The Need for Counter Cyclical Measures in a Falling Economy: Another Picture of Unemployment

Many journalists, when writing about the economy, focus on the broadest pictures:  Gross National Product, total Non-farm employment, etc.  But, sometimes the big picture needs supplementing with a narrower focus. 

In looking at employment, for example, it helps to break the total employment picture down into three primary sectors.

• Cyclical Services, which include information services, fire, professional and business services plus leisure and hospitality (sports, hotels, gambling, e.g.),  Employment in this sector follows the general business cycle.
• Acyclical Services, which include health, education, other services, and government.  These services, as the name implies, do not vary with the business cycle as much as the other sectors.
• Goods, i.e., produced goods, which are generally measured with  industrial production figures.

Below is a graph of these three sectors, measured in total payrolls for each sector as annualized six-month changes.  This chart shows how wide a path unemployment is cutting through our economy.  Most everyone is feeling it.

The see the graph and further analysis of sector analysis, follow this link.

Deflation as a Symptom: Leading Economic Indicators

Few economic events stir up fear faster than deflation.  In a technical sense, deflation is merely the opposite of inflation; overall prices drop rather than rise.  It doesn't mean that all prices drop, but the average of all prices drops during deflation.

The fear factor that deflation brings is because it is associated with bad economic times rather than good times.  The NY Times graph below does a good job of showing this association.  Note that in the shaded areas, areas when the economy is in recession, is also the time, for the most part, when price deflation occurs.  There are brief periods where year over year prices may fall for a short time without being in recession, but in all cases where falling prices lasted for a long time, a recession or depression was in

process. 

To read the balance of the article, including the analysis of the chart, and to see the latest release of leading economic indicators for November, follow this link.

Chinese Yuan To Fall in Coming Months

A report from Hong Kong states that the yuan is set to fall for about the next six months.  The Chinese monetary authorities have signaled they will allow the fall by small amounts in order to make Chinese exports more attractive to foreigners.  The China economy is heavily dependent on exports, and a strong yuan discourages sales to foreigners by making them more expensive.

China was criticized by American and European governments last year for purposely undervaluing the yuan in order to support Chinese goods over those in the western nations.  In response to this criticism the yuan was allowed to rise for some of last year and into 2008.  But, as the chart below shows the last six months the yuan  has fallen in dollar terms, as reflected by the Wisdom Tree Chinese Yuan Fund (CYB). 

To view the chart and the rest of the article, click here for rayhendon.com.

Pictures of the Real Estate Bubble Bursting

The bursting of the real estate bubble is no longer news.  We can watch it unfold before our very eyes, as if we were watching some distant star explode a billion light years away.  The three pictures shown below show a snap shot of the real estate explosion and subsequent implosion.

The first chart shows Washington DC housing prices from 2001 through part of 2008.  The dates are fixed on all charts.  Washington DC was chosen because of its similarities to the national average.  You can see the darker blue bars, which represent the national average, are fairly close to Washington D.C.'s figures. 

Overall, the nation's capital had a rather mild expansion and an equally mild crash.  Prices rose about 25% at the peak in early 2005, and down less than 20% in the middle of this year.

All charts from the NY Times

A more pronounced bubble is seen in the Los Angeles chart, below.  LA prices rose over 30% at their peak (in mid 2004), and have plunged closer to 30% since.

To read the rest of the article and see graphs of Los Angeles and Las Vegas, click Here

For a more detailed analysis of the current economic crisis, see my most recent article on Seeking Alpha.

November Job Losses Highest in 34 Years

The American economy lost 533,000 jobs in November, the most in 34 years.  The unemployment rate  shot up to 6.7 percent, the highest in 15 years.  The last time that job losses in a single month were this bad or worse was in December, 1974.

The chart below provides a picture of how the recession has deepened throughout the year.

source: Bureau of Labor Statistics

If anyone had doubts about the severity of the recession that began at this time last year, there are none left.  The current slowdown points to a more bad news for the United States and the rest of the world as the continuing economic crisis searches for a bottom that appears to be far lower yet.

Almost no sector in the economy was spared.  Cutbacks hit factories, often the highest paying jobs, construction companies, financial firms, retailers, leisure and hospitality, and others. Government and health services were two of the few who did not post job losses.

The forecast for losses in November had been 320,000, so economists were show to have missed the mark by more than 66%, a sure sign that the severity of the recession far exceeds general expectations. 

Job losses in September and October also turned out to be much worse. Employers cut 403,000 jobs in September, versus 284,000 previously estimated. Another 320,000 were chopped in October, compared with an initial estimate of 240,000.

The recession is going to be the Grinch who stole Christmas, deepening as the holiday season nears.  With high unemployment, gift giving is likely to be pared back by many consumers. 

Investor sentiment will also reflect this reality, and further pressure will be placed on the stock markets around the world.  Within five minutes after the opening bell on Friday, the Dow Jones Industrial Average was down over 100 points.  

My fear of unemployment as high as 10% was buttressed by today's news.  A bottom for this recession seems much deeper than it is now. 

34 Year High in Job Losses for November

The American economy lost 533,000 jobs in November, the most in 34 years.  The unemployment rate shot up to 6.7 percent, the highest in 15 years.  The last time that job losses in a single month were this bad or worse was in December, 1974.

The chart below provides a picture of how the recession has deepened throughout the year.

source: Bureau of Labor Statistics

If anyone had doubts about the severity of the recession that began at this time last year, there are none left.  The current slowdown points to a more bad news for the United States and the rest of the world as the continuing economic crisis searches for a bottom that appears to be far lower yet.

Almost no sector in the economy was spared.  Cutbacks hit factories, often the highest paying jobs, construction companies, financial firms, retailers, leisure and hospitality, and others. Government and health services were two of the few who did not post job losses.

The forecast for losses in November had been 320,000, so economists were show to have missed the mark by more than 66%, a sure sign that the severity of the recession far exceeds general expectations. 

Job losses in September and October also turned out to be much worse. Employers cut 403,000 jobs in September, versus 284,000 previously estimated. Another 320,000 were chopped in October, compared with an initial estimate of 240,000.

The recession is going to be the Grinch who stole Christmas, deepening as the holiday season nears.  With high unemployment, gift giving is likely to be pared back by many consumers. 

Investor sentiment will also reflect this reality, and further pressure will be placed on the stock markets around the world.  Within five minutes after the opening bell on Friday, the Dow Jones Industrial Average was down over 100 points.  

My fear of unemployment as high as 10% was buttressed by today's news.  A bottom of for this recession seems far away. 

China Turns Inward

Speaking at the Clinton Global Initiative conference in Hong Kong, the chairman of China’s sovereign wealth fund , Mr. Lou Jiwei, said on Wednesday that China had no plans for further investments in Western financial institutions. “Right now we do not have the courage to invest in financial institutions because we do not know what problems they may have,”

The sovereign wealth fund had invested heavily in Barclays and Morgan Stanley, only to see the value of its investments plummet as the American and U.K. financial sector crashed. 

Follow this link to read the full article: Link to full article.

U.S. and World Economies--Slow, Slower, Slowest

There is no good news today for the world’s economies, including America. In the United States, the monthly survey of business by The Institute for Supply Management showed that manufacturing activity fell to 36.2 from October's 38.9. A figure below 50 indicates the sector is contracting. The Associated Press reports: “The November reading is the lowest since May 1982. . ., when the economy was in the midst of a painful recession. Economists said the report indicates that the economy is likely in a steep recession and times will remain tough for manufacturing companies in the coming months.”

This kind of drop in manufacturing is also shown in American automobile sales, which have put the three domestic automobile manufacturers at the doorway of bankruptcy. Of course, a slowdown of the auto industry also spills over into steel and many other members of the manufacturing sector.

Below is a video presentation by Mark Vitner on Bloomberg TV about the U.S. ISM index (to see the video and read the rest of the article about the world wide slowdown, click here).

International Economic Growth:OECD Estimates for 2009

The OECD has released its estimates for growth in the major economies for 2009.  Robust growth of 6% to 8% is seen in China and India.  Less, but still good growth for Indonesia, while Russia, Brazil, and South Africa are less than robust, but still growing.  Australia and Turkey are growing, but even less than the others.

For most of Europe, the United States and New Zealand, it is recession.  Mexico, Spain and Scandinavia are expected to produce near zero growth.  Iceland, the tiny dark blue dot in the north Atlantic, is projected to have a -9.335% drop in GDP.

OECD Visualization of World Growth for 2009

The table below details the specifics of GDP projections for many countries.

 

Almost all of the largest economies and some of the smaller  ones, have growth stimulus packages in place or on the table.  This will help keep the recessions from going deeper in the red, especially if they all are implemented at roughly the same time.

If one country increases government spending is a stimulus program, then there will be an expected positive addition to GDP.  But, some of that growth will be exported to their trading partners.  For example, if the U.S. were to enact a stimulus program by itself, it would lose some of the growth to imports from Mexico, Canada and China.  But, if all four countries enact similar programs at the same time, there will be an even larger expansion in all countries.  The mathematics of this are somewhat complex, and they lack definitive precision.  But, the modeling that is used by economists are well tested over decades of experience.  Mr. Obama's economic team will be using this type of modeling in order to determine how large a stimulus is needed to grow our economy out of the recession.

One variable not tested in this type of modeling, however, is how the credit markets will accommodate simultaneous borrowing by many countries at the same time.  Is there enough world demand for debt to buy all the bonds that would be issued with the huge influx that would come from simultaneous borrowing?  I don't know the answer to this question, but it does seem to me to point to some limits on the ability of the world economy to engage in large-scale borrowing at the same time.

On the positive side, China is able to buy $2 trillion itself, out of current reserves.  If they stay positive in their trade balance, then they could buy even greater quantities next year.  There is still plenty of international credit available, even if the large banks are dried up for now.

Conservatives, Liberals and Progressives Speak on the new Stimulus Plan

Watch a well informed discussion of the new stimulus plan President-Elect Obama offered in his weekly radio (and YouTube) address.  George Stephanopoulos leads the discussion between George Will, Arianna Huffington, David Brooks and Robert Kuttner on the merits of the plan.

This is well worth the time if you want to see a well informed and civil discussion.  Every point of view is represented and debated--liberal, progressive and conservative.

Discussion of President Obama's Proposal on Stimulus Spending

In another interview, Paul Krugman, 2008 Nobel Prize winner in economics,  noted the need for a massive spending and employment program to get the economy away from the doorway of a major depression.  We are not there, he insisted, but we could get there without an immediate implementation of a plan to get people employed and money flowing again.

Mr. Krugman also emphasized that there are two crises happening at the same time: a financial crisis on Wall Street, where the American Banking system is breaking down, and another crisis on Main Street where breadwinners are losing their jobs, can't get loans and can't make their house payments.  So far, the Bush Administration has addressed only the Wall Street side of the problem.  Mr. Obama's plan goes a long way to begin a remedy of the second.  Mr. Krugman sees possibly another one and a half million additional jobs lost before Mr. Obama takes office.

Late breaking news on Sunday said that the Democrats in Congress would have a $700 billion stimulus plan ready for Mr. Obama's signature on the day he is sworn into office. 

President-Elect Obama's Stimulus Plan

Mr. Obama announced on Saturday a rough sketch of a major stimulus plan that would add several million new jobs to our faltering economy.  American workers will rebuild the nation's roads and bridges, modernize its schools and create more sources of alternative energy, creating 2.5 million jobs by 2011, Obama said in the weekly Democratic address, posted on his Web site.

"These aren't just steps to pull ourselves out of this immediate crisis," he said. "These are the long-term investments in our economic future that have been ignored for far too long."

To watch a video of Mr. Obama's Weekly Address to the Nation and to read the entire article:Click Here

Tim Geithner: The New Man at Treasury

A brief profile of Tim Geithner published last year at New York Times:

"If the brave new world of finance is daunting, the man in charge of it is not. With a boyish charm and a dry sense of humor, Mr. Geithner has taken advantage of the current calm waters of the financial markets to take an active stance, rallying Wall Street to peel apart the market of credit derivatives to try to understand its potential risks. . . .

To read the whole story, follow this link: to RayHendon.com

How Bad Can it Get?

How Bad Can it Get?

My last blog on the economy was entitled: It’s Worse Than We Think. So what comes after, worse than we think? Worser is not a word, but it’s what comes to mind today when I see the latest employment and price data.

To continue reading, follow this  link to the complete article.

Report of the G-20 Meeting

Here is a link to the full text of the press release of the attendees: Press Release of G-20 Members

There were two agendas at the G-20 meeting on Saturday:

• Strengthen the world's economies and reduce the effect of the world-wide recession that is getting worse daily.
• Find a way to share the authority over the structure of the global financial system. Europe, Asia and Latin America are all clamoring for more say-so in how things work.

On the first agenda, that of working together to strengthen the world's economies, there is progress to report. All that could reasonably be expected from the Conference would be to reach agreement on what to do for the next meeting, and this was accomplished. They agreed to meet at the end of April, about 100 days after Mr. Obama assumes his duties as President of the United States, and take up a specific list of agenda items:

Stimulus spending

Interest rate cuts

IMF funding and lending to shore up currencies under attack

Regulatory oversight on banks and other financial institutions

Oversight on credit default swaps and credit rating agencies

Transparent accounting standards for all world-wide financial institutions

A Supervisory College to meet and discuss world banking developments

Limiting compensation for financial executives

There has been no agreement on the structure of any of these issues, but there is agreement that these are the items that will be worked on for the next meeting. It is a rich agenda, and one full of difficulties to resolve. Bank regulation, alone, poses a host of thorny issues that will test the ability of the G-20 to work together.

As of yet, there has been no agreement as to who will fund the IMF in its increased lending activities, which is essential to stop the excessive volatility of the currency markets. There are, generally, three nations that have the wherewithal to do this: Saudi Arabia, China and Japan. All three of these countries have huge reserves of foreign currencies (China as over $2 trillion), and they will be needed if the plunge in currency values of both emerging and developed markets is to stop. There will probably be much discussion on this issue before the next meeting.

As to the second agenda, the spreading of authority, there is little talk, so any analysis of this issue will have to be done by reading between the lines. The background for this agenda has its roots in the vast changes that have taken place in the world economy since the 1944 Bretton Woods Agreement . The United States probably produced at least half the GNP of the world when the meeting took place. It now accounts for about 25%. Also, the economic power has shifted from Western Europe and North America to be more dispersed over all continents. Asia has enormous economic power since the rise of China, India, South Korea, and Taiwan. Plus, there are a host of South East Asian economies that are growing fast and that are now fully integrated into the world's finance system. In addition Europe has not only recovered from the devastation of WWII, but has coalesced within the EEC, and Eastern Europe is taking off.

The first reading between the lines is the fact that it was the G-20 that was called into meeting rather than the G-7 or G-8. This reflects the reality of the new power dispersion. In times past, it would have been the top industrialized nations meeting at the behest of the U.S.

The second reading regards the desire to expand the powers and monies available to the IMF. This institution, which has contributed to world economic stability over the years, has been a virtual fiefdom of the United States. But the ousting by Europe last year of Mr. Bush's appointee to head the IMF set the tone for things to come. In my view, it would be beneficial to expand the membership and voting of the IMF, to include the emerging markets. If this step cannot be done, then continuing the G-20 as the major tool of international policy making would be an important step. Over time, the members will sort things out and determine where the consultative power lies.

Below is a list of the world's top 20 economies, measured in U.S. dollars for the year 2007. This is not the exact membership of the Group of 20, however.

The G-20 has added Saudi Arabia, South Africa and Argentina, and eliminated Spain, the Netherlands and Belgium. the European Union was also added as a single member.

The list goes a long way in explaining how things need to change in regulating the world's economies. Although the United States still dominates--no one else is even close, there are many new, major players on the list. China will probably soon replace Germany as the third largest economy, and Brazil has been gaining on Canada the last few years. Turkey is now growing fast, and Indonesia will likely pass Belgium before long. The new world order needs to reflect these realities.

The final analysis may reflect that the most significant part of the G-20 meeting of 2008 was that the G-20 meeting was called. If they did nothing else, the fact that all twenty of the members came and participated marks a boundary of recognition that things have changed. Managing the world's economies will no longer be confined to the top seven or eight nations of the world. Power has shifted to include the newer, faster growing economies.

Join me in welcoming Mr. Obama to the world of international economics and finance. I hope he puts a strong team together, soon. There is some heavy lifting ahead.

Brief on the G-20 Conference Today in Washington

The emergency meeting of the Group of 20 this Saturday, November 15, was called because the world’s financial system is broken. The meeting was suggested by French President, Nicolas Sarkozy to President Bush. Although Mr. Bush did not want to take up the issues that will be brought up at the meeting, he agreed to host it at Mr. Sarkozy’s insistence.

The primary issue to be discussed will be helping the developed and emerging markets out of the deepening recession that the world now faces. But, included in the discussions will be proposals made by European and emerging market leaders to reform banking regulations that would prevent the kind of financial meltdown that started the downward spiral this year.

Mr. Bush has publicly warned about stifling economic growth by excessive regulation, while the European leaders and Brazil, specifically, are more prone to take a strong government hand when they see a larger public need.

This argument is ancient in origin, and there has never been a consensus about the exact amount of regulation that is needed in every situation. Don’t look for a resolution to this issue at the meeting today. Mr. Bush couldn’t do anything about it even if he wanted to, given his status as out-going President, and the discussions today will last only about five hours.

Another meeting is planned after Mr. Obama assumes the Presidency, and at that meeting, more detailed work can be done to help coordinate government efforts to stave off what threatens to be a major downturn in many of the world’s economies. America is just entering a recession now, and the prognosis is looking increasingly bad. Europe is already in a recession, lead by Germany, the world’s third largest economy. Almost all the emerging markets, with the exceptions of China and India, are in recession, and even China and India are experiencing significantly lower growth rates for 2009.

The following description from Economix of the NY Times will be helpful in understanding the structure of The Group of 20:

The Group of 20, or G-20, is an international body that meets to discuss economic issues. Some of the things members discuss are ways to expand (or at least stabilize) the international economy, to reform international economic financial institutions like the International Monetary Fund, and to coordinate economic and financial policies (like policies that reduce tax evasion)

Members – 19 countries with some of the world’s biggest industrial and emerging economies, plus the European Union – represent about 90 percent of the world’s gross national product, 80 percent of world trade (including trade within the European Union) and two-thirds of the global population. Member countries usually meet annually.

The annual meeting already took place last weekend in São Paulo, Brazil. This weekend’s meeting was not on the regular schedule and was arranged specifically to address concerns about the international financial crisis. It is unprecedented because heads of government will be attending.

The member countries are Argentina, Australia, Brazil, Britain, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey and the United States. The European Union is also a member, represented by the rotating council presidency and the European Central Bank.

The membership of the G-20 has not changed since it was established, and the organization says there are “no formal criteria for G-20 membership.” With the exceptions of Argentina, Saudi Arabia and South Africa, all of the member countries fall within the list of the top 20 biggest state G.D.P.’s in the world.

Usually, the attendees of the annual meetings are the finance ministers and central bank governors of the member countries, plus top leadership of the World Bank and the International Monetary Fund.

This is the first time that heads of governments will attend a G-20 meeting.

A number of economist and other leaders are hoping specific policy proposals will be discussed at this meeting, but the expectations for what can and will be accomplished in the next 24 hours are relatively low.

The last-minute nature of the meeting allowed for little preparation time. The meeting itself is also relatively short.

“I would be surprised if much happens,” said Edwin M. Truman, a senior fellow at the Peterson Institute who served as the assistant secretary of the Treasury for international affairs during the founding of the G-20. “When you think about it, it’s 20 people, and they’re all heads of government. They’ll meet tonight for dinner, informally, and then they’ll meet tomorrow for just five hours. That’s not a lot of time for everyone to talk.”

There is only so much that attendees at this event can commit to, anyway, since any major policy changes will likely have to be approved by leaders’ full governments back home. President Bush — as an outgoing president — would have an especially hard time committing to anything substantial. (Former Secretary of State Madeleine K. Albright, and former Representative Jim Leach will meet with representatives of G-20 nations on President-elect Barack Obama’s behalf this weekend.)

The smaller G-7 and G-8 have memberships of only the largest economies, which exclude, China, Brazil, India and Russia, to name a few, and there has been strong criticism leveled at these groups because they exclude far too many of the world’s economic powerhouses. Most would agree with this criticism, and for this reason, and bolstered by the enormous growth of the emerging countries, the G-20 will probably assume a much larger role in the future in discussions of global economic issues. We may be seeing the first emergence of this new role in today’s meeting.

I look for much more substance from the second meeting than this one, but this one is important as a necessary first step.

Economy: It's Worse Than We Think

The evidence is mounting that the American economic downturn is going to be much worse than generally thought. A downturn that was thought to see unemployment at 8%, which is a recession level, is seen now to have an easy potential of 9% or 10%--levels not seen for decades--a deep recession.

Here are the culprits:

• Falling home prices are not showing signs of stopping. This quotation from the AP sets the latest news:

The number of homeowners caught in the wave of foreclosures in October grew 25 percent nationally over the same month in 2007, data released Thursday showed.More than 279,500 U.S. homes received at least one foreclosure-related notice in October, an increase of 5 percent over September, according to RealtyTrac Inc. One in every 452 housing units received a foreclosure filing, such as a default notice, auction sale notice or bank repossession.

More than 84,000 properties were repossessed in October, RealtyTrac said.

A nasty brew of strict lending standards, falling home values and a tough economy is filtering through the housing market. By the end of the year, the company expects more than a million bank-owned properties to have piled up on the market, representing around a third of all properties for sale in the U.S.

The problem with home foreclosures is that once the mortgagee takes them over, the prices falls much more than if the home had been sold while occupied. Repossessed homes tend to sit vacant for longer, deteriorating and bringing down the entire neighborhood as they fall further into to disrepair. This puts pressures on all the other homes in the neighborhood, making it more likely that other owners will walk away from their mortgages which may be twice the current market value. It is a vicious cycle, and once started, it spirals quickly down.

• Lending standards have tightened to the extent that many consumers can no longer get automobile or furniture loans. This is pushing General Motors, Ford and Chrysler into bankruptcy, imperiling over three million jobs in the process.
• Rising unemployment is sapping the spirit and incomes from ten million Americans right now. This has a tremendous effect on the morale of everyone they know and everywhere they live. Unemployment is a killer for spending plans. Those unemployed tend to pull back significantly on their spending, and their gloom spreads to their friends and relatives. It is contagious and destructive and will kill consumer spending which has, for the last five to ten years, been the mainstay of the American economy. An AP report released today (11/13) shows the extent of new jobless claims:

The number of newly laid-off individuals seeking unemployment benefits has jumped to a seven-year high, the government said Thursday.

The Labor Department reported that jobless claims last week increased by 32,000 to a seasonally adjusted 516,000. That is the highest total since just after the Sept. 11 terrorist attacks and second-highest since 1992.

The total was much higher than analysts expected. Wall Street economists surveyed by Thomson Reuters expected claims to increase only slightly to 484,000.

The four-week average of claims, which smooths out fluctuations, rose by 13,250 to 491,000, the highest tally in over 17 years.

Thursday's figure is the first time claims have topped 500,000 during the current economic slowdown. Jobless claims above 400,000 are considered a sign of recession. A year ago, claims stood at 338,000.

• Falling economies around the world. As the world’s economies fall into below-trend growth, their spending slows down. The buy fewer airline tickets, fewer American cars, less software, and less American wheat. America does import much more than we export. But, we still export a lot, and many jobs depend on them.

the Commerce Department said the trade deficit declined by a bigger-than-expected amount in September, falling by 4.4 percent to $56.5 billion as imports experienced a record plunge.

The import decline was led by a huge fall in imported oil as the average price for crude dropped by a record $12.41 per barrel and the volume of shipments fell to the lowest level in five years. But demand for other types of imports also fell, with imported cars and car parts dropping to the lowest level in more than five years, an indication that foreign automakers are feeling the pinch hitting U.S. consumers.

The feedback loop in this kind of international recession is horrible. U.S. and European economies enter into recession. This feeds back to the emerging markets as a lower demand for their products, thus inducing recession in their economies. The recession there reduces demand in the U.S. and Europe for things they make: airplanes, large computer, computer software, agricultural commodities, etc. This further reduces employment in the U.S. and Europe, etc., etc.

It will take a Herculean effort by all the world’s economies to break this cycle. There is a meeting beginning the 15^th in Washington of the G-20, approximately the 20 largest economies in the world, and they will attempt to address the problem. Probably not much will come of the first meeting since American leadership is in a transition stage that won’t formally begin until January 20. But a second meeting will most likely be agreed to, and at the second one I would expect much better results of a comprehensive and coordinated efforts to bring the world recession under control.

For a more detailed look at this meeting, see my recent article @ http://seekingalpha.com/article/105737-the-g-20-sings-a-song-of-sixpence

Pictures of an Employment Crisis

The five graphs below show with stunning visibility how bad the economy is today. Chart 1 shows changes in nonfarm employment from 1990 through the end of October, 2008.  You can see the dramatic drop of 240,000 jobs lost last month in this graph. Also shown are the relative lengths of the last two recessions: the 1991 drop was relatively short, lasting about one year. The 2001-02 recession was much longer and less well defined than previous recessions.  There was an increase in jobs shortly after 2002, only to plunge back into the red again in 2003.

This graph also shows the anemic recovery that followed. Note that the job creations shown in the space above the zero line after 2003 were well below those of the earlier recovery. We never made a full recovery from the 01-02 recession.

Chart 1: Change in Nonfarm Employment

All data from Bureau of Labor Statistics: Graphs from NY Times

Chart 2, below, shows the overall unemployment rate over the same period. Again, the recovery during the early period of President Clinton’s Presidency showed a rapid recovery—seen by the falling unemployment rate to a low of around 4% when he left office. Beginning in 2001 the unemployment rate increased 2003.  After 2003 a fairly good recovery began and lasted from 2004 until 2007. At that point, things began getting bad again. What was an anemic recovery quickly gave way to a more serious downturn, which we are just beginning to experience.

Chart 2: Unemployment Rate

Chart 3 shows the unemployment rate among different ethnic groups. Blacks have always had a higher unemployment rate than whites, and since the Department of Labor began keeping track of unemployment by ethnic groups, Hispanics have traditionally been lower than Blacks and higher than Whites. Also, once Asians were tracked, their rates of unemployment have more closely mirrored that of Whites. All groups, however, are suffering with the current downturn.

Chart 3: Unemployment by Ethnic Group

Chart 4 shows that the unemployment crisis also affects those who keep working. The number of part-time workers who want full-time work rises dramatically once the unemployment rate begins climbing. This reflects the reality that many full-time workers are effective in getting only part-time work during the down-turn.

Chart 4: Part-Time Workers who want full-time work

This is a hidden cost of unemployment, since these workers don’t show up on the unemployment statistics or unemployment benefits program.

Chart 5: Real Weekly Wages

Chart 5 shows the effects of unemployment in terms of the general wage level of all workers. The real wage is the dollar wage per week adjusted for inflation, showing that even those who continue working in a downturn often end up getting behind the inflation curve.  During recession they work for less purchasing power than when the economy was sound.

It doesn’t look good for the coming months. Many respected economists predict that the unemployment rate could reach eight percent before it begins getting better. You can surmise from these charts, that this will be especially hard on the minority populations.  They will work less than they want and for real wages below what they need.

This is not a pretty picture, and it points to the need for a significant stimulus program that will directly create jobs. In a nation that needs to rebuild its infrastructure after decades of neglect, there will be plenty of men and women willing to work on such projects. Job creation, in my view, will be much more effective in easing the pain of unemployment than stimulus checks. Those checks that were mailed earlier this year were not spent as freely as Congress had expected. During tough times, when jobs are harder to get and hold, the fear factor enters the equation.  Stimulus checks given at that time are often hoarded rather than spent. 

The details of a new stimulus package will soon be discussed in Congress and the White House.  We should forget about trying to balance the budget, and go with a huge public works program.  The nation is in need, and quick and powerful action is necessary to bring us out of this trying period. 

China Shows Signs of Slowing

After years of hyper growth, averaging close to 10% a year, the great engine of growth that is China, is faltering. A series of government reports released over the last few weeks indicated that China’s exports are moderating. Real estate construction projects are being suspended. Consumer confidence is in decline. And many factories in southern China are closing, putting tens of thousands of migrant laborers out of work. Another sign, orders for Christmas from the Western nations, were down 20 percent this year. Big retailers and toy marketers are gloomy about the upcoming holiday season sales.

Newly released data suggests that nearly every sector of the economy is slowing and credit is tightening. While few economists expect China to fall into recession, analysts are forecasting the worst growth in more than a decade, with the economy expected to expand by as little as 5.8 percent in the fourth quarter this year, down from about 11 percent in 2007.

5.8 percent growth would be welcomed in any of the developed nations today; most all of the west is looking at declines in GDP for 2009. But for China, a moderation of this magnitude, spells trouble. China’s huge population is still largely rural, with hundreds of millions of farm laborers still stuck in medieval farming methods. The high growth generated over the last ten to twenty years in China has been the ticket for millions of these folk to make their way to the cities and find work in the burgeoning factories that lead China’s export industry.

A slowdown of the growth rate raises fears of political unrest within the Communist Party, so they are taking strong steps to keep the growth rate as high as possible. The government is preparing a large economic stimulus package, pushing new infrastructure projects, offering aid to exporters and searching for ways to prop up the nation’s severely depressed stock and real estate markets.

Domestically, there are also signs of a slowdown: Auto sales have plummeted this year. Air travel is in decline. Property sales have dried up, and weakness in the property market is hitting the makers of steel, cement and glass. “There is a nose dive in real estate construction in south China and east China, the two real estate boom areas,” said Yang Dongsen, a cement industry analyst at Merchant Securities. The real estate slowdown is expected to affect retail sales, which for the last few years had been lifted by new-home buyers purchasing appliances, decorations and other household goods.

It does not help that China’s stock markets have also collapsed, after a stunning rise in 2006 and 2007. Share prices in Hong Kong are down about 50 percent, and the Shanghai composite index has fallen 67 percent this year, wiping out nearly all the gains it had made in the previous two years.

These data do not necessarily spell doom for China’s growth, but they do point to a period of economic adjustment that they must navigate. The west and the east are, to a large degree, joined. They depend on us for demand for their factories, and we depend on them for supplying us with inexpensive goods. The developing markets in Latin America are, themselves, dependent on China for purchasing their raw commodities, such as iron ore and petroleum. The downturn in Europe, Latin America and America is too severe not to be felt in the China. As much as they would like to be insulated from our economic problems, the interdependence is unavoidable. It will probably be some time before China will be worried about inflation and growth that is too fast.

What Currencies are overvalued and Which under Valued

From our friends at Economy.com we learn of a new international currency comparator: The IPod inedx.  From their table below Australia, Indonesia, Canada, and Korea are selling the IPod for less than $140.  Argentiana, Brazil and Russia over over $250.  This index gives you a good indicator  of which currencies may decline in the future and which are more likely to rise.

>Just what we needed: A way to track shifts in global purchasing power that fits in your pocket. And is less greasy & caloric than the alternative...

Australia is the cheapest place in the globe to buy an Apple iPod, highlighting just how far the currency has plunged since July. The CommSec iPod index shows that Australia is the cheapest place of 62 countries to buy an Apple iPod 8gb nano music player when measured in US dollar terms.

The value of the iPod index is to highlight implications of currency changes and country relativities.

In other words, it's an update of The Economist's Big Mac Index. If you're clueless, all it takes is a common good or service that's sold in identical form the world over. The local price is simply converted to a common currency (typically U.S. dollars, though I wonder for how long?) and you can see who's living how high, in relative terms. Pretty neat.<

Perhaps this is a little better than the Big Mac Index.  It's more currency, and it reflects relative currency valuation more precisely than the Big Mac.  After all, the Big Mac takes a lot of locally prices labor and vegetable prices, as well as local rents.  The IPod is made in America and shipped, whole, to each country where it is sold.  To me, this makes it a more pure reflection of local currency value.

The Thin Line Between Recession and Deflation

There is no longer any debate about the U.S. entering a period of a declining economy.  Everyone who watches the leading indicators had been expecting a recession since the beginning of the year.  Finally, in the third quarter, it came.

Nor is there any debate about the global slowdown.  It's not that the United States controls the rest of the world.  It's just that the same things that have pushed us into recession are also affecting the rest of the world: overextended credit based on loose credit standards, and a growth spurt based on the loose standards.  As is almost always the case, growth spurts go too far, too fast, and have to be brought back to earth and consolidate before taking off again.  I think it will be some time before the emerging markets take off again, but they will, eventually.  Just not any time soon.  This is also true of the United States and Europe.  We will resume our growth, eventually.   But there is going to be some time before we are ready to sustain more growth.

And therein lies a problem.  With everyone declining at the same time, we can go too far to the downside and experience deflation--a spiral to the downside that frightens economists.  Depression, which is the companion of deflation, is not something anyone who knows would want to see.  There is nothing uplifting about suffering for years, where entire economies collapse under the weight of falling demand, falling employment and falling production.  Recessions are a necessary adjustment to a period of excess.  Depressions are not necessary, but they can happen if the economy isn't handled well.

A recession could see unemployment in the U.S., for example, reach 7% or 8%.  A depression could see 25%.  There is no comparison, though, between this set of numbers.  The level of suffering under a depression is much more than, say seven multiplied by three or four (7% x 3 = 21%).  From depression come revolutions and war, as scape-goats are sought and found.  Demagoguery rules when things look hopeless, and those afflicted by unemployment and despair are easily swayed into despotic politics. It happened in post WWI Germany, when the onerous provision of the Treaty of Paris pushed Germany into the arms of Adolph Hitler.  It has happened in Argentina where bad conditions led to the fascism of Juan Perón.  This specter could easily be duplicated in many of the emerging markets if things get bad.  The democracies in South East Asia, for example, are too fragile to handle a period of major deflation.

These conditions make it exceptionally important that the American, Japanese and European economies be handled properly during the downturn.  The burden falls on these three regions because it is demand from the large economies that drive production and growth in the smaller ones.  During this time we cannot look for strictly balanced budgets.  Deficit spending, if done on public projects that are needed and useful (roads, bridges, schools, etc.), can go a long way in reducing the ill effects of unemployment and help keep consumer spending up.  Longer unemployment benefits, veteran help for college and home loans are other measures that were especially effective after WWII that saw the return of more than a million soldiers and sailors to the economy.

We will have our hands full for most of 2009.  Most of the predictions I see point to a possible end of the recession by the third quarter of next year--if things go well.  One thing about deflation: it can be stopped by printing enough money.  But, the balance between enough and too much is sometimes hard to find.  And that task, in my view, will be the defining test of our next President.  Go too far, and we have hyper inflation, which, in its own way, is as bad as deflation.  Not go far enough, and we have deflation and depression.  It's a thin line between these poles.  I hope for a wise President and an equally wise Congress to keep the proper balance on this line. 

Even though there will be plenty of skeptics who think "wise President" and "wise Congress" are oxymoron terms, I disagree.  There are times when it appears that way, but I think when things get bad, there is a tendency of Americans to pull together.  We will certainly have this test to pass in the coming year. 

Things Got Bad and Things Got Worse

It's Friday, October 31st, and things just got worse for Senator McCain.  In the major tracking polls, he has not been over 45% for three weeks, and over the last three days, while his assault on Senator Obama has intensified, he has not budged in the polls.  At a time when he needed a breakthrough, he has been mired in his own mud and stuck in place.

Mr. McCain goes into the campaign's final weekend a bigger underdog than any victorious candidate in a modern election.  And with the economic news consistently going against him, it doesn't look good.

A Bloomberg article frames the facts: "With four days until Election Day, national polls show his Democratic rival Barack Obama leading by an average of 6 percentage points, and battleground polls show Obama ahead in more than enough states to win the decisive 270 Electoral College votes.

'There will not be a comeback curmudgeon by the name of John McCain,'' Kenneth Duberstein, who served as a chief of staff for President Ronald Reagan, said on Bloomberg Television's ``Conversations with Judy Woodruff,'' which will air later today. ``I think it's going to be Barack Obama. And I think it is going to be somewhere between 320 and 350 electoral votes.' "

Polls have been wrong before, of course, but modern polling has consistently gotten better.  And with the advantage as high as it is for Mr. Obama, there appears to be little hope for the Senator from Arizona.

If the election goes as it looks, with not only Mr. Obama taking the Presidency, but also with expanded majorities in the House and Senate, then the new administration will at least begin next year with a mandate to make some major changes.  If there has been one theme in this election that has worked, it has been that of change.  Almost 90% of Americans believe the U.S. is on the wrong track, so they appear to be ready for a change.

My hope, if Mr. Obama wins, is that the change will get us back on track and allow America to recover its place as a world leader, not only in military might and economic strength, but in moral leadership as well.  I am not convinced that Americans have abandoned their commitments to democracy, equality and fairness--those qualities that have served as a beacon of hope to the rest of the world during my lifetime.  This leadership has been squandered over the last decade by corrupt and foolish political and business leaders.  It's asking a lot of a single election to correct this huge a problem, but my hope is that it will at least start to reverse the process that has gotten us into this mess.

3rd Quarter GDP Goes Negative

We now have confirmation that the U.S. is beginning a recession.  Reuters reports: >

The economy shrank at a 0.3 percent annual rate in the third quarter, its sharpest contraction in seven years as consumers cut spending and businesses reduced investment in the face of rising fears that recession was setting in.

The Commerce Department said the third-quarter contraction in gross domestic product was the steepest since the corresponding quarter in 2001 though it was slightly less than the 0.5 percent rate of reduction that Wall Street economists surveyed by Reuters had forecast.>

The culprit was what all of us expected: consumer spending, which has propped up GDP growth for the last few years, finally succumbed to higher oil prices, lower home prices, and the shut-off of the second mortgage spigot that had fueled the borrowing binge of the last few years.

>Consumer spending, which fuels two-thirds of economic growth, fell at a 3.1 percent rate in the third quarter — the first cut in quarterly spending since the closing quarter of 1991 and the biggest since the second quarter of 1980. Spending on nondurable goods — items like food and paper products — dropped at the sharpest rate since late 1950.

Continuing job losses coupled with declining gains from stocks and other investments have put consumers under severe stress. The report showed that disposable personal income dropped at an 8.7 percent rate in the third quarter — the steepest since quarterly records on this component were started in 1947 — after rising 11.9 percent in the second quarter when most of economic stimulus payments still were flowing.

Consumers cut spending on durable goods like cars and furniture at a 14.1 percent annual rate in the third quarter, the biggest cut in this category of spending since the beginning of 1987. Car dealers have said that sales have virtually stalled, in part because tight credit makes it hard for even creditworthy buyers to get loans.<

These are not good numbers, and point to a protracted downturn.  If there is some kind of symmetry in business cycles, then the seven years of credit boom would be followed by seven years of credit bust.  I hope it won't be that way, and there will certainly be efforts by our political establishment to crank out another stimulus package, soon.  There is already one on the table in Congress, and it is hard to see that it will not be passed.

The statistical evidence that stimulus works is quite high, so that is good news.  The economy desperately needs a shot in the arm.  But, whether it will be enough to turn things around and stay turned around, is another question.  It is unlikely to be large enough to make a miracle, and that is what is needed for now.  But it looks as if there could be several quarters of decline, putting the recovery at or beyond June of 2009.  And that's the best outlook. It may be even worse, but I think there will be a Herculean effort from our new president to shorten the cycle once he takes office in late January.

Effects of Another Stimulus Package

Looks like we're in for another round of fiscal stimulus. (Does stimulus come in rounds? Just asking...) Anyway, Menzie Chinn at the venerable Econobrowser blog revisits Mark Z.'s Congressional testimony from last summer, wherein he rated the relative oomph of various legislative stimuli. (Also available in this Dismal Scientist article .)

Chinn avers:

Onebig caveat to the argument for infrastructure spending is that it usually takes a long time to plan such projects. Hence, it is not clear when the spending for such projects would actually occur, and hence the stimulus to the economy (this is called an outside policy lag, in the jargon). The "one-year horizon" shown in the table is for the horizon of one year from beginning of spending, not the beginning of planning and appropriation.

I have two observations here. First, if the spending could be directed to the states which had construction about to start, but hindered by financing or state revenue issues, then the problem of timing could be partly mitigated. I admit that it is unlikely that there are a tremendous number of such projects (although I am happy to be corrected). That leads me to my second observation.

The CBO study Options for Responding to Short-Term Economic Weakness (January 2008) laid out three principles for effective stimulus, loosely characterized as "timely, targetted, and temporary". Spending on infrastructure is problematic on this first count if one believes the recession will be short. If one believes that it will be prolonged (in the now outdated lingo, "L-shaped" instead of "V-shaped"), then this drawback is not so significant.

Rise of Japanese Yen May Bring Retaliation

From the NY Times: <Currency market traders were keeping nervous watch for central bank intervention, after Group of 7 finance and monetary officials expressed concern about the recent excessive volatility in the yen’s exchange rates.

“We are concerned about the recent excessive volatility in the exchange rate of the yen and its possible adverse implications for economic and financial stability,” the G-7 statement said. “We continue to monitor markets closely and cooperate as appropriate.”>

If intervention were carried out, central bankers would likely sell yen for other currencies, driving down the yen and providing support to other currencies.

Although I am bullish on the yen over a long period, it does look as if its rise in value has been to fast for too long, so be prepared for a downturn of some duration.

<Shoichi Nakagawa, the Japanese finance minister, said he was watching the currency market with great interest. His comments were read in the market as a warning of possible intervention in the currency markets. The yen’s appreciation to alarming heights against other key currencies, to the detriment of exporters, who are seeing their international competitiveness eroded as a result. >

If this program is carried out, look for the exchange traded fund, UUP, to rise dramatically.  This ETF is long on the U.S. dollar and short on the yen and other developed market currencies.  A dramatic fall in the yen plays into this short position.

However, in a late development: French Finance Minister Christine Lagarde said the Group of Seven nations doesn't plan to intervene to sell the yen after warning today against the currency's ``excessive volatility.''

``The yen has over the past 48 hours seen brutal trading that reflects a great volatility that's linked to current market moves,'' Lagarde said in an interview with Bloomberg News in Montpellier, France. ``We wished to support this possible intervention of Japanese authorities knowing this would be about a purely Japanese intervention.''

Asked specifically if the G-7 would intervene to sell the yen, after it rose to its highest in almost 13 years against the dollar, Lagarde said ``no.''

Japan, however, will probably enter the market to keep the rise in check. This may be enough to satisfy the G7 members, and allow them to keep out of the market.

Opportunity in the Currency Market Turmoil

If you think that the American equities markets have been hit hard lately, take a look at some of the emerging markets. The graph below charts the last six months of the Dow Jones Industrial Average, the iShares ETF, EEM, which tracks emerging markets around the world, and EWY, the South Korean ETF from iShares. Many emerging markets have fallen 60% or more over this period. 

Their currencies have also taken a significant hit. The chart below shows the U.S. dollar as measured against developed market currencies over the same period, with EEM and JEM, a basket of emerging market currencies in Asia, Latin America, Europe, the Middle East and Africa.

While the currency hit has been only about a 25% loss, it is about a 45% difference with the U.S. dollar. Also shown are the Mexican peso (FXM) and the Brazilian real (BZF), to show how similar the currency drops have been for all emerging markets. However you look at it, it has been a grim picture.

There are a couple of driving forces that explain the reaction of investors. The first is that everyone is concerned that the slowdown in America and European economies will disproportional affect emerging markets, since the western nations buy much of all EM goods. During a downturn, demand for many of the goodies the EM countries produce will fall, and their export trade, which largely drives their economies, will falter.

A second reason is an extension of this phenomenon. Hedge Funds have been particularly large investors in the EM economies over the last decade. And, their investments have covered the complete range of securities: currency holdings, equities investments and their sovereign debt. But, now that the party is over, the Hedge funds are having to pony up on margin. This leads them to dump much, if not all, they bought. This is exacerbating the downturn, just when it is hurts the most. Isn’t that always how it goes?

During this huge sell-off, two currencies have become safe haven plays: the U.S. dollar and the Japanese yen. The number one and two economies in the world, regardless of how bad it looks, are still the safest places to put one’s confidence—or at least that is what the financial markets around the world are telling us.

This concentration of trends does, however, bring with it a potential upside.

• Given the serious decline in currency prices in the emerging markets, and
• Given that most all of them have financed much of their expansion of export production capacity with debt, and
•   Given that much of that debt is owed to the U.S., Japan and western Europe,
• Therefore, the banks and Treasuries of all the lending countries are getting antsy about being repaid.

Debt repayment by the EM countries is partially impaired by their falling economies. That is to be expected, because economic downturns are always expected after a period of rapid expansion. But, the problem is made much worse by the fact that their currencies are falling at the same time. Much of the debt they owe is denominated in dollars, so they now have a double whammy to face. Their revenues are falling because of their shrinking production, and their currencies are depreciating at the same time that the U.S. dollar and yen are increasing. Now, they have twice to three times as much problem in repaying their debt.

Lenders are quite upset. But, the lenders (large banks) have the ears of their respective governments, and no one in any government want more bad news to capture the headlines of the financial pages. They are working as hard as they can to contain the carnage that has already been unleashed. If they add defaults of some of the major EM countries to the list, it would set off a new round of tumbling confidence and stock prices.

Therefore, there is a move afoot to help the EM countries by a coordinated effort of the developed nations to enter the foreign exchange markets and buy EM currencies—helping prop them up, at least until things settle down a bit. If this rescue effort comes about, then look for EM currencies to have a good bump. ETNs such as JEM would benefit, as would individual currencies such as Brazil, Mexico, South Africa, Russia, etc..

This is far from a done deal, and any monies put into this type of speculation would be an usual risk. The deal may not come off, and their currencies could continue their decline. If there is intervention, then I would take a short term view of the improvements in currency prices, and have a strong idea of when to get out. For those with a strong risk appetite, this may be a good place to look.

I'm still bullish on the Dollar (UUP) and the Yen (FXY), and I consider these currency plays to be much less risky than betting on an intervention in the EM currencies.

Economic Outlook is Dismal

Housing Market

The number of homeowners ensnared in the foreclosure crisis grew by more than 70 percent in the third quarter of this year compared with the same period in 2007, according to data released Thursday.
Nationwide, nearly 766,000 homes received at least one foreclosure-related notice from July through September, up 71 percent from a year earlier, said foreclosure listing service RealtyTrac Inc.

By the end of the year, RealtyTrac expects more than a million bank-owned properties to have piled up on the market, representing around a third of all properties for sale in the U.S.

Six states — California, Florida, Arizona, Ohio, Michigan and Nevada — accounted for more than 60 percent of all foreclosure activity in the quarter, with California alone making up more than a quarter of all U.S. foreclosure filings.

Last month, foreclosure resales accounted for more than half of existing home sales in California last month, as home sales jumped 65 percent from a year ago, while the statewide median home price fell 34 percent to $283,000, according to MDA DataQuick.

Alan Greenspan's Testimony (From NY Times)

Alan Greenspan, the former Federal Reserve chairman, said Thursday that the current financial crisis had uncovered a flaw in how the free market system works that had shocked him.

Mr. Greenspan told the House Oversight Committee on Thursday that his belief that banks would be more prudent in their lending practices because of the need to protect their stockholders had proved to be wrong.

Mr. Greenspan said he had made a “mistake” in believing that banks operating in their self-interest would be enough to protect their shareholders and the equity in their institutions.

Mr. Greenspan said that he had found “a flaw in the model that I perceived is the critical functioning structure that defines how the world works.”

China's Growth in Question

BEIJING — For three decades, China has fueled its remarkable economic rise by becoming the world’s workshop and unleashing a flood of low-priced exports. But faced with a possible global recession and weakening demand for Chinese exports, the question now is whether the ruling Communist Party can prevent the financial crisis from derailing the country’s economic miracle.

This question is pressing not just for China but also for the rest of the world. American officials and many economists say continued Chinese growth is vital to the global economy as the United States and Europe face severe downturns.

Yet to navigate the crisis, many analysts say, China will need to recalibrate its economic model, stoke domestic investment with heavy government spending and promote policies to increase consumer demand in a nation known for high savings rates.

At the geopolitical level, China would seem well positioned to expand its influence. It sits on $1.9 trillion in foreign exchange reserves, accumulated from giant trade surpluses and heavy foreign investment in China, and it could acquire discounted stakes in Western banks and industrial companies.

But for now, most analysts say China’s top priority is protecting its own economy. Chinese leaders say the domestic financial system is largely insulated from the global crisis — China’s banks remain domestically focused and have relatively small exposure to toxic securities sold by American and European banks. But economic growth has fallen to the lowest level in five years, unemployment is a growing concern, and scores of factories are closing in the country’s export region. Domestic stock exchanges have lost 65 percent of their value, and real estate sales have plummeted.

China still seems likely to avoid an outright recession, but a significantly slower growth would pose a political challenge for the Communist Party, which derives much of its legitimacy from delivering jobs and increasing wealth. Conventional wisdom holds that China’s output must grow at a minimum of 8 percent for the economy to produce enough jobs to absorb increases in the working-age population, and many economists expect growth to drop below that level next year.

Housing Starts Hurting

Back and Forth on Housing Starts

Economic hard times inspire two contradictory responses. One is to simply to want it to stop hurting. The other is to want the system purged and cleansed, at whatever up-front cost. The two are not mutually exclusive; indeed it's quite common to wish for each in turn, or even simoultaneously. But they point in opposite directions, and underly pretty much all the debate we're hearing among economists, policymakers and talk-show guests—such as this one .

Sorting them out, however, is necessary before you can intepret news such as today's about U.S. homebuilding. From Aaron Smith:

Builders slashed housing starts and residential building permits in September to their lowest level since early 1991 as they worked to realign supply and demand. Housing starts dropped 6.3% to an annual rate of 817,000 units, and permits fell 8.3% to an annualized pace of 786,000 units. The rate of decline in homebuilding has clearly intensified: Housing starts over the past three months have contracted at a 68.3% annualized rate, the worst such reading since March 1980.

You can see this as disastrous, an economic train wreck. All those lost housing jobs, all that idle investment in land, lumber and equipment. The ripple effects—on employment, retail sales, overall growth—will be severe. Somebody—like maybe a presidential candidate?—should propose a plan to boost housing construction and save the economy.

Or not. As Aaron also writes:

Although significant progress has been made in lowering the supply of new homes to a level more consistent with the current low demand, we think further cutbacks in homebuilding will be forthcoming to more quickly draw down inventories.

Progress? Yes. Remember that what ails the economy—the financial side of it, at least—stems from the plunge in house prices that followed the end of the recent bubble. Rising defaults, underwater mortgages, frozen securities markets and the global banking crisis all began there. Any recovery, therefore, depends on house prices stabilizing. But house prices can't stabilize if builders keep pumping inventory into an already glutted market. Something's got to give. And the faster and deeper it gives, the sooner we can begin to climb out of this hole.

Let me amend that. The faster and deeper it gives, up to a certain point. That being the point at which all those lost construction jobs and all that idle investment is enough to sink demand for new houses, so that even as prices plummet and "affordability" rises in some technical sense, it still doesn't revive the economy.

At which point we abandon all talk about system-cleansing, and just hope someone can make it stop hurting.

Andrew Cassel in West Chester on October 17 at 11:45 AM 

Small Men in Big Jobs

October 11, 2008
I don’t know if the market turmoil of last week marks the end of the financial crisis. But I do know that the crisis has changed the very nature of financial markets for far into the future. All over the world, the “hands off” approach to financial markets is being abandoned as quickly as it was adopted decades ago. The hype and certainty of the “let the markets be markets” mentality is now recognized as silly and irresponsible, as the life savings of millions of innocent investors have been wiped out or severely reduced, and the world’s financial system teeters under threat of collapse. An orgy of irresponsible risk-taking by our financial and political leaders has shown them to be small men in big jobs.

We now find ourselves in a strange, upside down universe, where the lead role of socializing the financial system in America is being led by a President who just weeks ago was touting the benefits of deregulation and singing the praises of neglectful capitalism. All the followers of the Reagan Revolution, it seems, are now counter-revolutionaries, looking in every quadrant for targets of their finger pointing—everywhere but where it belongs—right at themselves.

Fortunately, the American people, while fooled then, aren’t now. We get it that our welfare is too important to abandon to the greedy gyrations of unfettered financial markets. We knew it in the 1930’s, but, after decades of successful regulation, we forgot what got us there.

We need to turn the corner, and, if the polls are correct, voters will set this straight in a few weeks. There will be pain ahead, but we will recover. Americans can rise to the occasion, and the occasion is now.

Latest Articles by Ray

Do Currencies Belong in Your Portfolio

Whether you know it or not, you are probably investing in foreign currencies now. If you own an ETF or mutual fund in any international equity or fixed income product, you are taking a currency risk. It’s not an indirect risk; it’s as direct as it gets. Foreign holdings are priced in their native currencies, and every price movement is captured in the dollar denominated net asset value [NAV].
Even if you sell your foreign assets and invest only in American firms, you do not escape exposure. On average, large American firms do about 30% of their business in the international sphere. Their profits are immediately affected by movements in the currency markets. You can’t escape currency risks, but you can be aware of them, and you can do something to accommodate them.
The first line of defense against unhealthy currency risks is to make sure your portfolio is fully diversified in its international holdings. This spreads your currency exposure as widely as possible. Just as in stocks and bonds, where diversity is of utmost importance, the same applies to currencies and all other asset classes you own.
For many investors, just making sure your international holdings are well diversified is probably enough to reduce the currency risks to an acceptable level. But, you may want to add additional currencies to your portfolio, because there are substantial benefits derived from doing so. The most widely acknowledged benefit is the low correlation that currencies have with virtually all other classes. This feature of currenices is unique in its level of non-correlation. Other asset classes claim to be of low correlation (real estate, bonds, emerging markets for example), but when the correlations are quantified, currencies stand far above all others.
Just ask yourself, since early November of 2007 when equity markets began their slide, wouldn’t it have been great to have assets in your portfolio that actually increased in value over the period? Wouldn’t that help you keep on course for achieving your financial goals? It’s easy to talk “buy and hold,” but it isn’t so easy to actually stick to your guns when your investments drop by 20% or 30% in a steep market slide. This kind of market sends investors panicking to the sell window just when they should be standing fast.
Currency investing may provide just the cushion you need during rough periods, helping you to stay the course. And staying in the game is what it’s all about; you can’t win if you don’t play. If you panic and sell during the lowest periods, then you will be buying back at higher prices later - buying high and selling low - not what the doctor ordered.
If you decide to take a second step and buy currencies directly, you will discover some of the other properties of Forex (Foreign Exchange Currency) trading: first, currencies may actually make money for you by appreciating in price, and secondly, you will earn interest on your foreign currency holdings.
In Forex trading, a strategy that seeks to buy currencies that are expected to rise in price is called a “value strategy,” and it’s no different than your expectations that some equities are undervalued. If your analysis tells you that the Chinese Yuan, for example, is undervalued, then buy the Yuan. It’s available in an ETF (CYB) (from WisdomTree) or in an ETN (CNY) (from Van Eck/Morgan Stanley). If you are right, you’ll profit from the Yuan’s rise. If not, you will at least experience the second benefit from owning a foreign currency - you will earn interest on your investment. This comes about because the banks that hold the currency you bought use your investment deposit to purchase commercial and government-issued short-term interest bearing investments.
So, while you are technically holding currency, you are actually holding short-term debt obligations denominated in the currency you bought. When the debt instrument matures, the interest owed is paid and passed on to you. With the Yuan and most other emerging market currencies, where it’s often difficult to find local short-term deposit possibilities, the fund managers use futures contracts that accomplish roughly the same thing - you profit from receiving the differential between the spot price and the forward contract price. Either way, you earn something on your holdings.
This feature of earning interest on the currency you own is a significant strategy for making money on foreign exchange investments. It’s called the “carry trade,” and is responsible for trillions of dollars of currency trading. But, it is also possible you may incur a loss if the price of your currency falls during the time you were earning interest. This possibility makes holding foreign currencies different from holding U.S. dollars in a money market account. Money market funds are managed to keep a constant value - not difficult since there is no chance of the dollar falling in dollar value.
But when your money crosses an international border, the currency risk raises its head. This is a good reason not to engage in the carry trade - you might lose. Although currencies usually have lower volatility than equities, there are still risks. You must be comfortable that you want to take the risks and that you can afford the potential losses that may result from currency investing.
Once you have decided to allocate an appropriate amount to currencies in your portfolio, then the fun begins. Now you can choose among all the currencies available for trading, and the list is getting longer every month. This is a good thing, in my view, for not too long ago, if you wanted to hold Forex, you had to open a special trading account with one of the online trading brokers. It’s a fast-moving, wild and wooly environment, highly leveraged, where fortunes are made and lost on an hourly basis. This is not suitable for most investors, especially those who have lives outside the Forex arena.
Fortunately, a new kind of ETF and ETN has been recently introduced that allows an average individual investor to buy a fairly good range of currencies. There are currently about twelve pairs available, and additional pairs can be bought if you select one of the bundled exchange-traded products. Speaking of pairs, don’t be put-off by this terminology. In fact, one cannot speak of the dollar rising or falling without referencing another currency. The dollar can’t rise or fall in relation to itself; it can only change with respect to some other currency. Neither can any other currency. So, when you buy Mexican Pesos in the U.S., you are borrowing dollars from yourself and investing them in Pesos. You own a currency pair: U.S. Dollar/Mexican Peso. If you were in London and bought Pesos, your pair would be the Pound Sterling/Mexican Peso.
I’m going to post these lists in two groups: individual currency ETFs or ETNs, and bundled currencies of both formats.
Individual Currency Products:
Rydex Shares ETFs: Currencies: Australian Dollar (FXA), British Pound (FXB), Canadian Dollar (FXC), Euro (FXE), Japanese Yen (FXY), Mexican Peso (FXM), Swedish Krona (FXS) and Swiss Franc (FXF)
WisdomTree ETFs: Currencies: Euro (EU), Japanese Yen (JYF), Brazilian Real (BXF), Indian Rupee (ICN), New Zealand Dollar (BNZ), and South African Rand (SZR)
Barclays iPath ETNs: Currencies: Euro (EROS), British Pound (GBB), Japanese Yen (JYN)
Elements ETNs: Currencies: Australian Dollar (ADE), British Pound (EBG), Canadian Dollar (CUD), Euro (ERE), Swiss Franc (SZE)
Van Eck/Morgan Stanley ETNs: Currencies: Chinese Renminbi-Yuan (CNY), Indian Rupee (INR)
Bundled Currencies Product
PowerShares ETFs: Bundles: Group of 10 Carry Trade (DBV), U.S. Dollar UP (UUP), and U.S. Dollar Bearish (UDN)
Barclays ETNs: Barclays iPath Optimized Currency Carry (ICI), Barclays GEMS Index (JEM), Barclays Asian and Gulf Currency Revaluation Note (PGD).
In lieu of recommendations, let me leave you with disclosure on my current holdings: (BZF), (FXM), (JEM) and (UUP). If you will read through the currency posts I have made over the last year at Seeking Alpha, you will get a good idea of why I have chosen these products. But, I do not recommend others necessarily follow suit. My rationale is: the first two are individual carry trade holdings that pay high interest rates. The second two are bundles to give my portfolio more diversity and earn some interest; JEM holds fifteen emerging markets currencies and pays a good dividend. UUP holds the G10 currencies doubled up with leverage for the bullish dollar - strictly a value play.
I also keep tight limits on currencies as a percentage of my total portfolio. This year I have gradually allowed my allocation to be just under 15%. This is toward the high end of most recommendations. But this is a new area of investing, indeed, as all alternative asset classes are, and there is no consensus in the financial advisor community about it. Some don’t recommend any, some recommend more. Use your best judgment to keep the risks balanced and within your comfort zone.
You should support any decision you make with the full knowledge of the risks involved and a thorough investigation on your own about each possible investment. There are good reasons to own foreign currencies. There are also good reasons not to own them. Good luck!