Thursday, February 16, 2012

Euro Drops Below $1.30

This morning the value of the Euro dropped below $1.30.  The United States should thank the European Union for the diversion it has created.  With all the turmoil taking place in Europe, little attention is being paid to the monetary and fiscal policies of the United States and the impact these policies are having on the value of the United States dollar against other major currencies. 

As can be seen in the following chart the value of the United States dollar against other major currencies in the world continues its secular decline.  In terms of monetary policy and fiscal policy, international financial markets continue to give a negative rating to the United States and continue to see further future declines in the value of the dollar.

I continue to believe that, given the current policy leanings of the United States government, that the value of the United States dollar will continue to decline in the future.  Since the early 1960s the United States government, both Republican and Democrat, has generally followed a policy of credit inflation that resulted in the United States going off the gold standard and then resulted in the secular decline in the value of the dollar since President Nixon floated the dollar’s price in August 1971.  The two exceptions to this secular decline occurred when Paul Volcker was the Chairman of the Board of Governors of the Federal Reserve System in the early 1980s and when Robert Rubin was the Secretary of the Treasury in the Clinton administration in the latter part of the 1990s.

To me, there the Obama administration has continued the policy of credit inflation carried on by his predecessors and perhaps even improved upon it. 

The only times that the value of the dollar has rebounded over the past several years has been when there has been a “flight to quality” in US Treasury securities.  Other than this the value of the dollar has continued to decline except relative to the Euro.

Again, it seems to me that the United States should thank the European officials for all their follies because they have taken attention away from the political mess in the United States and the continued weakness in the value of the United States dollar in the world.   

Wednesday, February 15, 2012

The Progress of the Economic Recovery in the United States

The United States economy is growing.  However, the United States economy is not growing very fast and the growth does not appear to be very deep.  

January figures for Industrial Production were released today and about all one can say about the numbers is that the rate of growth is positive but modest.  And, the rate of growth seems to be declining. 

Year-over-year, industrial production grew at a 3.4 percent annual rate in January 2012. 

However, this is down from a 3.9 per cent, year-over-year, rate of growth in the fourth quarter of 2011 and down from a 6.2 percent, year-over-year, rate of growth in the fourth quarter of 2010.  In the fourth quarter of 2009 the economy actually declined by 5.5 percent, year-over-year. 

The numbers for industrial production are not inconsistent with the pattern of growth, year-over-year, of real Gross Domestic Product.  In the fourth quarter of 2011, the year-over-year rate of increase in real GDP was 1.6 per cent.  In the fourth quarter of 2010, the similar measure stood at 3.1 percent.  For the fourth quarter of 2009, like the figure for industrial production, the economy actually declined by 0.5 per cent.

Looking at the numbers in this way does not give one the upbeat feeling one can often get from just looking at the month-to-month change in the numbers.

Furthermore, information on the capacity utilization of industry (also released today) and the under-employment of working age people still indicates that there is a massive problem in our use of physical capital and of human capital. 

Capacity utilization in manufacturing stands at 78.5 percent in January.  That is, more than 20.0 percent of our industrial capacity is standing idle!  The important thing to me here is that the capacity utilization in the United States has been on a downward path since the 1960s.  Please check the chart below. 

Reading the chart from the left to the right shows a dramatic downward trend with each subsequent peak in capacity utilization being lower than the one previous to it. 

The question that remains to be answered is whether or not the trend will be continued with the “peak” in capacity utilization we are going to reach this time around.

The United States has a growing mis-match in the industrial capacity it has built and the industrial capacity that is useful.  This mis-match must be worked off…there is not an over night solution to this problem.

The same situation exists in the labor markets.  The under-utilization of working age people has grown since the 1960s.  In the 1960s about one in eleven or twelve people in the United States were under-employed.  The measure of under-employment now stands somewhere between one in four or one in five people that are of working age. 

The United States has a major problem.  Jobs and industrial capacity are not matched with the present makeup of our human and physical capital.  These under-employed persons and this under-utilized plant and equipment are not going to be matched up any time soon.  Thus, under-employment of labor and under-utilization of industrial capital are going to be around for a long time.  And, the rates of economic growth we are experiencing will not do much to help the situation.

Tuesday, February 14, 2012

The European Model: Broken Beyond Repair?

I am really tired of the German bashing!

The model for the Euro was unsustainable.  But, the lessons learned from the effort should not be taken lightly.

The major lesson from the experiment with the Euro is that a currency area cannot be set up without a central political body that is strong enough to enforce the rules of the currency area.  One can have separate states within the area, but, as in the United States, there must be a political union with enough authority to dominate the individual components of the area.

A second lesson from the experiment is that the economic model based upon “social engineering” is not sustainable.  The German economic model of low inflation, high labor productivity, and fewer government handouts has worked better than the model that includes substantial credit inflation, an inefficient private sector, and bloated government payrolls. 

And, as usual, the “losers” in the game cry foul against the successful. 

“The press review from around Europe does not make pleasant reading for the German foreign ministry these days.  ‘Look at this stuff, it’s just unacceptable,’ laments one diplomat—pointing to a front-page article from Il Giornale, an Italian newspaper owned by Silvio Berlusconi.  The piece links the euro crisis to Auschwitz, warns of German arrogance and says that Germany has turned the single currency into a weapon.  The Greek papers are not much better.  Any taboos about reference to the Nazi occupation of Greece have been dropped long ago.

Across southern Europe, the ‘ugly German’ is back—accused of driving other nations into penury, deposing governments and generally barking orders at all and sundry.

There is also a much more polite form of German-bashing going on at the official level.’ (

Economics, at one time, was defined as the study of the allocation of scarce resources.  That is, there are limits to what a country can attain given the amounts of human capital and physical capital that are available to it. 

Over the past fifty years, many countries came to believe that they had overcome these limitations and through credit inflation and social engineering they could achieve something beyond the boundaries set by the amounts of human capital and physical capital that existed.

Some of these programs included government created credit inflation that kept workers locked in jobs that were becoming legacy positions and that also promoted a home ownership scam that seemingly created middle-class piggy-banks; government hiring practices that resulted in excessive overstaffing of bureaucratic agencies (about one-third of the Greek workforce is in the public sector); and pension benefits that allowed for very comfortable early retirements. 

The economies of these countries just did not have the resources to sustain these programs. 

If everyone is following these policies then everyone is basically in the same boat.

However, a problem occurs if one or more other countries do not follow the same policies. 

The eurozone is having a problem because Germany, for one, has not taken the path most travelled.  And, over time, their more disciplined approach came out on top.

Germany now has the wealth, the resources, that others don’t.  Consequently, those that don’t have the wealth and are now struggling believe that Germany should compensate them for Germany’s success. 

The article quoted above states that the weaker countries in Europe are asking three things from the Germans: first, to commit more money to a European “bailout” fund that would be “so large that it would frighten the markets from speculating against southern European bonds”; second, to commit to Eurobonds to make the debts of individual countries the debts of the eurozone itself; and to stimulate the German economy so that Germans would buy more goods from southern Europe.

These requests, in my mind, are totally off-the-wall!

The Germans should not give in on these issues and they should maintain their position of strength.  And, the German-bashing should stop!

The eurozone is not going to get stronger by making every one of its members weaker!

This is because the eurozone is not the only game going on in the world.

Other areas in the world are maintaining their discipline and can only benefit, competitively, from a weaker eurozone.  Need I mention China?  And, Brazil?

And, these other areas of the world are growing in relative economic strength as Europe fights its own little family fights.  The pressures coming from this competition are not going to go away and Europe, as a whole, may have already postponed dealing with its problems for so long that it may still be years away from a resolution in which it becomes as competitive as it needs to be in the world of the 21st century.

I still fail to see anyone in Europe that I would call a leader.  Consequently, I find it hard to defend the continued existence of the Euro, as we now know it.  At this point in time, I see several countries leaving the Euro over the next couple of years.  I see a much-diminished role for the eurozone in the world, both economically and financially.  I also see economic social engineering receding as a government policy in the western world even though Paul Krugman and Joseph Stiglitz will still be around.  The era of economic social engineering is past its prime, even though this fact is not fully recognized yet.

The United States should be grateful to the eurozone for the way it has conducted itself, otherwise we would be talking more about the fifty-year weakness in the value of the US dollar.       

Monday, February 13, 2012

Depression in Europe?

There seems to be growing optimism in the United States that the economic recovery is picking up steam.  This is all fine and good, but I still believe that the major potential bump in the road for the United States is the economic and financial situation in Europe. (See my post of January 4,

Now we have the new austerity program passed by the Greek parliament and the unrest in the streets of Greece protesting the austerity program.

But, the new austerity program, at this point, does not end the concern over whether or not this new plan will be sufficient to end the Greek insolvency.

Greece is insolvent.

With the government’s new austerity program, however, Greece will get a new financial bailout.  The question now becomes: will this new bailout program buy Greece enough time to get its ship in shape so that it can work its way out of its insolvency?

Some think not.  For example, Wolfgang Münchau writes in the Financial Times, “My central expectation is that the program will happen.  A period of calm will set in, but after a few months it will become clear the cuts in Greek wages and pensions have worsened the depression…. Before long, another round of haircuts will be beckoning.” (This from the article “Why Greece and Portugal ought to go bankrupt,” 

There is another problem on the horizon, however, and that is the fact that a new Greek government will be be elected in April.  The expected winner at this time is Antonis Samaras.  The question is, what will this new government do after it assumes power?

Münchau argues: “I cannot see how this (the bailout) is going to work politically.  For a new prime minister who contemplates a full term of four years, the temptation to pull the plug and blame the mess on his predecessors must be big. He will then have four years to rebuild the country from the rubble of a eurozone exit.  It would be politically much riskier for him to stick to a program that he himself says does not work, and which will keep his country in a depression for the length of his mandate—possibly beyond.” 

And this is exactly the dilemma a “turnaround” leader faces…do I struggle along with the things that were left me…or, do I clean house and start with as clean a slate as possible.

I have successfully completed three corporate turnarounds and to me there is no choice.  The nice thing about being brought in to turnaround an organization is that you have a certain time period to blame everything on the previous management and clean house.  If you don’t do the house cleaning right up front, however, you lose most of your leverage to change things.  The decision is not difficult: you start with as clean a slate as possible.  In the case of Greece, then, declare bankruptcy

Greece is insolvent.  “To rebuild itself, Greece needs a functioning economic infrastructure, a modern labor market, and a less tribal political system.”  It also needs less corruption throughout its culture. 

This is not the only set of problems that Greece…and Europe…faces.  New data on the economies of Europe coming out this week are expected to be rather dismal.  The forecasts for the fourth quarter GDP of the eurozone run from a 0.4 percent to a 0.6 percent contraction.  These figures include the fact that even Germany seems to be in a decline.  Industrial production figures for December are also to be released this week and some analysts see a decline in this measure of more than one percent. ( 

There is some feeling that the first quarter of 2012 may find growth in positive numbers, but not by much.  Germany and others may experience some kind of recovery then, but the southern peripheral countries are not expected to start growing again for some time.  And, with unemployment in excess of twenty percent in some of these countries and continued government austerity, 2012 prospects remain quite gloomy. 

The next question, though, is where the pressure will be applied next.  Münchau contends that Portugal is also bankrupt and should follow Greece in declaring bankruptcy.  Will the international investors now turn their attention to Portugal?  I wouldn’t be surprised. 

Countries…businesses…individuals…do not resolve their financial difficulties until they resolve them.  Continued bailouts only tend to postpone a final solution.  They very seldom correct the insolvency that is causing the problem. 

Friday, February 10, 2012

The Problems in Housing and the Labor Markets Will Not Go Away Soon

President Obama announced a mortgage plan aimed at giving relief to homeowners that are facing problems with their mortgages.  Yet, this is just putting a finger in a hole in the dike.

The problem is that after fifty years of governmental credit inflation many homeowners are facing the reality that their homes were grossly over-valued and that they assumed too much debt to finance their “American Dream.”

One out of every four or five houses has a mortgage on the property that is greater than the market value of the house.  Many of these homes are now valued at only 75 percent or less of their mortgage value. 

Regardless of a government “solution” to this situation, either through debt relief or a renewed bout of government-induced inflation, the attitudes and expectations of homeowners have changed.  These homeowners have been “burned” and are unlikely to expose themselves to this possibility again in their lifetimes. 

Even if the market stabilizes in the near term and housing prices bottom out, many potential home buyers will be much more financially conservative in the future given the experience that they have just been gone through. 

The reluctance to buy a home will also be affected by the situation in the labor market.   And, here again there is a longer-term problem that will not be resolved in a matter of months. 

One out of every four or five people of employment age are either unemployed, employed in a part time job but would like to be employed full time, or are not seeking employment.  The percentage of working age people in the labor market has recently dropped to a level not seen for several decades. 

With conditions in the labor market so tenuous, people will not have the same resources to purchase housing as they have had in the recent past. 

But, how is this under-employment situation in the labor market going to be resolved in the short-run?

The fundamentalist preacher Paul Krugman cries out for short-run government “solutions” to put people back into the jobs that were in existence at another time.  Krugman writes, “We have become a society in which less-educated men have great difficulty finding jobs with decent wages and good benefits.”  For example, “Adjusted for inflation, entry-level wages of male high school graduates have fallen 23 percent since 1973.” (

Maybe, part of this problem is that the government has emphasized putting high school graduates into what have historically been entry-level jobs, jobs that are shrinking as a proportion of the jobs available due to changes in technology and needed training.  And, what about those that do not graduate from high school…they are in an even less-favorable position. 

Elsewhere in the New York Times, we read that “Rich and Poor Further Apart in Education.” ( “Education was historically considered a great equalizer in American society, capable of lifting less advantaged children and improving their chances for success as adults.  But a body of recently published scholarship suggests that the achievement gap between rich and poor children is widening, a development that threatens to dilute education’s leveling effects.”

This is a gap that cannot be overcome quickly.  And, it is a gap that cannot be overcome by national tests and government spending.
Since the end of World War II, politicians have generally believed that they could get elected and re-elected by keeping people employed and by helping more and more people become homeowners.  This underlying emphasis has resulted in the fifty years of credit inflation the United States has experienced since the early 1960s. 

People were kept employed by short-term government economic programs that put the unemployed back into the jobs that held previously before becoming unemployed.  And, why should someone going through high school be concerned about employment when they knew that the government would continue to stimulate jobs in heavy manufacturing and industry and keep them employed. 

The government continued to promote these kinds of stimulus programs even though under-employment increased steadily over the past fifty years and the capacity utilization in manufacturing was declining over the same time period. 

The federal homeowner programs and credit inflation created in the housing sector over the same time period created a “piggy bank” for many people not only helping them to own their own home, but also to allow them the ability to borrow more and more money to binge on consumer goods.     

So, we ended up with the “less wealthy” being under-educated and hence not readily employable in the labor markets of the 21st century and with many of these same people owning homes and over-their-heads in debt. 
This is a situation that does not have an easy or ready solution. 

Under-employment can only be resolved over an extended period of time.  The same holds for people with too much debt.  Short-run stimulus is not the answer.  In fact, the emphasis on short-run stimulation has created and further exacerbated the situation. 

A safety net may be necessary for many of the under-employed and overly leveraged.  In fact, the efforts to keep people in “legacy” jobs and to put families in homes to make their life better may have resulted in a whole generation of individuals being excluded from the mainstream.  They are going to need some economic support.

But, the only real solution to the labor market situation is a long run one and it begins with education and the environment that surrounds the culture of education. 

The situation in the housing market will only get better as people lower their expectations and get their balance sheets back in order.  This, too, will take a substantial amount of time because it is related to a major change in expectations.  People, in the future, just cannot expect a “free ride.”      

Monday, February 6, 2012

Developments in the Banking Sector: Large Amounts of Funds Still Going to Foreign Institutions

There seem to be three major stories in commercial banking these days: first, the cash going to foreign-related institutions; second, the pickup in non-real estate business lending; and three, the continued weakness in consumer borrowing.

Excess reserves at depository institutions in the United States averaged $1,509 billion in the two weeks ending January 25, 2012.  Cash assets at commercial banks in the United States were $1,597 billion in the week ending January 25, 2012.

In December 2010, excess reserves were $1,007 billion and cash assets $1,082 billion. 

Both excess reserves and cash assets rose by about 50 percent during this time period.

In recent years excess reserves at depository institutions and cash assets held by commercial banks have moved closely together.  The reserves the Fed has injected into the financial system have gone primarily into cash assets. 

It is interesting to note that of the $590 billion increase in cash assets at commercial banks, $403 billion went onto the balance sheets of foreign-related institutions in the United States.

For the week ending January 25, 2012, roughly 47 percent of all the cash assets held in commercial banks in the United States were held on the books of foreign-related institutions.  This is up from about 32 percent in December 2010. 

Note: These foreign-related institutions hold only 14.5 percent of the total assets in the United States banking system (up from about 11 percent a year earlier) so they are now holding a disproportionate share of the cash assets in the banking system.   
On the liability side of these foreign-related institutions there was a net increase in “net (deposits) due to foreign offices of $625 billion and a decrease in US held deposits (large time and other deposits) of $185 billion.  Thus, the right side of the balance sheets of these foreign related institutions rose by a net amount of $440 billion related to movements of funds “offshore”, i.e., primarily to Europe.

The Federal Reserve has not only supplied liquidity to the European continent through dollar swaps with foreign central bank, it has supplied funds to international financial markets through its open market operation.

It is not expected that many of the funds going to these foreign-related financial institutions will go into loans in the United States market as these institutions only hold about 8 to 9 percent of all commercial loans in the United States.

Therefore, when we look at what the Federal Reserve has done, we have to realize that only about fifty percent of the funds the Fed has injected into the banking system has gone to domestically chartered banks.  It is only this domestic portion of the Fed’s injection of funds that can have the greatest possibility of impact on business lending and hence economic growth.

Cash assets did increase at domestically chartered commercial banks during this time period: the increase was about $112 billion as total assets grew by $243 billion.  At the largest twenty-five banks in the country, the increase was $75 billion in cash assets and $130 billion in total assets.

The important thing is that business loans (Commercial and Industrial loans) at commercial banks have been increasing, primarily at the largest twenty-five domestically chartered banks in the United States.  From December 2010 to December 2011, C&I loans rose by $123 billion in the commercial banking system, with $94 billion of this increase coming at the largest twenty five banks, a 15 percent year-over-year rate of increase. 

Business loans did increase at the rest of the domestically chartered US banks, but they rose by only about $18 billion or about 5 percent year-over-year.

Over the past thirteen-week period, however, C&I loans at these smaller banks hardly increased at all and actually fell over the last four-week period.

At the largest banks, business loans continued to rise over the past four weeks ($15 billion) and over the past thirteen weeks ($35 billion).  My question about these increases has to do with the uses that the funds are being put to.  The national invome statistics showed that inventories increased in the latter part of last year and these loans could have gone to increase the inventory buildup.  Many economists seem to believe that given the weak consumer behavior (see below) that the inventories will decline in the first quarter of 2012 and this will result in some weakness in business loans.  Alternatively, some of the borrowing could be so that corporations could buildup cash positions for either acquisitions or for stock repurchases.  There does not seem to be any inclination to increase spending on business plant or equipment.

Commercial real estate loans continue to decline at the smaller banks in the country although there has been a pickup in these loans at the largest banks.  All-in-all, lending on commercial real estate continues to go down: and given all the loans that will mature over the next 12 to 18 months, with many of them being unable to re-finance, there is a continued likelihood that these loans will continue to decline in the near future.    

On the other hand, residential mortgage lending rose across the board at commercial banks.  Although residential mortgages fell on the books of the banks from December 2010 to December 2011 by $12 billion, over the past thirteen-week period, these mortgages grew by almost $19 billion, with $11 billion of this increase coming in the last four weeks.  And, the increases came in all sizes of banks.

This line item will be interesting to watch over the upcoming months since housing prices continue to decline and foreclosures and bankruptcies seem continue to occur at a rapid pace.

Just a further note on real estate lending: home equity loans have declined over the last thirteen weeks and held roughly constant over the past four.  

Counter to this increase in residential spending is the decline in the dollar amount of consumer loans on the books of the banks.  Over the past six months consumer lending has dropped by a little more than $6 billion with a major decline of roughly $15 billion coming over the last four weeks.   Most of this decline has come in credit card debt outstanding at the banks. 

This information on consumer lending seems to point to a continued weakness in consumer expenditures. 

In terms of the domestic economy it seems as if there is not much encouragement for a stronger economic recovery in the banking numbers.  There seems to be little demand for any kind of loans in the current environment, but, one also gets the feeling that the banks, especially the smaller ones, are not willing to lend even if there were an increasing demand for loans. 

Friday, February 3, 2012

Federal Reserve Report: No Need for QE3

I keep reading that some people want to have the Federal Reserve begin a new round of quantitative easing…QE3.

I see nothing in the financial figures that calls for more quantitative easing.

For one, there seems to be no pressure on interest rates.  Looking over the last 13-week period the yield on the 10-year US Treasury (constant maturity) has remained relatively constant.  The weekly average for the week of November 4, 2011 was 2.07 percent: for the week of January 27, 2012 the weekly average was 2.01.  And, the market yield on 10-year Treasuries has been below 2.00 percent all of this week.

The European sovereign debt situation has certainly contributed to this weakness in yields.  Hence, there does not seem to be any demand pressure on interest rates at this time.

Economic growth continues to be modest and consequently is not adding any demand pressure on rates.

The commercial banking system is quiet and even though bank closures average around 2 per week adjustments are being made smoothly and with little or no disruption to the industry. 

Excess reserves in the banking system have fluctuated around $1.5 trillion over the past three months indicating little or no pressure on the financial system on the loan demand front.  This, too, is consistent with the modest economic growth.

Overt Federal Reserve actions have been absent over the past 13-week period indicating that the Fed is allowing operating factors to work themselves out without undue disturbance to the monetary system. 

The big change on the Fed’s balance sheet has to do with the European debt crisis.  Central bank liquidity swaps have risen by a little more than $100 billion since November 2, 2011 as the Fed moved to assist central banks in Europe.  It appears as if part of this increase went to take pressure off the market for Reverse Repurchase agreements with foreign official and international accounts.  The account recording this activity fell by about $41.0 billion over the same time period.

This has resulted in a net increase of about $53 billion in Reserve Balances at Federal Reserve banks but this has had little or no immediate impact on the United States banking system.

Actually, Reserve Balances at Federal Reserve banks declined by $7.0 billion over the past four-week period.  The increase in central bank liquidity swaps was just about totally matched by the decline in reverse repos with foreign official and international accounts as other factors removed reserves.

In terms of Federal Reserve open market operations, the securities account at the Fed actually declined in both the latest 4-week and 13-week periods.  Securities bought outright dropped by a little more than $11.0 billion since November 2 and by a little more than $5.0 billion since January 4. 

Over the past 13 weeks, about $20.0 billion in federal agency issues and mortgage-backed securities ran off in the portfolio.  The Fed only replaced this runoff by a little more than $8.0 billion.  In the latest 4-week period, the runoff in securities was across the board.

The conclusion I draw from the latest Federal Reserve statistics is that the Fed has had a relatively peaceful 13 weeks.  Money continues to flow into the United States Treasury markets seeking a “safe haven” from what is going on in Europe.  This, along with the mediocre economic growth in the country, has taken pressure off the Fed to buy more securities in order to keep interest rates low.  The fact that the securities portfolio at the Fed has declined over the past 13 weeks indicates that the Federal Reserve is letting market forces keep interest rates low and, for a change, is staying out of the market. 

If these conditions continue, I see no justification for any talk about another round of quantitative easing.

The money stock numbers are continuing to maintain excessive growth rates.  The year-over-year rate of growth of the M1 measure of the money stock for the week ending January 24, 2012 is 18.7 percent; the M2 measure of the money stock is growing at 9.7 percent.

Over the past three years I have been arguing that the reason that these money stock growth rates are so high, given the fact that commercial banks did not seem to be lending and that the reserves being pumped into the system by the Fed were going into excess reserves, is that the dire economic conditions have caused individuals and businesses to move their funds from interest bearing assets to transaction assets like currency and demand deposits.  The very low interest rates on the interest bearing assets also contributed to this movement.

Now, however, it seems as this re-arrangement of liquid asset holdings has slowed down.  This is something I think we want to keep our eyes on, for it could be that households and businesses have done all they can do to “be liquid” in bad times.  Thus, we will either see a slow-down in money growth measures (the rates have dropped since the first of November from a 20.0 percent year-over-year rate of growth for M1 and a 10.0 percent rate for M2) or we will see spending starting to increase as these transactions accounts are being used to actually buy things.  It will be interesting to see what happens here.

If people and businesses do speed up their expenditures, this fact would be another reason why another round of quantitative easing would not be necessary.  The Fed would have done enough.