The Focus Should Be On Under-Employment Not Un-Employment

The president, the press, and the political pundits focus on the unemployment rate in November as it dropped to 8.6 percent of the workforce, a drop from 9.1 percent in October.

However, under-employment still remains in the 20.0 to 25.0 percent range as it has for the past several years.

Under-employment includes those people that are working part time but would like to work full-time.  This component did decline by more than 4.0 percent in November from a month earlier but was down by only about 5.0 percent year-over-year.

Under-employment also considers people that are not working but say that they would like to be.  This includes discouraged workers and those who cannot work for reasons like ill health.  The number included in this classification increased by about 6.0 percent over the last year.  Does this capture the movement from part-time employment to discouraged workers? 

These figures indicate that there are long-run factors at work in the labor market that cannot just be solved by short-run fixes or election-year accusations and verbal confrontations.

My argument is, and has been, that fifty years of credit inflation has left the United States with a substantial dislocation of economic resources, like labor, and a vast redistribution of income toward the wealthy.  These dislocations are not subject to the “quick fix”. 

The economy is recovering, but the economic recovery is not doing much…and cannot do much…to create the restructuring that is needed.  You cannot try and put an employee of the auto industry back to work in the same job he/she held for the last ten years when the industry has moved on technologically and that job no longer exists. 

Another significant indicator of this is that the share of the population in the labor force has dropped to 64.0 percent, the lowest level in decades. 

This drop in labor force share is being driven by people retiring early from the labor force.  We see this in a lead article in the New York Times this morning, “Many Workers in Public Sector Retiring Sooner.” (http://www.nytimes.com/2011/12/06/us/more-public-sector-workers-are-retiring-sooner.html?_r=1&hp)  This is a result of the budget problems being faced by state and local governments, but it is also a result of events taking place in the private sector as well.

Further supporting information comes from the data of the manufacturing sector.  Capacity utilization continues to be below the levels attained over the past fifty years. 

The latest figure for capacity utilization was 77.8 percent.  This is above the level capacity utilization reached in the depths of the Great Recession, 67.3 percent in June 2009, but it is only slightly higher than the level at the trough of the 2001 recession.  And, the trend throughout the last fifty years has been down with capacity utilization being near 90 percent in the 1960s.

Over the past fifty years in the United States, under-employment has increased dramatically and capacity utilization has declined dramatically.  Note, that this is the time period that the income distribution skewed so dramatically toward the wealthy in the United States.

The economic policies of the United States government, both Republican and Democratic, have produced this outcome over this time period.  More of the same will not be helpful. 

Economic growth and economic recovery will not be robust unless and until people come to understand that the economic policies of the government must change.  And, these economic policies must deal with the structural dislocations that have evolved over the past fifty years as well as put the economy back on a more stable foundation with less reliance on debt and credit inflation. 

Credit inflation paints a very pretty picture while it is accelerating.  But, the consequences of this inflation is anything but pretty.  Just ask the less wealthy, the under-employed, and the manufacturers that cannot use their full capacity.   

Central Banks in Liquidity Action...Not Solvency Action

Here we go again!

The central banks acted yesterday and the markets went wild!  Six central banks acted in concert to make sure that European banks…and others…could get dollars if they wanted them.

This is a liquidity action!

It is an act to keep the flow of short-term funds flowing in world financial markets…just as these six central banks did after the Lehman Brothers failure. 

Once again, the definition of a liquidity crisis is that there is a short term need for “buyers” in a market because, for the short term, the “buyers” that are usually there are not there.  The “sellers” want to sell assets and obtain dollars.

“Buyers” without dollars are not what is wanted.  So the central banks are making sure that there are plenty of dollars available so that the “sellers” can sell their assets.

The emphasis, however, should be on the short-term nature of a “liquidity” crisis. 

The fundamental problem is still the solvency problem facing several of the sovereign nations of Europe. (See my post from yesterday, “European Debt Must Be Restructured,” http://seekingalpha.com/article/310994-european-sovereign-debt-must-be-restructured.)

Providing liquidity to the market will not resolve the solvency problem.  As almost everyone except the officials in Europe know, the efforts of the last two years or so to treat European debt problems as a “liquidity” issue has resulted in the situation we now find ourselves in. 

As in the past, central bank action has gotten a favorable response from stock markets around the world.  In the past, the quick, dramatic response to the central bank action has been followed by a retreat.  If nothing is done on the sovereign debt restructuring need, the stock markets will, in all likelihood, retreat once again.

The word out is that this liquidity action on the part of the central banks gives the officials in Europe some time to deal with the restructuring. 

But, the restructuring is also only a short-term response for eventually the eurozone must deal with the whole question of how the fiscal affairs of the eurozone will be handled.  The concern is that restructuring of the debt without reforming how the nations of the eurozone discipline their fiscal affairs just creates a situation in which fiscal irresponsibility can survive into the future.

Revising how the eurozone conducts its fiscal affairs, however, cannot be done overnight.  Yet, the financial markets must be given some kind of credible assurances that fiscal discipline will be forthcoming before they will really settle down. 

This seems to be the unknown…for the single currency framework will not last without the eurozone achieving some kind of fiscal unity.  Is this what Germany is holding out for?

So, is the problem going to be resolved now…or, are we just going through another cycle?

I still am not convinced that the Europeans, at this stage, possess the backbone to do what is necessary!

Oh, and once all these dollars get out into world markets…will they be withdrawn once the “liquidity” crisis is over?

Small Banks Are Getting Smaller

Check out the Wall Street Journal article “Ax Falls at Smaller Banks.” (http://professional.wsj.com/article/SB10001424052970203764804577060752595022804.html?mod=ITP_moneyandinvesting_0&mg=reno-secaucus-wsj) And, the subtitle to the piece: “Cuts at Lenders as Industry Job Growth Slows: ‘There will Be More to Come.”

This article is right in line with my Monday post “While Small Banks Disappear, Big Banks Get Bigger.” (http://seekingalpha.com/article/310644-while-small-banks-disappear-big-banks-get-bigger)

“Smaller U. S banks and savings institutions are cutting jobs in a sign of a deepening financial industry retrenchment that is shaking firms from Main Street to Wall Street.”

“Banks that cut jobs in the third quarter outnumbered those that added jobs by 605, according to data from the FDIC.”

“Overall, banking industry employment rose slightly in the third quarter due to continued growth at the nation’s biggest banks.”

“Small banks are under especially intense cost pressure because they are as a group less efficient than larger rivals.”  And, they cannot achieve the economies of scale that larger banks can experience. 

“In the third quarter, about 76 cents of every $1 in revenue at banks with $100 billion or less in assets was consumed by expenses…. At the biggest banks, the figure was 58 cents.  The efficiency gap has widened by 50 percent in the past decade.”  

Many of the smaller banks just cannot compete in today's environment.

And, the recognition of the industry problems continues to grow as Standard & Poor’s “downgraded some of the world’s largest financial institutions.”  (http://dealbook.nytimes.com/2011/11/29/s-p-cuts-ratings-on-big-banks/?ref=business)

The line I like best in this article is “This is confirmation that rating agencies are lagging indicators.”  These downgrades should have taken place a long time ago.  But, I have written about this many times over the past three years and even suggested how market instruments might be used to provide an “early warning indicator” for the purposes of bank regulation. 

The banking industry still has a ways to go to regain its health.  Until then, the economic growth of the economy will continue to be mediocre…at best.

European Sovereign Debt Must Be Restructured

A debt crisis for an organization occurs when either its debt repayment cannot be covered by the cash flow being generated by the organization or the outstanding debt of the organization cannot be reduced sufficiently to reduce the debt repayment needs. 

In the case of a governmental organization, the cash flow needed to cover the debt repayment requirements comes from economic growth that is large enough to generate governmental revenues that cover the government’s cash outflow.

Or, the cash needed to reduce the amount of government debt outstanding comes from a cash surplus generated by the government’s prudent fiscal budgets.

If neither of these conditions is met, then the government is insolvent and the debt outstanding must be restructured.

What is so hard to understand?

The growth rate of many countries in the eurozone is exceedingly low or non-existent. 

The new budgets being generated in these countries do not reduce deficits sufficiently to reduce their ratio of government debt to Gross Domestic Product.

The current efforts of the effected governments produce a cumulative result that just exacerbates the situation.  If the deficits cannot be reduced sufficiently, the debt repayment crises continues which puts greater pressure on governments to reduce budget deficits, and so on, and so on.  The experience of the eurozone over the past few years just confirms this dilemma.   

This reality pervades the bond markets. 

But, this reality is still being evaded by eurozone officials. 

A movement to enact a “fiscal union” to go with Europe’s “currency union” cannot correct the current situation without a debt restructuring because it ignores the reality of what the current situation has inherited.

A “fiscal union” can only be achieved if, at the same time, a debt restructuring takes place in those nations that are fiscally insolvent.  That is, the resolution of the current problems can only be achieved when the fact of insolvency is dealt with AND some form of a “fiscal union” with sufficient power is put in place. 

The past must be dealt with and some hope must be established for the future.     

A debt restructuring will be costly because of the impact this restructuring will have on European banks…and other banks and financial institutions throughout the world.  Any new “fiscal union” combined with a debt restructuring must include some plans to “backstop” banks.  This “backstopping” may spillover into other countries, like the United States and the United Kingdom.

And, all of this will have further negative repercussions on economic growth…in Europe, in the Untied States, and elsewhere. 

As Milton Friedman warned, “There is no such thing as a free lunch.”  Well, it appears as if the “free lunch” we have been trying to live off of is just about over. 

Big Banks Get Bigger While the Smaller Banks Disappear

The FDIC released data on the state of the banking industry last week.  And, we see that the size and number of the bigger banks increase while the size and number of the smaller banks continue to decline.

Let’s look at the number of banks in the United States first.  The number of banks in the United States dropped by 61 from June 30 to November 30 leaving only 6,352 banks still in existence.  Note that the FDIC closed only 26 banks in the third quarter of 2011.

Over the past 12 months, the number of banks in the banking system dropped by 271 banks. 

Obviously, if we focus on just the number of banks that the FDIC closed, we are not getting the whole picture as many unhealthy banks that might eventually be closed are being acquired.

The number of banks on the FDIC’s list of problem banks dropped to 844 on September 30, down from 865 on June 30.  So, the number of banks on the problem list dropped by 21, the number of failed banks was 26, and the number of banks leaving the banking system was 61.  Seems like more banks went on the problem list than left it in the third quarter of the year.  Maybe the statistics on problem banks is not as "jolly" as indicated. 

Over the past 12 months, however, the largest bank classification, banks with assets in excess of one billion dollars rose by 10.  Banks with less that $100 million in assets declined by 176 over the past year and banks with assets between $100 million and $1.0 billion dropped by 105.

Whereas the average size of banks in these last two categories remained about the same over the past year, the average size of banks over $1.0 billion in rose by $1.5 billion to $22.0 billion.

At the end of September 2011, there were 2,208 banks that were less than $100 million in asset size and these banks represented about 1.0 percent of the assets in the banking industry.  On the same date, there were 3,626 banks with assets ranging from $100 million to 1.0 billion, and all of these banks just controlled slightly more than 8.0 percent of the assets in the banking industry.

There were 518 banks in the United States that had assets in excess of $1.0 billion, and these 518 banks controlled 91.0 percent of the assets in the banking industry.

In terms of loans, Net Loans and Leases at the smaller commercial banks declined by almost $8.0 million over the past year, by $2.5 million over the past quarter.  The Net Loans and Leases at the middle range of banks dropped by a little less that $50.0 million over the past year and by about $4.0 million over the past quarter.

In the larger banks, Net Loans and Leases increased by more than $70.0 million over the past year and by about $36 million over the past quarter. 

The bottom line is that commercial banks with assets totaling less than $1.0 billion continue to produce statistics that cause one to question the health of this segment of the banking industry.  In addition, given the decline in total assets in these banks, the sector has not observed a consistent reduction in noncurrent assets (past due loans).  That is, there has only been a modest reduction in the average amount of noncurrent assets to total assets over this time period. 

Consequently, the larger banks are getting larger and becoming more dominant all the time.  And, if one looks at Federal Reserve statistics, the largest 25 domestically chartered banks in the country control about two-thirds of all the assets held by domestically chartered banks.  Thus, if the largest 518 banks in the country control 91.0 percent of the banking assets, this means that 493 banks that are larger than $1.0 billion in asset size but are not among the 25 largest, control about 24 percent of the assets. 

All the statistics show that the small- to medium-sized banks are really becoming insignificant in the United States banking industry and, given the troubles that many of these banks still face, will become even less significant in the future. 

An article in the Monday edition of the Wall Street Journal presents research showing that the health of the banking industry is being questioned by the stock markets.  Andrew Atkeson and William Simon write that “The recent volatility in bank stocks is a signal that U. S. banks, large and small, are not as healthy as many analysts assume.” (http://professional.wsj.com/article/SB10001424052970204531404577052493270860130.html?mod=ITP_opinion_0&mg=reno-secaucus-wsj)

“The dynamic has played out twice before over the past 85 years—in the Great Depression and the panic of 2008-09—with devastating consequences for the broader economy.  Over the past three months, investor uncertainty about the soundness of bank balance sheets, manifested in the daily volatility of stock prices is back up to levels seen historically only in advance of these two great crises.”

“This extraordinary volatility is not limited to the stocks of large banks but extend to small and midsize banks as well.”

So much has been written about the condition of the banking industry in Europe.  Very little has really been written about the condition of the banking industry in the United States.  Investors in the stock market seem to have picked up this concern.

And, I have argued for more than two years now that the major reason that the Federal Reserve has pumped so much money into the banking system is that the United States banking industry has severe problems.  And, the fact that banks have held onto these funds as excess reserves and have not loaned them out is an indication of the fact that many of the banks are still not solvent.  However, the fact that the Fed has provided so many excess reserves to the banking system has allowed the FDIC to either close banks or approve acquisitions of weak banks as smoothly as possible.  The Fed and the FDIC have, so far, prevented any panic from occurring. 

However, problems remain. 

Deficit Reduction: An Absence of Leadership

I spend a lot of time writing…and talking…about the credit inflation that has taken place in the United States over the past fifty years.  In my mind, this period of credit inflation set the stage for the Great Recession of December 2007 through July 2009.  It also set the stage for the debt overhang that burdens the United States economy to this very day.  It also will account for the mediocre economic growth that the United States will experience for the next four or five years.

Essentially this credit inflation laid the foundation for all the private sector credit expansion that took place during this fifty-year period and for the financial innovation that dominated the country in the latter part of the last century. 

Over the past fifty years, the Gross Public Debt of the United States increased at a compound rate of growth of approximately 8.0 percent.  Private debt rose somewhere between a compound rate of 10.0 percent and 15.0 percent. 

All of these figures exceed the growth rate of the economy, which averaged a compound rate slightly in excess of 3.0 percent.

When credit growth exceeds the rate at which the economy can grow, that is called “credit inflation.”  A good portion of this credit inflation has gone into consumer prices, but even more has gone into asset prices, or, has gone offshore.

The Gross Public Debt stands around $15.0 trillion as of this last October.  In just the past three years this figure has grown by about $4.0 trillion.

If this pace is continued, the Gross Public Debt will rise by more than $13.00 trillion over the next ten years, slightly below the forecast I have been putting out for the last year or more, which is $15.0 trillion or more.  I have argued that, given current attitudes, the government’s debt outstanding will double in the next ten years. 

I feel much more comfortable, at this time, arguing that the debt will double in the next ten years than I do that the debt will increase by only 50.0 percent or 75.0 percent. 

I have very little faith, at the present time, that much will be done to divert us from the path that we are on.  And, just ten years ago we were experiencing a surplus in the government’s budget.

It comes as no surprise, therefore, that I am not surprised in the breakdown in the deficit talks of the Congressional supercommittee.  There is no leadership in Washington to bring about a change in direction.  The President’s ability to lead the situation is almost non-existent given the evidence of the recent polling data on support.  And, Congress is even less able to lead given that polls on the public’s confidence in it are substantially below that of the President. 

The problem, as I see it, is that the leadership style of the President is to state, in general, what he would like…a health care bill, a financial reform act, an increase in the debt ceiling, and a deficit reduction plan…and then turns it over to Congress to come up with a plan.

The Republicans in Congress knows that they will not be punished if they stand up and take a very intransigent position.  They have become very direct in this in the last two skirmishes, because they knew that there was no way they would be called out.   They learned this from the first events surrounding the development of the health care bill and the financial reform act.  The Democrats in Congress have just been left out to “hang”.  You really don’t hear anything from them anymore.  They know they have the weak hand. 

So, I continue to predict that the federal debt outstanding will grow…and grow…and grow.

And, as the debt continues to grow, the value of the dollar will continue to trend downward.  Over this time period the debt of the United States government has trended upwards. 

Since 1971, when the dollar was taken off the gold standard, the dollar has declined in value by about 33.0 percent.  Since 1971, the debt of the government has increased by 39 times.  The reason that the dollar has not declined by more is that other countries have followed policies that are similar to those of the United States and the U. S. dollar is still the reserve currency of the world.

As the debt continues to grow, the value of the dollar continues to decline.   Here is the chart of the value of the U. S. dollar against other major currencies over the last ten years.   

The chart begins near the start of the Bush (43) administration.  The two years previous to the beginning of the Bush (43) administration, the federal budget was in surplus.  As can be seen, the value of the dollar was about 10.0 percent above the level it was at the time the dollar was removed from the gold standard.  As federal deficits rose through the last decade, the value of the dollar continued to decline, reaching historic lows earlier this year. 

Thus, I continue to be a pessimist about the ability of the United States government to get its budget under control and I continue to be a pessimist about the future value of the dollar.  We cannot expect to see the value of the dollar really get stronger until we achieve some control over our fiscal affairs. 

Given this view about the future, I continue to be a pessimist about the ability of the United States to maintain its economic lead on the rest of the world going forward. (See http://seekingalpha.com/article/309054-signs-of-the-future-developed-countries-vs-emerging-countries for more on this.) Right now, that is the environment I believe businesses and investors should prepare for.

How Do You Cover Up Your Failure: the Greek Case

I believe that Gretchen Morgenson of the New York Times has done investors a big favor in writing her piece for the Sunday morning paper of November 20.  This article reveals the extent that officials will go to try and avoid the consequences of when they royally “screw up”! (http://www.nytimes.com/2011/11/20/business/credit-default-swaps-as-a-scare-tactic-in-greece.html?_r=1&ref=business)

The situation: “the debt mess in Europe.”

The event: “bankers are pressing Greece’s bond holders to swallow big losses.”

The intended consequence: “Leading the charge is BNP Paribas, the big French bank, which has been hired by the Greed government to help persuade investors to accept a deal that would cut the value of their investments in half.”

The cover-up: “On paper, this restructuring would be voluntary!”

The reason for this behavior: the Credit Default Swaps that are supposed to cover the losses on a write down like this.  “If Greece stops paying after the restructuring (the swaps that investors bought as insurance on the Greek debt) are supposed to cover their losses, much the way homeowners’ insurance would cover a fire.” 

The effort: if the restructuring is declared voluntary then the “credit insurance may not pay off down the road, because after the restructuring is completed, the terms of the old debt might be changed.”

Who stands to gain: “BNP which stands to profit from the restructuring.”  BNP will “generate fees from the exchange” or is concerned about “its own exposure to Greece.  A question being discussed is whether or not “BNP Paribas has written a lot of insurance on Greek debt.  If so, getting people to unwind such swaps now would be less costly for BNP than having the insurance pay off.”

Most suspicious, an official of BNP Paribas, Belle Yang, is also on the “powerful” International Swaps and Derivatives Association (I.S.D.A.) “determinations committee” that will decide what constitutes a “credit event” both in Greece and elsewhere in Europe. 

When you don’t do your job, things happen.  And, when things happen and you deny that things are happening, things get worse.  And, when things get worse you sometimes do very stupid things in order to keep avoiding what you really have to do.

Just ask Penn State University officials about this!

Politicians in Europe created too much debt in trying to remain in office by paying off their constituents in order to get re-elected.  When financial markets started to complain about the excesses of debt created, European officials claimed that the problems were caused by speculators and other “greedy bastards” that were trying to disrupt things for their own gain.  When things got worse, officials claimed that there was a liquidity crisis at hand, not a solvency crisis.  And, because it was a liquidity crisis, bailouts could resolve the issue by giving governments enough time to get their budgets in order. 

This did not work and when these officials finally came to accept the fact that they might have to deal with the insolvency of their countries, they began working on a “new gimmick” that a default really was not a default…if it were voluntary.

And, if the default was just voluntary then contracts written to insure against a default could not really be collected upon!

That is, the legal contracts that were written to insure parties against default are really worthless!

“If investors think debt terms can be changed by fiat, they will flee the market.  Ditto, if they find that their insurance can be made worthless.” 

“The discussions with BNP Paribas confirm the view of some investors that credit default swaps are not insurance at all, but rather instruments that big banks use to benefit themselves.”

Hello, Occupy Wall Street!!!  

My prediction: “the debt mess in Europe” is not going to be cleared up until people stop lying to themselves and really start to address the issues that are outstanding.  The problem with this, as I have written about many times before, is that I see no leaders in Europe that are willing to stand up and really discuss the issues that are outstanding. (See my post: “In Europe the Issue is Leadership,” http://seekingalpha.com/article/280658-in-europe-the-issue-is-leadership.)  

The sovereign debt problems that Europe faces are problems of solvency.  How many times does someone have to say this!  Until the officials of Europe address this problem “head on” and really try to “get their hands around it” they will continue to come up with “screwball” ideas like the one that Morgenson writes about in the Sunday NYTimes.

Resolving solvency problems are not easy and I’m sure this is why many European officials “put off” going for a real solution.  Solving solvency problems are going to cause a lot of hurt and pain…and will take a lot of time to correct. 

Unfortunately, there was a lot of hubris connected with the conceit of many European governments, a conceit that these governments could engineer high rates of employment and a social infrastructure that took care of all ills within a world in which there would be no international repercussions for such excessive and undisciplined behavior.

Unfortunately, there are no “good” solutions to living beyond ones means for an extended period of time.  If you “screw up” you finally end up paying for it.  And, solving the problem can hurt many, many people.