sales dwindle. Recently we went to upgrade our copier machine. Instead of paying cash I was offered a zero-percent loan. We took the zero-percent option. If they are giving away free money, why not? Maybe next we will get zero-percent mortgages. Here in San Diego my friend, the mortgage broker, tells me they are bumping housing prices so that zero down payment homeowners can have their closing costs rebated to them by the seller.

If you follow this through to conclusion you can see that a very frightening situation is developing in our credit markets. The Fed is inflating the banking system along with quasi government entities such as Fannie and Freddie through the securities market. The Fed lowers interest rates by injecting reserves in the banking system through its purchases of Treasuries from the banks. This increases their lending base, which can be multiplied through our system of fractional reserve banking. The GSE’s are also fueling the credit cycle through the securitization of mortgages. Financial intermediaries are also inflating credit by securitizing everything from auto loans to credit cards. Today most kinds of loans can be turned into asset backed mortgages. This is creating another bubble in the bond market. The money that has been fleeing stocks is going into bonds, mortgages and real estate. All three are becoming bubbles and are dependent on a Ponzi scheme structure that is going to implode in the same way as the Nasdaq and Internet mania of only a few years ago. Today bond fund managers are buying asset backed securities along with Treasuries for their bond portfolios. The credit created is simply offloaded to the securities market.

So instead of one bubble, we have multiple bubbles. We also have multiple new bubbles in the real estate, mortgages, and a new bond market bubble. These bubbles must be added to the already existing bubbles in the stock market and the US dollar. The stock market, although lower today, has yet to fully deflate itself. It is being held up by spin and intervention. If you look at the larger picture, the US economy is built on the shaky ground of debt, which sooner rather than later will come crashing down from its own weight. The US is now in a debt trap of its own making that is going to take more than spin an illusion to solve. As I see it, there is no way out other than to hyper inflate. As far as deflation and inflation are concerned, it is a moot point. We are going to see both. The coming implosion of credit will see deflation in those areas where credit had its greatest impact, which is in the stock and bond market, the housing market and in luxury goods. We will see inflation in basic necessities, such as raw materials, energy, and imported manufactured goods that we need to live. Forget pure deflation; it isn’t in the cards. The US is too dependent on foreign goods and raw materials as well as energy for all the things we need. At some point, the rest of the world is going to get tired of taking our paper money in exchange for the goods and raw materials they ship us. When that point arrives, you will be paying more for the things you need from the food you eat, the fertilizer that is used to grow food and make your garden grow, to your utility bill and the gasoline you put in your car. That is what today’s graph of the CRB is showing. If reflects the future price of goods we consume from coffee, cocoa, soybeans, sugar, oil, natural gas, cotton, to wheat and orange juice.

Forget the CPI, which is a worthless gauge of inflation that is a contrived and manipulated index for the benefit of public consumption. Look at your checkbook and do your own survey. Look at what your food and energy bill was a year ago. Look at what it now costs you to send your kids to school, or even worse, to college. Look at your insurance premiums; examine your medical bills. Look at the size of your mortgage, your credit card bills and what you will pay in social security taxes this year. Then ask yourself if this jives with the CPI.

Stocks rebounded today on what has been a persistent pattern of weakening volume. Traders bought technology stocks, biotech, and airlines. Analysts and economists have almost begged investors to ignore the economic news, which keeps getting worse. Forget the double-dip. What is coming is a consumer led recession that will be added to the profit recession giving us a full-blown recession. The double-dip is a mild palliative suggesting that things will eventually get better.

Volume came in at 1.34 billion shares in the NYSE and 1.48 billion on the Nasdaq. Market breadth was positive by 22-9 on the big board and by 21-12 on the Nasdaq. Be wary of today’s rebound. What happened yesterday was the first instance of a 90% downside day since April of last year. It indicates that more days like it are ahead of us.

Overseas Markets
European stocks rose on expectations profits will improve at companies ranging from Carrefour to Gallaher Group, Volkswagen and Axa. The Dow Jones Stoxx 50 Index gained for the first day in three, adding 0.8% to 2547.81. Six of the eight major European markets were up during today’s trading.

Asian stocks fell, with Japan's Topix index closing below 900 for the first time in 18 years, after a U.S. manufacturing report indicated a recovery in the region's largest overseas market is faltering. Exporters, such as Sony Corp. and Hyundai Motor Co., led declines in the region. The Topix lost 2% to 886.39, and South Korea's Kospi index had its biggest drop in a month. Taiwan's TWSE Index slid 1.2% to a nine- month low.

Treasury Markets
At last check, the price of the benchmark 10-year Treasury note rose 5/32 to yield 3.94% and the 30-year bond was up 5/32 to yield 4.80%.

Money Man - THE FED - To prevent financial gridlock, the understated banker made the boldest of moves — he flooded the system with cash.
"On a normal day, the Federal Reserve lends U.S. banks about $100 million to keep the system running smoothly. On Sept. 12, those loans totaled $45 billion. On a normal day, the Fed exchanges no foreign currency into dollars. On Sept. 12 and 13, it exchanged $90 billion worth.

It was extraordinary to the point of never having occurred before."

Will Alan Greenspan Be Stripped of His Crown?

HEDGE UP - US Banks' Derivatives Top $50 Trillion

CBS MarketWatch.com
By Greg Morcroft
September 6, 2002
Source

NEW YORK (CBS.MW) -- U.S. banks and their customers continued to pour money into derivatives in the second quarter, as the total value of the specialized contracts passed $50 trillion.

Derivative investments generally rise during times of economic uncertainty, and the recent scandals, concerns about a possible war with Iraq and volatile share prices all inspired investors to hedge risk through derivatives.

In a report issued by the U.S. comptroller of the currency, the total amount of derivatives in U.S. insured commercial bank portfolios rose by $3.8 trillion in the second quarter, to $50.1 trillion. See the OCC report(PDF File).

Bank earnings from derivatives rose to $3.4 billion in the second quarter, a 7.1 percent jump from the first quarter, and a highly unusual move according to the OCC's Michael Brosnan.

"This is the first time we've been looking at the data that second-quarter revenues increased from the first quarter," Brosnan said, adding that the large rise in total value of derivative positions caused the jump.

The top seven banks accounted for 85 percent of total trading revenue, compared to 84 percent in the first quarter.

During the second quarter of 2002, banks charged off $25 million from derivatives, or 0.005 percent of the total credit exposure from derivative contracts, the report said. That compares to banks' second-quarter charge-offs totaling 0.82 percent of loans.

Seven commercial banks account for about 96 percent of the total amount of derivatives, with more than 99 percent held by the top 25 banks, the report said.

The banks with the largest derivative positions were J.P. Morgan For all banks, the fair value of contracts past due 30 days or more totaled $31 million, or .006 percent of total credit exposure from derivatives contracts, the report said.

Interest rate contracts increased by $3.4 trillion, to $42.7 trillion during the second quarter. Foreign exchange contracts rose by $183 billion to $5.8 trillion, excluding spot foreign exchange contracts, which increased by $332 billion to $504 billion, the report said.

Equity, commodity and other contracts jumped $85 billion, to $1.1 trillion, and credit derivatives increased by $54 billion, to $492 billion.

Interest rate contracts accounted for 85 percent of the total amount of derivative positions, foreign exchange made up another 12 percent and the balance comprised equity, commodity and credit derivatives.

The number of commercial banks holding derivatives increased by 12, to 391, the OCC said.

Greg Morcroft is New York news editor of CBS.MarketWatch.com.

Corporate debt saps nation: Credit stress hits Depression level

You can no longer safely shrug off Japan's economic crisis. It just might drag the world into a depression

THE GREAT DEPRESSION

Deepening pessimism actually may do the stock market some good
"Analysts say the mood of the market must plummet to truly miserable levels to hit bottom and then head higher again.

''Historically, that has been the turning point. Whenever we have had a really bad run as we have been having this year, you don't have the bottom until everyone throws in the towel,'' said Arthur Hogan, chief market analysts at Jefferies & Co. ''You need to have everyone be bearish.''

Get pessimistic, the analysts need you. Hurry, hurry, hurry, get as miserable as you possibly can in the shortest time possible...

Dow Closes Down 202; Nasdaq Sheds 36

Wall Street Falls After War and Fed Talk

Jobless Claims Raise Economy Worries

Shares of McDonald's Corp. fall to Seven-year Low

Dollar Mostly Lower

Greenspan Urges Congress to Look at "Spending"

Greenspan Sees 'Depressing Effects'

The Associated Press
By Martin Crutsinger
September 12, 2002
Source

WASHINGTON (AP) - Federal Reserve Chairman Alan Greenspan told Congress on Thursday that a year after the terrorist attacks, the U.S. economy appears to have done a good job of withstanding a series of severe blows, "although the depressing effects still linger."

Greenspan cautioned that such problems as the terrorist attacks and the huge drop in stock prices were still having a lingering impact on growth as the country tries to mount a sustained recovery from last year's recession.

"The U.S. economy has confronted very significant challenges over the past year - major declines in equity markets, a sharp retrenchment in investment spending and the tragic terrorist attacks of last September," Greenspan told the House Budget Committee.

"To date, the economy appears to have withstood this set of blows well, although the depressing effects still linger," Greenspan said.

The Fed chairman said one area of major impact was on the federal budget, which has seen projections of a decade of surpluses of more than $5 trillion replaced with the return of huge deficits.

The Congress Budget Office is now predicting that the deficit for this budget year, which ends on Sept. 30, will hit $157 billion after four straight years of surpluses, the longest such stretch that the budget has been in the black in seven decades.

Greenspan said the sharp fall in stock prices, which have been tumbling since the spring of 2000, was a major reason that government revenues have declined and he said this impact "will likely damp tax revenues relatives to earlier expectations for some time."

Greenspan said the success Congress had been able to achieve in attacking an entrenched deficit problem was in danger of being lost unless lawmakers retained tough rules that require increases in permanent benefit programs or reductions in taxes to be offset by spending cuts or tax increases in other areas.

"If we don't preserve the budget rules and reaffirm our commitment to fiscal responsibility, years of hard work could be squandered," Greenspan told the budget panel. "Failure to preserve them would be a grave mistake."

Those pay-as-you-go rules, which were implemented in 1990, are set to expire at the end of this month.

"The budget rules worked far better than many skeptics, myself included, had expected," Greenspan said. "The pay-go rules changed the way policy-makers analyzed fiscal policy proposals. Rather than focusing solely on the benefits of a proposal, policy-makers were required to recognize the costs as well."

Greenspan made no specific mention in his testimony about what the Fed would do next with interest rates. So far this year, to deal with all the shocks that have hit the economy, the Fed has kept interest rates at a 40-year low of 1.75 percent for the overnight bank lending rate.

The Fed's next meeting is Sept. 24 and many analysts believe that the central bank will continue to leave rates unchanged even though Wall Street got excited last month about the possibility of additional rate cuts.

In recent weeks, many economists have revised upward their growth forecasts for the current quarter, some by a full percentage point to 3.5 percent, which would be far above the 1.1 percent growth rate of the April-June quarter.

"August was a strange month. We started off thinking the wheels had come off the economy ... and then the data seemingly changed," said economist Joel Naroff of Holland, Pa., who predicted "volatile, contrasting indicators" would continue for some time as the economy regained its footing.

Sung Won Sohn, chief economist at Wells Fargo in Minneapolis, said he believed that Fed would leave rates alone for the rest of the year despite the weakness discussed in the latest Fed survey of economic conditions in its 12 regions released on Wednesday.

"We had a fairly soft economy in the summer as a result of the stock market crash and ensuing uncertainties facing consumers and businesses," he said. "But the stock market has been doing better of late and manufacturing orders are starting to show improvement."

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