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Friday, February 24, 2012

Mish's Global Economic Trend Analysis

Stockton California, Population 292,000, Takes Steps Toward Bankruptcy, City Manager Says
ECRI Sticks with Recession Call on CNBC; More than a Bit of an Exaggeration by Achuthan to Make His Call?
Fatally Flawed Approaches to the Budget Deficit and Taxes; Debt Will Swell Under 3 of 4 Republican Hopefuls' Tax Plans
Price of Oil Hits Record High in Euros and British Pounds; Oil Shock Coming; Nancy Pelosi Blames Speculators; What About Iran? Israeli Intelligence Concludes "No Iranian Nuclear Weapons Program"

Stockton California, Population 292,000, Takes Steps Toward Bankruptcy, City Manager Says

Posted: 24 Feb 2012 06:01 PM PST

Bondholders of Stockton, California debt are about to be punished as City Manager Takes Steps Toward Bankruptcy.

Stockton, California, may take the first steps toward becoming the most populous U.S. city to file for bankruptcy next week because of burdensome employee costs, excessive debt and bookkeeping errors that misrepresented accounts, city officials said today.

The Stockton City Council will meet Feb. 28 to consider a type of mediation that allows creditors to participate, the first move toward a Chapter 9 bankruptcy filing under a new state law. The council will also weigh suspending some payments on long-term debt of about $702 million, according to a 2010 financial statement.

"Somebody has to suffer and in this case the city manager has decided it should be the bondholders who suffer," Marc Levinson of the Sacramento-based law firm Orrick, Herrington & Sutcliffe LLP, which represents the city, said at a news briefing at Stockton's City Hall today.

Stockton, a farming center about 80 miles (130 kilometers) east of San Francisco, has fought to avert bankruptcy by shrinking its payroll, including a quarter of the roughly 425- member police force. At 292,000, the city has more than twice as many residents as Vallejo, California, which became a national symbol for distressed municipal finance in 2008 when it sought protection from creditors.

Stockton's council will be asked to reduce the current budget by $15 million because of newly uncovered accounting errors and fiscal mismanagement that have left the city almost broke, City Manager Bob Deis told reporters. To keep the city solvent through the end of the fiscal year June 30, the City Council will be asked to default on $2 million of debt payments owned to bond holders.

"Our employees and the citizens of Stockton who receive city services have borne the entire brunt of our restructuring efforts so far and now it's time for others to do the same," Deis said in a report to the council. "We can't 'grow our way' out of the problem and no amount of forward looking financial planning will properly fix it."

Deis said the city is facing a $20 million deficit in the next fiscal year. Expanded retiree health insurance commitments in the 1990s have left the city with a looming $450 million unfunded liability.

"Next year, we expect to pay more for retiree health insurance than for our current employees," Deis said, likening the promises to a "Ponzi scheme."

A state law backed by unions and passed last year in response to Vallejo's bankruptcy requires cities to work with a "neutral evaluator" for at least 60 days before seeking bankruptcy court protection. The process is similar to mediation and gives creditors a right to participate. It can be bypassed if the city declares a fiscal emergency, according to the law.

Entering the 60-day mediation process could cause a "run on the general fund" by vendors, bankruptcy attorney Lee R. Bogdanoff of Klee, Tuchin, Bogdanoff & Stern LLP, the firm that filed the biggest municipal U.S. bankruptcy on behalf of Jefferson County, Alabama, said today in a telephone interview.

Once again we see fraud and untenable union benefits at the heart of the problem. The bondholders should suffer, and so should the unions. Those contracts should be wiped out in bankruptcy.

I commend the actions of the city manager to not tax its citizens to death to meet ridiculous, probably fraudulent, union benefits that should never have been granted.

Chapter 9 bankruptcy was established to deal with these situations. Unions better get used to it, because more actions like this are coming.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

ECRI Sticks with Recession Call on CNBC; More than a Bit of an Exaggeration by Achuthan to Make His Call?

Posted: 24 Feb 2012 10:43 AM PST

ECRI's Lakshman Achuthan sticks with his recession call. This time his call is based on coincident indicators as the following video shows.

CNBC has an interesting feature where you can click on any snip of generated text and it will take you to that spot in the interview. However, do it a couple times and it hangs.

Here is the link to a complete transcript if interested: ECRI Sticks With Recession Call

More than a Bit of an Exaggeration by Achuthan

At one point Achuthan says "I want to be first on this. On the right-hand side of the chart, that's a 21-month low. It has not -- you haven't had a decline like that in the past 50 years without a recession following in short order, okay?"

Well - Not OK.

Annotations in Red by Mish.

The above chart, clipped straight from the CNBC video, was obviously prepared in advance (I have no problem with that). However, Achuthan's claim based on that chart is clearly preposterous.

I count three instances between 1990 and 2000 where ECRI coincident indicators flagged a recession by the methodology Achuthan cited.

I have numerous other problems historically with ECRI claims, including their alleged "perfect" track record. Please see A Look at ECRI's Recession Predicting Track Record for details.

This time, I happen to think Achuthan has very valid points. However, once again, Achuthan has a hard time articulating them in a purely factual manner in spite of the fact he is clearly bright and articulate.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Fatally Flawed Approaches to the Budget Deficit and Taxes; Debt Will Swell Under 3 of 4 Republican Hopefuls' Tax Plans

Posted: 24 Feb 2012 04:40 AM PST

A number of proposals on taxes and the budget have come out recently, one by President Obama, one by Mitt Romney, and one by a friend, John Mauldin.

Every one of the proposals are fatally flawed, most of the for multiple reasons. Before one can fix a problem one must understand it.

In general, Democrats want to raise taxes and spend money.

Republicans on the other hand generally want to cut taxes and spend money. Military spending and Medicare spending both soared under Republican. Bush signed a disastrous Medicare bill.

Both parties claim to be against deficit spending. However, if neither party wants deficit spending then why are their deficits?

Before we get to what's wrong let's take a short look at some recent proposals.

Tax Cuts to Prosperity

Mitt Romney proposes A Tax Reform to Restore America's Prosperity

First, I will make an across-the-board, 20% reduction in marginal individual income tax rates.

Second, I will reduce the corporate tax rate to 25% from 35%, transition from a world-wide taxation system to a territorial one, and make the R&D tax credit permanent.

Third, I will promote savings and investment by maintaining the low 15% rate on capital gains, interest and qualified dividends, and eliminate the tax entirely for those with annual income below $200,000.

Fourth, I will take long overdue steps to correct failures in the tax code. I will abolish the death tax, whose primary effect today is to foster elaborate schemes for transferring wealth. I will also repeal the Alternative Minimum Tax, which was intended to make the code simpler and fairer but has accomplished precisely the opposite.

Fifth, I will bring stability to the tax code by making these changes permanent.

A Simple Question

Excuse me for asking a simple question: How the hell are you going to pay for this?

What spending cuts would Romney make? He did not have the decency to say.

Take another look at point number 5. It's a blatant lie. There is no way to make changes permanent. Any Congress at any time can make tax changes undoing prior Congressional actions.

Obama's Plan to Close Tax Loopholes

President Obama has a plan to lower the corporate tax rate. However, on close inspection, To close tax loopholes, Obama would open new ones

President Barack Obama wants to close dozens of loopholes that let some companies pay little or nothing in taxes. But he also wants to open new ones for manufacturers and companies that invest in clean energy.

To some analysts, the new loopholes risk upending the level playing field Obama says he wants to create.

Is Obama attempting to level the playing field on taxes or level the playing field with a potential presidential debate with Rick Santorum and Mitt Romney on manufacturing?

Who knows? What I do know is this will do nothing to cut the deficit.

Obama, Romney Tax Plans Propose Unfunded Corporate Rate Cuts

The Huffington Post reports Obama, Romney Tax Plans Propose Unfunded Corporate Rate Cuts

President Barack Obama and Mitt Romney have begun a new form of competition: proposing corporate tax cut plans that they claim, wrongly, won't cost the Treasury a dime. Almost immediately after Obama unveiled his plan on Wednesday, one of the nation's leading tax policy experts threw cold water on the administration's claim that its tax overhaul could be implemented "without adding a dime to the deficit." A separate plan released Wednesday by Republican presidential contender Romney, the expert said, would almost certainly expand the deficit.

Debt Will Swell Under 3 of 4 Republican Hopefuls' Tax Plans

Given the pathetic lack of details in most tax plans one should not be surprised to learn Debt Will Swell Under 3 of 4 Republican Hopefuls' Tax Plans

The national debt would balloon under tax policies championed by three of the four major Republican candidates for president, according to an independent analysis of tax and spending proposals so far offered by the campaigns.

The lone exception is Texas Rep. Ron Paul, who would pair a big reduction in tax rates with even bigger cuts in government services, slicing about $2 trillion from future borrowing.

According to the report released Thursday by U.S. Budget Watch, a project of the bipartisan Committee for a Responsible Federal Budget, former Pennsylvania senator Rick Santorum and former House speaker Newt Gingrich would do the most damage to the nation's finances, offering tax and spending policies likely to require trillions of dollars in fresh borrowing.

Both men have proposed to sharply cut taxes but have not identified spending cuts sufficient to make up for the lost cash, the report said. By 2021, the debt would rise by about $4.5 trillion under Santorum's policies and by about $7 trillion under Gingrich's plan, pushing the portion of the debt held by outside investors to well over 100 percent of the overall economy, the study said.

The red ink would gush a little more slowly under former Massachusetts governor Mitt Romney, the report said. Until this week, Romney had paired $1.35 trillion in tax cuts with $1.2 trillion in spending reductions, leaving the debt rising on a trajectory that closely tracks current policies.

But that changed Wednesday, when Romney proposed to cut federal income tax rates by 20 percent more for all earners, which would slash U.S. revenue by more than $2 trillion over 10 years.

Romney economic adviser Glenn Hubbard said the lost cash would be recovered by closing tax loopholes and boosting economic activity. But until the campaign offers a more specific plan, Budget Watch analysts said Romney's entire framework would add about $2.6 trillion to the debt by 2021.

Only Paul emerged as a fiscal conservative in the report. His policies would cut tax revenue by more than $5 trillion over the next decade, the report said, but the loss would be offset by more than $7 trillion in spending cuts, including deep reductions in defense and federal health programs.

The True Conservative

Romney, Santorum, and Gingrich are collective hypocrites and fake conservatives. Ron Paul stands alone as a true fiscal conservative and a true conservative on military policy as well.

John Mauldin VAT Proposal

Rather than cut taxes, Mauldin primarily seeks to fix the deficit by hiking taxes. Let me say up front that Mauldin is a friend, he is a Republican, and on this issue I politely suggest he is also off his rocker.

Please consider snips from The Cancer of Debt and Deficits by John Mauldin.

The growing debt and the deficit is a deadly cancer on the economy. It will deliver a mortal blow to the economy if not dealt with.

The problem is solvable. It is not that there are not a lot of solutions. It is that we have not yet found the political will to decide what course of treatment is needed. Let's start with a few basic presuppositions that I think must be addressed in order to marshal an effective set of choices.

1. It has to be politically feasible. The Right would like to address the problem with spending cuts and reforms. Reforms and spending cuts are necessary but not sufficient to deal with the problems. For instance, disability payments are now running $200 billion a year and growing rapidly. Some 25% of those unemployed since the beginning of this crisis have somehow qualified for disability payments. We can cut the time allowed for unemployment benefits, but that does not offer large numbers. Government transfers now account for 22% of household income. Cutting that will be politically difficult.

The real problem is health care. How much do we want and how do we want to pay for it? Health care must be thoroughly reformed, but the will (the votes) to go back to the 1990s is just not there. Rising costs can be controlled but not eliminated. The same goes for Social Security. We can raise the retirement age, do means testing, and make other changes; but the fact is that there are more Baby Boomers retiring each year. There is no Social Security Trust Fund. The money was spent on other projects, and now Social Security runs in the red each year. What Republican is running on a platform of taking away Social Security from those who are presently receiving it or will be eligible for Social Security within 10 years? Want to cut defense? Military pensions? Government pensions.

....

The hard reality is that the rich just don't make enough to cover our current deficit. If we raised taxes to something like 60% on the top 10% of income earners, not just the 1%, we might get enough tax revenue, if the "rich" cooperated by making the same income they do now. That type of tax rate is just not politically feasible under any conceivable elected Congress.

It will require both spending cuts AND different and higher forms of revenue to get a deficit reduction plan through Congress, even a majority Right or Left Congress. If Obama could not get higher taxes (except for health care in the future) in his first two years, with a decidedly Democratic Congress, it is very unlikely to happen in time to deal with the deficit crisis. Something must be done SOON. We don't have another five election cycles to debate this.

...

[Citing Marc Sumerlin and Larry Lindsey, economic advisors in the White House, and co-authors of a book What a President Should Know … but most learn too late Mauldin adopts their suggestions]

Marc outlined to me their thoughts on reforming the tax code. I read the chapter in the book on reforms, and like it better than anything else I have seen.

What they suggest is to tax consumption with a 20% Value Added Tax (VAT). There would be no taxes for incomes under $100,000. None. No Social Security. No Medicare. If you make less than $100,000 you pay nothing.

All income over $100,000 is taxed at 20%, no matter what the source. No capital gains rate or dividend break. I assume that also means no municipal bond exemptions. No exemptions for anything. Every last tax expenditure goes away. Corporate tax rates would be 20%, and again I assume no exemptions. If you make a profit, you pay taxes.

They also note that their proposal was revenue-neutral in 2007, and included a $2,000 per child tax credit. Every worker would get an approximate 7.5% pay raise from the removing of Social Security and Medicare taxes. While businesses would also get that same tax break, they would have to pay a VAT on salaries, which would be an increase in cost. Welfare, the social safety net, and health care would all be funded.

One can adjust the levels of both the VAT and income taxes to match the desired level of government spending. I might prefer less, but that is not the point here. Match these taxes (along with the normal excise taxes) with entitlement reform, a properly structured health-care system, and some cuts in other areas, and you are close to a balanced budget.

Politically Feasible - Not

For starters, Mauldin's proposal immediately violates requirement number one.

The proposal is not close to being politically feasible. Even it it was politically feasible, it would be a horrendous idea. To see why let's start with a look at spending.

Military Spending

Military spending may not be the biggest problem, but it certainly is a very big problem.

Indeed the US spends as much as the next 14 nations combined.

Defense Outlays

The above chart is from Decline and Fall of the Roman Empire by Jeffrey Gundlach

Warmongers (basically Republicans, Democrats, and President Obama with a few exceptions like Ron Paul) like to point out that defense spending is shrinking as percentage of the budget.

However, anyone with any common sense will point out a needless rise from $300 billion to close to $800 billion, now projected to be around $700 billion. This happened because of inane wars in both Iraq and Afghanistan.

Now the warmongers are hell bent on starting a war with Iran even though the price of oil is soaring and Israeli Intelligence Concludes "No Iranian Nuclear Weapons Program"

What If?

What if we could roll back the hands of time to when Bush was trumping up complete nonsense about weapons of mass destruction in Iraq and make a change. The change I want to make is to have in place a balanced budget amendment that allows no exceptions.

You want more spending, then you either cut spending elsewhere or raise taxes.

Would Republicans have been so gung-ho about starting that war? If they did start it, would the public have stood for all the tax increases to pay for it?

What if we could roll back military spending to 2003 levels? Why is that impossible?

Note that the US has troops in 140 countries. Does the UDS need troops in ANY country but the US? I suggest, as does Ron Paul, as would any true constitutionalist conservative, the answer is no.

Defense vs. Healthcare

Defense is a problem, but Healthcare is an even bigger problem.

Mauldin pointed out "disability payments are now running $200 billion a year and growing rapidly". I pointed out the same thing in Disability Fraud Holds Down Unemployment Rate; Jobless Disability Claims Hit Record $200B in January.

Before we start raising taxes, don't you think we ought to cut out the fraud?

And what about Medicare fraud? What about Medicaid fraud? What about Food Stamps?

Economic Insanity from Gingrich

Please consider Economic Insanity from Gingrich on Marijuana Use: Life imprisonment With No Parole; Who Benefits from War on Drugs? Big-Brother Expansionist Ideas: Gingrich Proposes "Free Radios" for Everyone in Cuba!

Yes, Gingrich actually proposed "Free Radios" for Everyone in Cuba. He also proposed drug testing for food stamp recipients. I had three questions for Gingrich.

Three Questions for Gingrich

How much will it cost to administer drug tests to everyone getting a government subsidy?
How much more chipping away at states' rights does Gingrich want?
How can this proponent of big government even call himself a Republican?

See how easy it is for even Republicans to propose complete nonsense? Both parties will keep doing the same thing if we blindly follow Mauldin's guide of raising the VAT to meet expenditures.

Mish Food Stamp Proposal

When it comes to food stamps I have a far better set of ideas than Gingrich's drug testing proposal.

Do not let those on food stamps buy frozen pizza, potato chips, snacks of any kind, soft drinks, etc.
Explicitly limit food stamp users to generic (store brand vs. name brand) dried beans, rice, peanut butter, pasta, canned vegetables, canned soup, soda crackers, fresh vegetables, fresh fruit, frozen (not bottled) juice, poultry, ground beef, chuck steak, bread, cheese, powdered milk, eggs, margarine, and general baking goods (flour, sugar, spices).
Calculate a healthy diet based on current prices, number in the family, ages of recipients, and base food stamps allotments on that diet.

My proposal will not only lower the cost of the food stamp program, healthy diets would lower Medicaid and Medicare costs as well. Moreover my proposal would give people a strong incentive to get off the food stamp program without intrusive, costly big-brother ideas like drug testing which cannot possibly work for the simple reason that anyone who fails will steal to get food rather than starve. Also note that Gingrich's proposal would harm innocent kids on the program. My idea would help them nutritionally.

Corruption of America

Porter Stansbury wrote a tremendous article on The Corruption of America and how public unions are at the center of it.

It has now been almost 50 years since the start of the War on Poverty, President Lyndon Johnson's program to radically increase domestic welfare spending. These programs and their various spinoffs have been at the center of Democratic politics ever since. In fact, if you compare speeches about these programs from the mid-1960s until today, you will find the verbiage never changes. Obama is merely echoing the same calls for "social justice" that Robert Kennedy used in his ill-fated 1968 campaign for president.

But besides the soaring rhetoric, besides the promise of a "chicken in every pot," what have these programs actually achieved? The wholesale destruction of urban communities across America, communities that are overwhelmingly African American. If the intention of these programs had been to destroy black communities, you could have hardly done more damage than the last 50 years of Democratic policy.

I don't think most Americans realize how dangerous these communities have become or the toll they take on our country as a whole. That's primarily because talking about this problem is seen as racist. That's complete nonsense. The victims of these policies are primarily black people. Trying to help them restore dignity and independence to their communities isn't a racist goal. It's humanitarian.

In Detroit, only 27% of the black male students in the school system graduate from high school. This is not a racial problem: Only 19% of the white male students graduate from those same schools. What's causing this problem? A complete breakdown of society. When communities can no longer teach their children the most basic academic skills, such as reading, math, history, literature, and economics... what future can we expect? And what kind of society do you expect after several generations of total ignorance?

How did this all happen? How did we end up with expensive schools that can't teach? How did we end up with young mothers who aren't married? How did we end up with entire generations of people who won't – and probably can't – work in the labor force? How did we end up with a skyrocketing prison population? The prison population in America has soared from less than half a million people in 1980 to more than 2.5 million people today. More than 7 million adults are in prison or on parole in the United States. We have an incarceration rate that's seven times higher than any other industrialized nation.

Let's ask the most basic question: What has the gigantic increase in welfare spending and education spending done for the underclass of America?

The article is lengthy and it starts out slowly but quickly picks up. At times Stansbury uses some politically incorrect language that may appear racial. It's not. He attacks Republicans and Democrats alike, whites and blacks alike. He talks about the corruption of unions and the corruption of corporations. Everyone would be well served to read the entire article.

Golden State on road to Greece, by way of Detroit

Stansbury touched on Detroit in his article and so did the Orange County Register in an editorial Golden State on road to Greece, by way of Detroit

California's tax burden, according to the Tax Foundation, is heavy. The Register reported that per-person state and local taxes, fees, licenses and "intergovernmental revenue" amount to $8,634, ranking California 13th-highest among the states. California businesses fare worse, the Tax Foundation said, ranking 48th in tax climate, based on corporate, income, sales, property and unemployment insurance taxes.

What's unsaid is the effect on individuals of extremely high corporate taxes. Companies not driven out of state or out of business are less likely to hire or expand, more likely to contract and struggle to provide for current employees.

But high taxes are needed to pay for leftist policies that interject government into private life, while heaping generous benefits on government workers who do the interjecting. Progressives, as they like to call themselves, seem oblivious to Big Government's damage.

We have a glimpse of where this leads. It's called Detroit.

Detroit is where "all the major economic planks of the statist or 'progressive' platform have been enacted," writes Jarrett Skorup of the Mackinac Center. "A 'living wage' ordinance, far above the federal minimum wage, for all public employees and private contractors. A school system that spends significantly more per pupil than the national average. A powerful school employee union that militantly defends the exceptional pay, benefits and job security it has won for its members. Other government employee unions that do the same for their members. A tax system that aggressively redistributes income from businesses and the wealthy to the poor and to government bureaucracies."

Sound like California? What has all this done for Detroit, "dubbed the most liberal city in America"? Detroit in 1950 was America's wealthiest city on a per capita income basis. Today it's the second-poorest major city.

"[I]t is striking that the decline in per capita income is exactly what classical economists predict would occur when wage controls are imposed and taxes are increased," Skorup writes.

Despite progressivism's poisoned fruits on display, what does California do? Recent headlines trumpeted proposed tax increases of billions, additional "rights" for state government workers and clamoring for more tax subsidies for education and health care and, let us not forget, Gov. Jerry Brown's desire to squander billions on a high-speed train no serious analyst says can operate profitably, if it can even be built for its estimated $98.5 billion.

Still Like That VAT Idea?

Anyone still like that VAT idea? If so expects states like California and Illinois to embrace it. Expect every public union in the country to be clamoring for more tax hikes to support more wage hikes.

Heck, they already are, even before a VAT. On February 17, the Chicago Tribune reported Chicago teachers asking for 30% raises over next 2 years.

Is that insane or is that insane? The only way to stop such insanity is by ending collective bargaining of public unions, scrapping Davis Bacon and all prevailing wage laws, and instituting national right to work laws.

Desired Level of Government Spending

Instead of blindly raising taxes, I propose we take a serious look at every government program and decide what is really needed. Student aid is another program of negative benefit. Such aid drives up the cost of school and makes debt slaves out of some kids for life. The program needs to be scrapped entirely.

Returning to Mauldin's thesis that any proposal must be politically feasible, spending cuts alone will not fly.

However, Republicans need to demand a lot in return for any necessary tax hikes. As a compromise, I would accept Some amount of tax hikes in return for scrapping Davis Bacon, ending all prevailing wage laws, and instituting national right to work laws.

Those actions will help cities and states get back on their feet. But we also need pension reform, welfare reform, drug imports from Canada, and a host of other items including tax reform.

I am against a VAT completely. And I certainly do not like exempting the first $100,000 because the tax burden would then fall only on the middle class.

Instead of a VAT, and in order to be fair to everyone, a sales tax that excludes food, shelter, medicine, and perhaps clothing is the way to go. Everyone gets the same break so the proposal is fair. However, the poor spend nearly all their money on food, shelter, medicine, and clothing, so they benefit proportionally speaking.

A national sales tax is easy to collect, hard to avoid, and promotes saving over consumption, all of which are very good things. Perhaps some combination of income tax and national sales tax is the way to go, but only after eliminating fraud and unnecessary spending.

In this regard, a very good place to start would be with Ron Paul's proposed cuts.

The cardinal rule of taxes is legislators will spend every dime collected and then some so a definite control is needed. I propose a balanced budget amendment to stop both parties from doing just that.

Legal Bribery

The above actions are a good start but corporations and unions like to buy votes. Lobbyists write our legislation and they are often the only ones who really know what is in the bills and why. Nancy Pelosi famously remarked "we have to pass the health care bill to see what's in it". Indeed. But the lobbyists knew. They read every line of it.

As long as public unions, corporations, and lobbyists can bribe legislators with campaign contributions, then bills are going to be written by public unions, corporations, and lobbyists.

The result is the worst legislation (from a taxpayer perspective) that money can buy. Proof is easy to find. There are 72,536 Pages of Tax Code.

Nearly all those pages of code exist because some corporate or union sponsor made campaign contributions to some member of Congress who piled on page after page of tax code.

My proposal to end collective bargaining of public unions and institute right to work laws will fix one of the problems, but something still needs to be done about corporate campaign bribery. I am open to ideas.

Correct Approach

The correct approach is not Obama's, not Romney's, and not Mauldin's.

Three Step Approach

First, there are numerous structural problems and fraud items as noted above that should be fixed as part of a compromise package.
Then before deciding on the amount of tax, we need to take a serious look at Ron Paul's proposals to see what we can get rid of.
Then tax code needs to be simplified in a fair way, as would my national sales tax idea exempting food, medicine, and clothes (Perhaps a combination sales tax and income tax).

Unfortunately that still is not enough. Congress is highly unlikely to do this on its own. We need a presidential leader willing to make tough choices, not just say he is willing to make tough choices.

Obama has clearly failed. By their pathetic proposals to date, so will Mitt Romney, Newt Gingrich, and Rick Santorum.

And so here we are, careening towards the 2012 elections with a guaranteed loser as a sitting president, and unless Ron Paul pulls off a miracle, a set of fatally flawed candidates with fatally flawed proposals on what to do about the deficit on the Republican side as well.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Price of Oil Hits Record High in Euros and British Pounds; Oil Shock Coming; Nancy Pelosi Blames Speculators; What About Iran? Israeli Intelligence Concludes "No Iranian Nuclear Weapons Program"

Posted: 23 Feb 2012 11:25 PM PST

Bernanke is hell bent on producing price inflation. He has succeeded, just not where he wants most. What Bernanke desperately wants is for housing prices to rise because that more than anything will help the banks and all the foreclosed properties they are sitting on.

The Bernanke Fed has certainly assisted the stock market, as intended, but that is not doing the average Joe much good in the face of soaring oil prices, soaring food prices, falling home prices, and zero% interest on savings.

Oil Shock Coming

As a direct consequence of Fed policy, in conjunction with an inane US and European oil embargo on Iran, Europe (already in the midst of what is going to be a long and deep recession) will be hit with an oil shock on top of it.

Record Price of Oil in British Pounds

On Wednesday the Financial Times reported Record sterling oil price sparks fears

Oil prices have soared to a record high in sterling terms and are approaching euro highs, raising fears that European countries struggling with heavy debts will face further barriers to economic recovery.

"This is a regional oil shock," said Amrita Sen, commodities analyst at Barclays Capital in London.

Brent rallied to £78.48 a barrel, passing the previous all-time high of £77.71 a barrel set in April last year at the peak of the Libyan civil war supply disruption. In euro terms, the oil benchmark reached a three-year high of €92.70 a barrel, a fraction below the peak of €93.50 a barrel set in July 2008.

Record Price of Oil in Euros

It took precisely one more day for the Financial Times to report Euro denominated oil hits record

Oil prices soared to a record high in euro terms, surpassing the peak touched in the 2008 price spike and posing a fresh problem for eurozone economies already struggling under the weight of the region's debt crisis.

The euro-denominated price of Brent crude, the global benchmark North Sea crude, rose to a peak of €93.63 a barrel on Thursday, surpassing the previous high hit on July 3, 2008. The new euro record comes just a day after Brent hit a record in sterling terms.

Nancy Pelosi Blames Speculators

The Hill reports Dem leader Pelosi blames Wall Street for spike in gas prices

Oil speculators, not a lack of domestic drilling, are to blame for the nation's rising gas prices, the top House Democrat argued Wednesday.

House Minority Leader Nancy Pelosi said unscrupulous Wall Street investors have artificially inflated prices at the pump, which are climbing toward $4 per gallon.

The California Democrat called on Congress to take "strong action" to rein in the allegedly excessive speculation, and accused Republicans of protecting Wall Street profits at the expense of consumers.

"Wall Street profiteering, not oil shortages, is the cause of the price spike," Pelosi said in a statement. "Unfortunately, Republicans have chosen to protect the interests of Wall Street speculators and oil companies instead of the interests of working Americans by obstructing the agencies with the responsibility of enforcing consumer protection laws."

Irony of it All

No one gives a rat's ass if speculators drive up the price of houses or the stock market to absurd heights. Indeed, Congress goes out of its way to actively promote rising home prices.

The Greenspan and Bernanke Fed did the same. Now Bernanke openly takes credit for the rising stock market and encouraging speculation.

And where the hell is the blame for this absolutely inane embargo on Iran?

No Iranian Nuclear Weapons Program

As a matter of record, Israeli intelligence concluded in January of this year, there is No Iranian Nuclear Weapons Program!

As Gen. Martin Dempsey, Chairman of the Joint Chiefs of Staff, arrived in Israel Thursday, the left-leaning Haaretz newspaper dropped its own atomic bombshell.

Israeli intelligence agencies have worked up an intelligence assessment that Iran has not yet decided whether to begin a military program to construct a nuclear warhead. Put in other words, Mossad believes that there is no current Iranian nuclear weapons program. Haaretz writes:

"The intelligence assessment Israeli officials will present later this week to Dempsey indicates that Iran has not yet decided whether to make a nuclear bomb. The Israeli view is that while Iran continues to improve its nuclear capabilities, it has not yet decided whether to translate these capabilities into a nuclear weapon – or, more specifically, a nuclear warhead mounted atop a missile. Nor is it clear when Iran might make such a decision."

This is the same conclusion to which the 16 US intelligence agencies have come in 2007 and 2010. It is also consistent with what the Iranian government itself says, which is that the Iranian nuclear enrichment program is a civilian one and that Iran is not trying to construct a nuclear weapon. Likewise, the International Atomic Energy Agency, which continues to inspect Iranian nuclear facilities, has repeatedly and consistently stated that no nuclear material has been diverted from the civilian program.

Haaretz says that Israeli Minister of Defense Ehud Barak gave an interview with the Army radio, in which he come to another surprising conclusion. Asked if Israel plans a military strike on the Iranian nuclear facilities in Natanz near Isfahan, Barak replied: "We haven't made any decision to do this . . . This entire thing is very far off."

ZeroHedge properly blasted Pelosi two days ago in his take Nancy Pelosi Issues Statement On Soaring Gas Prices

Speculators? Such as the Federal Reserve and other central banks who have pumped $2 trillion of "liquidity" into the capital markets in the past 3 months just so Italian BTPs don't implode to fair value and so Europeans can continue living in a socialist "paradise" even as the bankers steal their gold?

Or is it the same congressional speculators who until recently had every right to front run the public on advance knowledge that the SPR would be tapped due to Democrat insistence to sacrifice America's last energy backstop only to win the election?

Whatever the reason for the gas surge, with these idiots in charge, one thing is certain - the situation is about to get far, far worse.

Staggering Idiocy

The idiocy of this government and central bank created mess is staggering. The Fed is actively encouraging speculators and the Obama government is angling for another Mideast war over weapons of mass destruction that once again do not even exist.

Instead of placing the blame on the Fed and on the warmongers, Pelosi is enough of an outright idiot to demand Congress do something to rein in speculators.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Thursday, February 23, 2012

Mish's Global Economic Trend Analysis

Troika Demands 38 New Changes in Greek Tax, Spending and Wage Policies in Next 6 Days
Pact With the Devil Over Gold
Don't Worry, It's Only a "Mild Recession"
Misunderstanding "China's Sweatshop As Great Wall Starts Building Cars In Bulgaria"

Troika Demands 38 New Changes in Greek Tax, Spending and Wage Policies in Next 6 Days

Posted: 23 Feb 2012 03:40 PM PST

The hit parade of demands on Greece keeps right on marching. The Troika has 38 new demands in addition to 10 pages of prior demands that have not been met.

The ten-page list of prior demands need to be met by the end of the month. Fortunately this is leap year so Greece gets an extra day.

The Financial Times reports Athens told to change spending and taxes.

European creditor countries are demanding 38 specific changes in Greek tax, spending and wage policies by the end of this month and have laid out extra reforms that amount to micromanaging the country's government for two years, according to documents obtained by the Financial Times.

The reforms, spelt out in three separate memoranda of a combined 90 pages, are the price that Greece has agreed to pay to obtain a €130bn second bail-out and avoid a sovereign default that the government feared would throw Greek society into turmoil.

They range from the sweeping – overhauling judicial procedures, centralising health insurance, completing an accurate land registry – to the mundane – buying a new computer system for tax collectors, changing the way drugs are prescribed and setting minimum crude oil stocks.

"The programme is much, much more ambitious than economic reform," said Mujtaba Rahman, Europe analyst at the Eurasia Group risk consultancy. "This is state building, as typically understood in traditional low-income contexts."

Most urgency is attached to a 10-page list of "prior actions" that must be completed by Wednesday in order for eurozone finance ministers to give a final sign-off to the new bail-out at an emergency meeting scheduled for Thursday.

Among the measures that must be completed in the next seven days are reducing state spending on pharmaceuticals by €1.1bn; completing 75 full-scale audits and 225 value added tax audits of large taxpayers; and liberalising professions such as beauty salons, tour guides and diet centres.

Demands Designed to Fail

The Troika demands 75 full-scale audits and 225 valued added tax audits in 6 days! Is that going to happen?

This setup is without a doubt designed to fail and that should have been obvious ever since Germany asked to put a commission in charge of the Greek budget on Feb 7. Please see Greece to Cede Sovereignty to Eurozone "Budget Commissioner" for details.

These new demands are in addition to a requested a constitutional change that is impossible before 2013.

For details, please see Greece Needs New Constitutional Provision Imposed by the Troika; Slight Problem, Constitutionally It Can't Do it

It is possible some of the new demands need constitutional changes as well. I simply do not know.

Please also consider the Pact With the Devil Over Gold

As I have said repeatedly ...

Germany has put up roadblock after roadblock attempting to get Greece to scuttle the deal, only to have fools like Finance Minister Evangelos Venizelos agree to them.

It may be up to Germany to come up with still more ludicrous demands in hope that the Greek finance minister and Greek politicians finally get the message "it's not wise to make a pact with the Troika devil", especially one that requires Greece to relinquish its gold.

On Tuesday I said it's a 9 Day Race to Ecstasy; Only Way Greece Can Win Is To Lose

It's now 6 and counting.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Pact With the Devil Over Gold

Posted: 23 Feb 2012 12:44 PM PST

The one and only thing that might possibly spare Greece the agony of a completely worthless currency is Greece's small hoard of 111 tons of gold.

Pact With the Devil

Yet, in the fine print in the latest deal, Greece's lenders will have the right to seize its gold reserves according to the New York Times article Growing Air of Concern in Greece Over New Bailout.

In the fine print of the 400-plus-page document — which Parliament members had a weekend to read and sign — Greece relinquished fundamental parts of its sovereignty to its foreign lenders, the European Commission, the European Central Bank and the International Monetary Fund.

"This is the first time ever that a European and probably an O.E.C.D. state abdicates its rights of immunity over all its assets to its lenders," said Louka Katseli, an independent member of Parliament who previously represented the Socialist Party, using the abbreviation for the Organization for Economic Cooperation and Development. She was one of several independents who joined 43 lawmakers from the two largest parties in voting against the loan agreement.

Ms. Katseli, an economist who was labor minister in the government of George Papandreou until she left in a cabinet reshuffle last June, was also upset that Greece's lenders will have the right to seize the gold reserves in the Bank of Greece under the terms of the new deal, and that future bonds issued will be governed by English law and in Luxembourg courts, conditions more favorable to creditors.

Causing a Nightmare Scenario

On Tuesday, Finance Minister Evangelos Venizelos defended the new debt agreement, calling it "the most significant deal in Greece's postwar history" and asserting that it had "averted a nightmare scenario."

Today this same puppet of the Troika installed government claims, as he has been for weeks, No Loan Deal Means Absolute Catastrophe

Greece Finance Minister Evangelos Venizelos said Thursday Greece would face an absolute catastrophe if it didn't approve the terms demanded by international creditors in exchange for a second bailout, which includes a EUR107 billion debt write-down plan.

Greece is already in a state of absolute catastrophe. The one thing 100% guaranteed to make matters worse for Greece is if Greece lost its hoard of gold to the thieves and plunderers at the IMF and Troika.

Rather than "averting a nightmare scenario" that pact is going to "cause" a nightmare hyperinflation scenario.

Value of 111 Tons of Gold

One tonne = 1000 kilograms = 32150.746 troy ounces.
At $1780 per troy ounce, the value of that gold is roughly $6.35 billion.

Given an estimated size of the Greek economy at $290 billion or so, that is not a huge hoard.

However, something is better than nothing as Zimbabwe proves. Something is enough to prevent a currency from going completely worthless, although obviously not enough to prevent a massive devaluation.

Still Time

There is still time for Greece to come to its senses and reject the deal. Also recall the conditions of the deal require a constitutional change and that is impossible before 2013.

For details, please see Greece Needs New Constitutional Provision Imposed by the Troika; Slight Problem, Constitutionally It Can't Do it

Biggest Hope for Greece is Germany

In an enormous irony, Germany may be the biggest hope for Greece. Although France and other countries do want this pact to go through, Germany's words and actions prove that Germany does not.

Germany has put up roadblock after roadblock attempting to get Greece to scuttle the deal, only to have fools like Finance Minister Evangelos Venizelos agree to them.

It may be up to Germany to come up with still more ludicrous demands in hope that the Greek finance minister and Greek politicians finally get the message "it's not wise to make a pact with the Troika devil", especially one that requires Greece to relinquish its gold.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Don't Worry, It's Only a "Mild Recession"

Posted: 23 Feb 2012 07:30 AM PST

The economic clowns in the EU have finally acknowledged something that was blatantly obvious at least six months ago (and a lot longer if one factored in the likely effects of multiple austerity programs in numerous countries).

However, the economists' new conclusion is about as silly as the "no recession" call that preceded it. The new forecast: there will be a recession in the eurozone but not the EU and it will be "mild".

Please consider Euro zone economy to shrink in 2012.

The euro zone's economy is heading into its second recession in just three years, while the wider European Union will stagnate, the EU's executive said on Thursday, warning that the currency area has yet to break its vicious cycle of debt.

"Recent developments in survey data suggest that the expected slowdown will be rather mild and temporary," EU Economic and Monetary Affairs Commissioner Olli Rehn told a news briefing following the release of the European Commission's interim report on the EU economy.

The wider, 27-nation European Union, which generates a fifth of global output, will not manage any growth this year, the Commission said.

"The EU is set to experience stagnating GDP this year, and the euro area will undergo a mild recession," it said.

"Negative feedback loops between weak sovereign debtors, fragile financial markets, and a slowing real economy do not yet appear to have been broken," the Commission said.

Germany and France, the euro zone's two largest economies, are likely to escape recession this year, growing 0.6 percent and 0.4 percent respectively, while Greece will enter its fifth year of economic contraction and Spain will shrink 1 percent, the Commission said.

Alternate Viewpoint

Let me reiterate things I have said many times: Germany and France will not escape recession, the German export machine will see a shocking slowdown (likely billed as "no one could have possibly seen this coming"), the overall EU will face a recession with the UK leading the way (the UK is highly in recession already), and these recessions will be neither mild nor fleeting.

By the way, a "negative feedback loop" is self-correcting by definition.

Negative feedback occurs when the output of a system acts to oppose changes to the input of the system, with the result that the changes are attenuated. If the overall feedback of the system is negative, then the system will tend to be stable

The writer meant a positive feedback loop (with negative consequences).

Mike "Mish" Shedlock
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Misunderstanding "China's Sweatshop As Great Wall Starts Building Cars In Bulgaria"

Posted: 23 Feb 2012 12:23 AM PST

ZeroHedge posted an interesting article called Europe Is Now China's Sweatshop As Great Wall Starts Building Cars In Bulgaria. Unfortunately the article contains many often repeated trade fallacies as well as numerous other errors.

ZH: "With China Forecast To Reach Wage Parity With The US In Five Years, Is A New Manufacturing Golden Age Coming To The US?"

Mish: China's wages are rising fast. Sometimes in leaps of 20%. From where? How sustainable is it? Please consider this snip from the Reuters article HP, Dell watch rising China labor costs for Apple written February 22, 2012:

"Taiwan-based Foxconn said the pay of a junior level worker in Shenzhen, southern China, had risen to 1,800 yuan ($290) per month and could be further raised above 2,200 yuan if the worker passed a technical examination. It said that pay three years ago was 900 yuan a month."

Let's do the math. $290 a month is $3,480 a year. Assume 20% annual wage hikes, once a year for 5 years. Should that happen, at the end of that time, the salary would be 8,659.35. US minimum wage is $7.25 an hour (not sure what it will be five years from now), but that is about $14,500 assuming a 40 hour work-week and 2 weeks unpaid vacation.

It would take 33% raises every year for five years just to match US wages. Is that likely?

Bear in mind that shipping costs and productivity issues are also in play. This is not simply a wage issue.

ZH: As Spiegel reports, carmaker "Great Wall this week became the first Chinese automobile manufacturer to open an automobile assembly plant inside the European Union in the latest move suggesting the country's carmakers are seeking to establish a beachhead into the European market." Yes, that's right: it is now cheaper for China to make cars in the European Union: "It used to be that European carmakers opened plants to assemble their cars in China. Now the Chinese have turned the tables with the opening of their first factory in Bulgaria, an EU country with low labor costs and taxes.

Mish: Is it really cheaper to build cars in Bulgaria, or is something fundamentally different happening? I suggest the latter, possibly both, but the latter point is critical. China is sitting on huge piles of forex resereves. Those reserves must return at some point. China can either buy goods from Europe, or it can invest in Europe. What better place to invest than in a country with low taxes and low labor costs? The Bulgarian Lev currency is pegged to the euro at €1 = BGN 1.95583. Bulgaria is expected to join the Eurozone by 2015. Whether joining makes sense is debatable, but China sees an opportunity. China also has a need to put euro reserves to work. That need is a mathematical identity. By the way, this is likely a good deal for Bulgaria. It gets badly needed jobs.

ZH: Chinese carmakers are setting their sights on the European and American automobile markets." The ramifications of this landmark development are massive for virtually every aspect of the economy: for domestic labor migration, for inflation, for the trade balance, and certainly for US workers.

Mish: Agreed but for different reasons. This is a necessary part of global rebalancing.

ZH: Bulgaria, the EU's poorest country, is attractive as a labor market because it is an oasis of cheap wages and low taxes. Workers are considered well educated and the country is ideal as the site for a company like Great Wall to launch. Given that wages for factory workers have risen considerably in China in recent years, assembly sites abroad have become increasingly attractive for some manufacturers.

Mish: Exactly. So just how likely are those 33% annual raises for Chinese workers if the trend catches on? How likely are those 33% annual raises regardless?

ZH: So the real question is if Chinese wages can no longer compete with those in a poor EU member, just how high are they?

Mish: $290 a month for junior level workers and I will take a stab at not much higher for senior level workers.

ZH: And how long before China, for so many years a happy mercantilist importer of Bernanke's monetary inflation courtesy of its currency peg, is no longer competitive with ever growing parts of the EU, and then America? Does this mean that China's cheap labor force has pleateaued and the labor migration of peasants moving from the periphery to the cities no longer provides cheap labor? This was the topic of an extended analysis by SocGen from early January (posted here), of which the salient chart is presented below.

Mish: Is that alleged shortage of labor due to inflation and monetary stimulus in China or the US? How much Chinese labor goes into totally unaffordable projects driving up the price of labor? How much of the worker stagnation is simply do to falling export demand? I do not have the answers to those questions but there are multiple explanations for the alleged "shortage of labor". The single most likely explanation however, is unsustainable stimulus and growth, in China.

ZH: Aside from demographics, the macroeconomic implications on foreign trade and capital flows are monumental: most immediately for the US, it puts today's Wal Mart miss in a very different perspective, as it means that China is no longer the source of cheap commoditized produce, which in turn means that the entire discount retail vertical may have entered the secular sunsetting phase.

Mish: For a completely different viewpoint, and a deflationary one at that, please consider Hugh Hendry of Eclectica Discusses Hyperdeflation, Europe, China, and Japan.

ZH: Most importantly, it means that going forward China will have zero tolerance for Fed monetary expansion as any hot money will immediately set off an inflationary forest fire as China suddenly finds itself with absolutely no output gap slack (unlike America which allegedly has more than enough, even though it is really just a secular regression to the mean shift).

Mish: Most importantly, such events are a necessary part of global rebalancing. As a mathematical identity, China's hoard of euros must eventually return to Europe just as China's hoard of dollars must eventually return to the US. The sooner this happens the better. The US and Europe should both embrace Chinese investment. Unfortunately, that is highly unlikely.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Wednesday, February 22, 2012

Mish's Global Economic Trend Analysis

Chris Christie to Warren Buffet "Write a Check and Shut Up"; Christie's Sound Advice to Everyone Else "Don't Send Them Money In the First Place"
Hugh Hendry of Eclectica Discusses Hyperdeflation, Europe, and Japan
Citigroup Whistle-Blower to Rake in $31 Million for Providing Evidence Citigroup "Defrauded" Fannie, Freddie
Stop the Nonsense About the "Falling Dollar" Being the Cause of Rising Gasoline Prices
Liquidity Floodgate Set to Backfire; Transmission Broken; Shutting Down the Liquidity Spigot
Eurozone PMI "Worse Than Expected" and Back in Contraction; Expect German-Periphery Divergence to Resolve to the Downside for Germany

Chris Christie to Warren Buffet "Write a Check and Shut Up"; Christie's Sound Advice to Everyone Else "Don't Send Them Money In the First Place"

Posted: 22 Feb 2012 05:39 PM PST

New Jersey governor Chris Christie has me laughing today with a pair of interviews. Please consider Governor Christie's Advice: Don't Send It To Them In The First Place

Now, some in this chamber may want to return to the days of outrageous state spending growth. To gimmicky programs that take money out of the taxpayers right pocket, and have Trenton keep most of it. Then return far less of it in their left pocket, take a bow and call it tax relief.

Now, New Jersey has seen 30 years of this as Trenton's solution to fix property taxes. It never has fixed a problem and it never will fix the problem. And New Jerseyans will not fall for the same old Trenton politicians' trick again.

We know that the only way to ensure that Trenton politicians will not waste your money is to not send it to them in the first place.

Chris Christie to Warren Buffet

In a CNN interview on Tuesday, Christie has this message for Warren Buffett "write a check and shut up"

Famously outspoken New Jersey Governor Chris Christie says he's "tired" of making the discourse surrounding tax reform all about Warren Buffett - and that if the billionaire investor wants so badly to pay more taxes, "he should just write a check and shut up."

In a CNN interview on Tuesday, Christie sparred with Piers Morgan over the issue, arguing that, as governor, he's "not going to let the most vulnerable suffer." But the Republican governor added that he also is "not going to get into this class warfare business, where certain people are more important than others or deserve more attention than others."

"I'm so tired of talking about Warren Buffet. What are you going to bring up next, his secretary?" asked Christie on CNN.

"He should just write a check and shut up," Christie said, later on in the interview. "Really, and just contribute, OK? I mean, you know, the fact of the matter is that I'm tired of hearing about it. If he wants to give the government more money, he's got the ability to write a check, go ahead and write it."

Christie said that in New Jersey, he's proposed lowering tax rates for everyone, even the highest earners.

"What we're doing here in New Jersey is everyone will get a 10 percent tax cut. Everyone will get their taxes reduced," he said.

If you start sending government more money, I guarantee you politicians will find thousands of ways to waste it.

Christie will be on CBS' "Face the Nation" on Sunday, Feb. 26. It should be entertaining.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Hugh Hendry of Eclectica Discusses Hyperdeflation, Europe, and Japan

Posted: 22 Feb 2012 04:08 PM PST

With the masses screaming their lungs of about hyperinflation, something that is highly unlikely at best, Hugh Hendry of Eclectica Talks About Hyperdeflation, why China might have a hard landing, and various off-the-beaten tracks Japan plays.

Here is clip from a Barron's interview.

Barron's: Where do you find yourself outside the existing belief system today?
Hendry: In 2009, I made a YouTube video of the empty skyscrapers in Wuhan, China. Goldman Sachs and others articulate a very reasonable and compelling argument of being invested in China. With the evidence of my own eyes, I concluded that China had a very robust system of creating gross-domestic-product growth, but forsaking the creation of wealth.

When America was having its China moment in the 19th century, it occurred against the backdrop of a gold standard, a hard-money regime, with a public sector that was minuscule versus the overall size of the economy. As an entrepreneur, if your project failed to generate a sustainable level of cash flow, you failed.

If you talk about a hard landing in China, you talk about GDP growth of 5%, not minus 5% or minus 15%. The Chinese government prints money. It can build superfast railways and overbuild airports, because the rest of the economy can subsidize it. China's swollen public sector is directing asset allocation, rather than pursuing profit maximization. They see [their system] as a success. But it creates a bubble, which can prove quite damaging.

Barron's: You've already had a hard landing—in the Chinese stock market.
Hendry: I should add something else that is contentious—U.S. quantitative easing [that eventually sent more money flowing to China], promoted because America had two sharp recessions and pursued orthodox policies, and had very little to show in the creation of jobs.

The policy was very successful. China now has inflation. Minimum wages have grown 20% annually for the past three years. This has encouraged the Chinese to tighten monetary policy. When you have bubbles and you tighten, bad things happen. China's stock and property markets are weak, a side-effect of quantitative easing. We may now have the pricking of the Chinese bubble. A year or two down the line, it could have enormous repercussions for the global economy.

Barron's: How does one play it?
Hendry: The world is very fearful of hyperinflation. Pension schemes have a preponderance of real assets, from forestry to gold to TIPS [Treasury inflation-protected securities], because they are very fearful. The road to hyperinflation is via hyperdeflation. That is why it's proving so difficult for hedge funds to make money. How does the rational mind that anticipates hyperinflation own 10-year government Treasuries yielding less than 2%? It can't. That's why people are struggling. To lay the seeds of hyperinflation, you need really, really bad things to happen. I thought the U.S. housing market having a massive crash would be hyperdeflationary. But then my Chinese friends pumped $1 trillion of credit into their $5 trillion economy, and created a global recovery, which has just come to an end. I'm speculating that hyperdeflation happens before hyperinflation. What's the worst that could happen? But the sum of all my fears would be China having a real hard landing of minus 5% or minus 10% GDP growth. If we had that—and Europe—the Fed would be printing $20 trillion, and I would have gold at $5,000. You can have a modest amount of gold, but you can't have all your assets in real assets, in case we get that hyperdeflation event.

Barron's: So how do you make money?
Hendry: Would you believe that the AIG strategy of selling too much credit protection in risky assets like mortgage-backed securities is alive and booming today in Japan? It doesn't concern mortgages. It is credit-default swaps on individual Japanese corporations.

Barron's: Do you seriously believe Japanese corporations are going to fail?
Hendry: Clearly, they can and do go bust. I'm buying the CDS on investment-grade Japanese corporations because of the overpricing anomaly. Japan had a bust 20 years ago, and yet today the banking stocks, relative to [Japanese bourse] Topix, are making fresh lows.

If I'm a Japanese bank and I lend money to a new business, I get 1% on 10-year paper. Then the bank gets a call from me, and I'm willing to pay 50 basis points for five-year protection on this same company. So suddenly, the yield has gone from 1% to 1½%. Compare that to five-year Japanese government bonds, yielding 30 basis points. The bank thinks: This is a great trade! Japanese steel companies are investment-grade and won't go bankrupt. So, the bank gets this huge yen yield, and thinks it is not taking any risk. You'd better believe it will sell way too much of that good thing.

One of my partners told me about Japanese steel: Here is a country with no energy, no iron ore or coal, yet it's the largest exporter of steel in the world, exports half its output. To put that in context, China manufactures 700 million tons of steel and exports perhaps 30 million. Japan produces 110 million tons and exports 40 million. As long as Asia is strong, they are fine. But if Asia hiccups or reverses, plant-utilization rates go from very high to very, very low very quickly.

Then we discovered that Warren Buffett owned shares of South Korea's Posco [5490.S. Korea], and that Korea was the biggest importer of Japanese steel, but Posco and Hyundai [5380.S. Korea] are building huge, integrated steel plants. They have a surplus of steel capacity and—guess what?—they're exporting to Japan, because the yen is so strong.

Initially, I wanted to buy a three-year, out-of-the-money put on Nippon Steel. My broker said, "I've been in a 20-year bear market; my boss will kill me." Then I thought, being long credit protection is being long volatility. I redialed his credit counterpart. I said: "I'm thinking of purchasing up to a billion yen of five-year credit-default swaps in Nippon Steel." The first thing he said was, "Would you consider 10 billion?" So one part of the bank is banned from selling volatility, and the other part is having a party. I bought reams of the stuff.

Barron's: We've barely discussed Europe.
Hendry: We are partly playing it through Japan. If events kick off again in Europe, the correlation across all [global] asset classes will go to one. So the steel CDS is 130 basis points, while to insure against default by the French government, I'd be paying the same amount. Which is riskier? A very leveraged steel company that can't tax you? Or a government that can? Our bearish bets are largely outside Europe. As for Greece, the end game will be the Greeks rejecting austerity. The euro is nothing but a gold standard lacking flexibility, and all the onus is on private citizens to take the pain. Eventually, a Greek politician will say, 'Vote for me, and I'll get us out of this system.'

I certainly agree with that last comment above.

I as I have said and repeated Eventually, Will Come a Time When ....

Eventually, there will come a time when a populist office-seeker will stand before the voters, hold up a copy of the EU treaty and (correctly) declare all the "bail out" debt foisted on their country to be null and void. That person will be elected.

The Barron's interview is well worth a read in entirety.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Citigroup Whistle-Blower to Rake in $31 Million for Providing Evidence Citigroup "Defrauded" Fannie, Freddie

Posted: 22 Feb 2012 01:29 PM PST

Sherry Hunt, a Citigroup quality-assurance vice president turned in evidence of purposeful fraud against Fannie Mae and Freddie Mac and now stands to gain as much as $31 million as her share of the fine.

Please consider Citigroup 'Defrauded' Fannie, Freddie.

Citigroup Inc. (C), which last week admitted breaking Federal Housing Administration rules and paid a fine, also violated regulations for home loans sold to Fannie Mae (FNM) and Freddie Mac (FRE), according to a whistle-blower's complaint.

The bank "defrauded, falsified information or misled federal government entities" by selling or securing insurance for mortgages with defects such as improper appraisals and not reporting them as required, Sherry Hunt, a Citigroup quality- assurance vice president, said in her complaint, which was unsealed yesterday. It was filed under the False Claims Act in federal court in Manhattan in August.

Hunt's charges formed the backbone of the U.S. Justice Department's case against Citigroup, which paid $158.3 million in a Feb. 15 settlement and admitted that it certified loans for FHA insurance that didn't qualify. Her complaint provides additional details into the bank's broken mortgage-processing system. In last week's agreement, the government reserved the right to pursue criminal and other charges related to mortgages originated or underwritten by Citigroup and not insured by the FHA.

As a whistle-blower, Hunt's share of the settlement will be $31 million before taxes and attorney's fees, she said in a Feb. 15 interview.

For Citigroup, the third-largest U.S. bank by assets, the high defect rates could be costly. It might be forced to buy back substandard mortgages sold to government-controlled Fannie and Freddie, who buy or guarantee most U.S. mortgages.

Last year, Citigroup repurchased 6,600 loans from government buyers, an 89 percent increase from 2010, according to a presentation on its website. The bank set aside $1.2 billion to buy back defective mortgages as of the end of 2011. That's the most ever, and up from $969 million in 2010.

Hunt said Citigroup knowingly vouched for the quality of loans that were "deficient" in income documentation, had incomplete borrower job histories, appraisal problems, errors in closing paperwork, missing credit reports and miscalculated maximum mortgage amounts, among other flaws.

Some managers' compensation was tied in part to reducing the defect rate, Hunt said.

For certain types of home loans, Citigroup's "defect rate" -- the rate at which the underwriting raised questions -- was 80 percent, said Hunt, 54.

Taxpayers are on the hook for over $180 billion in bailouts to Fannie and Freddie. Citigroup got off the hook with a $158.3 million fine, of which Hunt gets a bonanza jackpot of $31 million.

Meanwhile, fraud is everywhere, and no one has gone to prison or held remotely accountable.

Mike "Mish" Shedlock
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Stop the Nonsense About the "Falling Dollar" Being the Cause of Rising Gasoline Prices

Posted: 22 Feb 2012 12:15 PM PST

Louis Woodhill, Forbes contributor says he applies "unconventional logic to economic issues". He proves it with this headline report Gasoline Prices Are Not Rising, the Dollar Is Falling

Forget the "logic" and skip straight to reality.

Crude Monthly

US Dollar Monthly

That's "unconventional" thinking for sure.

As for why the price of gasoline is rising, how about a discussion of ...

Peak oil
Supply disruption in the Mideast
Unsustainable growth in China
Liquidity spigots in the US, Europe, Japan, and China

... because the falling dollar theory sure is not the right answer.

Nor does this statement from the article make much sense "At this point, we can be certain that, unless gold prices come down, gasoline prices are going to go up—by a lot."

Really? Why can we be certain of that?

I get the fact he likes gold, and so do I. However, while the factors driving gold and oil overlap to a degree, they are not identical, and as I have pointed out gold can rise in deflation (it already has).

Woodhill's comment "because the dollar is currently a floating, undefined, fiat currency, there is no inherent limit to how far the price of gold in dollars can rise, and therefore no ultimate ceiling on gasoline prices" is technically true, but only in the context of hyperinflation.

Otherwise there is indeed a practical limit on the rise of the price of oil. Moreover, and as I have explained many times, many ways, the odds of hyperinflation in the US are extremely small.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Liquidity Floodgate Set to Backfire; Transmission Broken; Shutting Down the Liquidity Spigot

Posted: 22 Feb 2012 08:53 AM PST

The ECB's LTRO was a stunning success. Or was it? Certainly rates dropped in Italy and Spain. However, all that really happened is the ECB became the buyer of first resort in which banks front-ran the trade, buying sovereign bonds for sure profit, plowing back into the same problem that created the European mess.

The ECB's balance sheet skyrocketed in the process, and banks that plowed into those 3-Year LTROs (long term refinance operations) at cheap rates will face a huge rollover problem when the program ends, if not substantially before then.

Should something go wrong (and it will), then the ECB (or rather EMU member countries, especially Germany) will be on the hook for losses.

Consider the enormous mess over the past few weeks caused by a measly 40 billion euro holding of Greek debt by the ECB. Now take a look at the ECB's Balance Sheet expansion recently.

ECB Balance Sheet

Since July 8 2011, the ECB's balance sheet has expanded from 1.92 trillion Euros to 2.66 trillion Euros, a rise of 740 billion euros. €489 billion of that that was taken by 523 banks in the ECB's long-term-refinance-operation LTRO.

Round two is scheduled for February 29, and the ECB is rightfully getting nervous.

ECB Transmission Mechanism is Broken

FT Alphaville explains in the "Diagram Du Jour" How the ECB Transmission Mechanism is Broken

Courtesy of Nomura's euro area economics and strategy team:

Nomura explains In a normal functioning money market a rate cut by the ECB should trigger a tick up in money (i.e. deposits) and credit growth.

But, in abnormal times the interest rate and the bank lending channel can break down. And when banks are shut out of the money markets, they are forced into asset fire sales; the pressure on bank balance sheets can be severe, preventing banks from expanding the supply of credit.

It doesn't appear that the interest rate channel has improved since 2008; a worrying conclusion given the myriad ECB unconventional policy interventions in that period.

ECB Buyer of First Resort, Banks Still Aren't Lending

Simply put, banks aren't lending and funds pile up at the ECB just as excess reserves have piled up at the Fed.

The ECB is in worse shape than the Fed because rules prevent it from taking losses. When, not if, Spanish rates head back up, the ECB is going to have a pile of losses it will have to force onto member countries.

The ECB is already sitting on small stack of losses on Portuguese bonds, but for now the ECB supposedly has a profit on Spanish bonds, just as it supposedly had a profit on Greek bonds.

Salivating Over LTRO Round Two

On January 30, I commented You Ain't Seen Nothin' Yet; Another Trillion (or Two) Euro LTRO Coming Next Month

Last month, European banks tapped the ECB for €489bn in a long-term refinance operation dubbed LTRO. On February 29, another round of LTRO is coming up and expect banks to go for the gusto. Banks like cheap money to speculate and that is exactly what they will do.

Several of the eurozone's biggest banks have told the Financial Times that they could well double or triple their request for funds in the ECB's three-year money auction on February 29.

"Banks are not going to be as shy second time round," said the head of one eurozone bank at last week's World Economic Forum in Davos. "We should have done more first time."

Unlimited Money for Three Years at One Percent

The ECB is offering unlimited money to banks for three years, at one percent. Banks are salivating because the first round went well.

The money is supposed to go for bank lending but it won't. Why should banks lend? They have a guaranteed profit by speculating in Spanish or Italian bonds, assuming of course Spain and Italy do not need bailouts coupled with a writedown on government debt.

However, that's quite a risk, and in my opinion Spain will need such a writedown. If so, Germany will be on the hook once again.

Money Supply Will Soar, Lending Won't

Don't expect the next LTRO to make it into the real economy. It won't. Rather the LTRO will fuel more bank speculation and more leverage in government bonds. Money supply will soar, lending won't and this rates to be good for gold.

Money supply did soar, gold rose, lending didn't, and the ECB is getting nervous.

Shutting Down the Liquidity Spigot

Reuters reports ECB Preparing to Close Liquidity Floodgates

The European Central Bank wants its second offer of cheap ultra-long funds next week to be its last, putting the onus back on governments to secure the euro zone's longer-term future.

Powerful members of the central bank's 23-man governing council are privately hoping demand at the February 29 auction will fall well short of the 1 trillion euros some expect, backing their view that it should be the last.

Central bank sources say they are worried that banks will become too reliant on ECB funds, removing the incentive to restart lending between themselves.

The ECB first offered banks low cost three-year money in December to stave off a freeze in interbank lending that threatened to make the region's debt crisis much worse.

Banks flocked to take advantage of the offer, filling their coffers, and ECB President Mario Draghi said "a major, major credit crunch" had been averted.

The ECB funneled banks nearly half a trillion euros in cash at the first operation on December 21. A Reuters poll of over 60 economists showed a mid-range expectation for it to allot another 492 billion euros next week with some expecting up to a trillion to be taken.

ECB officials accept they have to help the banking sector but they also want to send a message that the unprecedented liquidity provision will end.

Bundesbank chief Jens Weidmann has warned that "too generous" supply of liquidity could create risky incentives for banks, which could in turn store up future inflation risks.

Bank of Finland chief Erkki Liikanen is also worried about ample liquidity provision leading to future problems and has said the ECB must think about how to unwind the extraordinary measures. Other senior policymakers are concerned too.

Anecdotal evidence suggests banks in Spain used the first LTRO to make most use of this "Sarkozy trade" - a term adopted by markets after the French president suggested governments look to banks that tapped the ECB operation to buy their bonds.

Italy faces a debt issuance hump in the next few months and could do with the second LTRO fuelling demand for its debt. It needs to sell around 45 billion euros of its bonds a month in both March and April versus 19 billion in February.

Temporary Fix

Market News International reports ECB 3-LTRO Cut Funding Crisis Risk But Won't Stoke Loans

The European Central Bank's new three-year refinancing operations have reduced the risk of a major funding crisis in the Eurozone, but they will not prevent banks from shrinking their balance sheets and constricting loan growth, Standard & Poors said in a study released Tuesday.

The rating agency also warned that the ECB's massive long-term lending has only deepened the divide that already existed between healthy banks and those that are more dependent on ECB funding. The ECB pumped E490 billion worth of three-year loans into the banking system in late December and is expected by some analysts to inject a similar or even larger amount at the second three-year LTRO to be held next Wednesday.

"The increase in ECB loans to banks and in bank deposits at the ECB reflects a deepening divide of the European banking industry. The gap is between the liquid, more credit-worthy banking groups that stockpile liquidity at the ECB and those that are less credit-worthy and relatively dependent on central bank funding and on government support programs in general," S&P noted. "The larger role of the ECB reinforces the credit tiering in the industry, in our view."

The reported cited "high dependence" on ECB funding for the banking industries of Greece, Ireland and Portugal, with "growing net use" by banks in Italy and Spain, and a "relatively neutral" position for French and Belgian banks. The banks in Germany, the Netherlands, Finland, Austria and Luxembourg, on the other hand, are net lenders to the ECB, the study showed.

The report also noted that the historically high volumes deposited by banks with the ECB -- a total of E730 billion as of February 3, in the overnight deposit facility and in one-week term deposits used to sterilize the central bank's sovereign bond purchases -- shows that the interbank market is still on very tentative footing.

"In our opinion, the huge amount of very low yielding deposits (25 basis points in the deposit facility, roughly 30-40 basis points on the fixed-term deposits) indicates that the top-tier banks prefer the safety of the ECB due to the uncertain conditions in the bank funding markets," S&P said, though it conceded that required risk weightings on interbank loans might also be a factor behind the large bank deposits at the ECB.

S&P's assessment of the ECB's three-year lending program is strikingly less upbeat than the central bank's own view. ECB President Mario Draghi and other top ECB officials have repeatedly argued in recent weeks that new cash is beginning to circulate in the economy and that the high level of deposits at the ECB was not necessarily evidence to the contrary.

Liquidity Floodgate Set to Backfire

The diagram above shows banks are hooked on LTROs
Those LTROs have created an exit problem for the ECB
Banks still are not lending so there has been no help to the real economy
Reserves are piling up at the ECB
The ECB is on the hook for losses, rather the net lenders to the system are: Germany, the Netherlands, Finland, Austria and Luxembourg

The widely touted "success" of the program will be fleeting. Look for huge stress on the system the moment rates in Spain and Italy head back up. A mess in Portugal (100% guaranteed) may trigger a catastrophe long before then.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Eurozone PMI "Worse Than Expected" and Back in Contraction; Expect German-Periphery Divergence to Resolve to the Downside for Germany

Posted: 22 Feb 2012 06:33 AM PST

Bloomberg reports Stocks Decline in Europe After Worse-Than-Expected PMI Data

Purchasing Managers Index

European (SXXP) services and manufacturing output unexpectedly shrank in February as the euro-area economy struggled to rebound from a contraction in the fourth quarter. A euro-area composite index based on a survey of purchasing managers in both industries dropped to 49.7 from 50.4 in January, London-based Markit Economics said in an initial estimate released by e-mail today. Economists had forecast a reading of 50.5, according to the median of 16 estimates in a Bloomberg News survey.

A separate report showed German services and manufacturing expansion unexpectedly slowed in February amid declining orders at factories in Europe's largest economy.

Unexpected?!

Exactly why anyone thought this would not happen is a mystery. The second mystery is why the data is so "good". Let's take a look at the actual data.

Markit Flash Eurozone PMI®

Please consider Markit Flash Eurozone PMI

Flash Eurozone PMI Composite Output Index at 49.7 (50.4 in January). Second-highest in six months.
Flash Eurozone Services PMI Activity Index at 49.4 (50.4 in January). Second-highest in six months.
Flash Eurozone Manufacturing PMI at 49.0 (48.8 in January). Six-month high.
Flash Eurozone Manufacturing PMI Output Index at 50.4 (50.4 in January).

The Markit Eurozone PMI® Composite Output Index fell from 50.4 in January to 49.7 in February, according to the preliminary 'flash' reading based on around 85% of usual monthly replies. The latest figure signalled a slight contraction in business activity following the marginal expansion seen in January, which had been the first month in which the Index had risen above the 50.0 no-change level since last August.

The latest reading was nevertheless the second-highest of the past six months, and suggests that the Eurozone economy has stabilised over the first two months of the year having contracted in the final quarter of 2011.

Incoming new business fell for the seventh month running, but the rate of deterioration eased for the fourth month in a row to register the smallest drop in demand for six months. Rates of decline eased in both manufacturing and services, with the latter showing the smaller decline. Manufacturers reported the weakest drop in demand for seven months, led by an easing in the rate of loss in new export orders, while the decline in service sector new business was the smallest in the current six-month sequence.

Backlogs of orders fell across the region for the eighth successive month, but at reduced rates in both manufacturing and services. The overall fall was the smallest for six months. However, a combination of falling inflows of new business and lower backlogs of work caused companies to trim their headcounts, leading to a slight drop in employment for the second successive month.

Reductions in headcounts were only marginal in both manufacturing and services, but contrasted with robust employment growth in both sectors during the first half of last year. Employment growth in Germany slowed to the weakest since March 2010, while only a modest gain was seen in France. Elsewhere in the Eurozone, the average rate of job losses eased to a four-month low but remained steep.

Commenting on the flash PMI data, Chris Williamson, Chief Economist at Markit said:

"A retreat back below the 50.0 no-change level for the Eurozone PMI is a disappointment, and highlights the ongoing risk that the region may be sliding back into recession. Although business conditions are showing signs of stabilising so far this year, which represents a marked improvement on the widespread deepening gloom seen late last year, the Eurozone is by no means out of the woods. Demand needs to improve considerably in coming months before we can safely say that the region will return to anything like reasonable growth.

"Encouragingly, business confidence continues to improve on the better news flow surrounding the sovereign debt crisis and renewed stimulus from the ECB. But even German companies remain unsure about the outlook, and many are clearly seeking to cut costs where possible in order to be more competitive in a tough business environment.

"Sharp divergences in performance also continued to be evident across the region, with modest growth in Germany contrasting with a steep decline in the periphery. Given the lack of domestic demand in austerity-hit peripheral countries, this divergence looks set to continue for some time."

Expect German-Periphery Divergence to Resolve to the Downside for Germany

The idea that Europe can avoid a recession is complete silliness. Europe is clearly in a recession already.

The amazing thing is things have not deteriorated more than they have. Unlike the Chief Economist at Markit, I expect the divergence to resolve to the downside for Germany, not for the divergence to continue for some time. Given conditions in Europe and Asia, the odds that Germany is immune from the global slowdown are essentially zero.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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