Thursday, December 20, 2012

Social Security on the Chopping Block

The White and Congress are presently engaged in heated Fiscal Cliff negotiations. With the national debt exceeding $16 trillion and the CBO projecting continued deficits for the next decade, even Social Security has entered the budget-cutting discussions.

However, Social Security is financed by an independent payroll tax, which solely funds the program. For 75 years, Social Security collected more funds than it paid out. By the end of 2011, that surplus had reached $2.7 trillion. Those surplus funds were used to buy special bonds from the U.S. Treasury, creating the so-called Social Security Trust Fund. This fund is expected to keep Social Security fully solvent until 2033.

Even after that time, payroll taxes are projected to cover approximately 75% of program obligations.

Under current law, the securities in the fund represent a legal obligation the government must honor when the program's revenues are no longer sufficient to fully fund benefit payments.

According to the Social Security Trustees, who oversee the program and report on its financial condition, program costs are expected to exceed non-interest income from 2011 onward. However, due to interest (earned at a 4.4% rate in 2011) the program will run an overall surplus that adds to the fund through the end of 2021.

The problem is that, over many years, the government used the monies slated for the Trust Fund to instead finance its annual budgets. In other words, the $2.7 trillion Trust Fund was transferred to the general fund, which pays the government's everyday operating expenses each year. And it's all gone.

In order to repay retirees the money that was already collected from them, the government will have to redirect money from it's future budgets, or general fund, back to retirees. This is why Social Security is suddenly on the chopping block in current budget negotiations.

Though Social Security is independently funded and does not contribute to the government's annual budget deficits, there are some reasons for concern.

According to the Social Security Administration (SSA), just over 1 in 4 of today’s 20 year-olds will become disabled before reaching age 67. That will be a heavy burden for the system to bear. It may also force a reexamination of the definition of "disabled" and result in stricter rules for qualifying.

The SSA also notes the following:

• In 1940, the life expectancy of a 65-year-old was almost 14 years; today it's almost 20 years.

• By 2033, there will be almost twice as many older Americans as today -- from 43.4 million today to 75.7 million.

• There are currently 2.8 workers for each Social Security beneficiary. By 2033, there will be 2.1 workers for each beneficiary.

Given longer life expectancies, the coming tidal wave of retirees, and the diminishing number of workers per retiree, it's clear that some changes may be needed by 2033, when the Trust Fund (aka, the money the government collected and spent on other things) is finally exhausted.

In the meantime, the government owes it to its citizens to return the surplus money that's been collected from them, and it is legally obligated to do so. That money will have to come out of other government programs, such as military spending. Regardless, it will surely have to come from elsewhere in the budget.

It should also be noted that the Social Security retirement age is already 67 for those who were born in 1960 and after. That's something that needs to be considered in any negotiations.

One way or another, the government needs to repay the citizens the money it has already collected from them. And it should not attempt to tax them again in order to repay them.

Monday, December 10, 2012

Despite Headlines, Jobs Problem Continues to Confound U.S.

The government reported that 146,000 nonfarm payroll jobs were created in November. Though the creation of jobs is always welcome news, it must be viewed in the proper perspective.

Over the past year, employment has risen by an average of 157,000 per month in a country with 134 million jobs. That’s an increase of about 0.1% a month.

While the unemployment rate also fell sharply to 7.7%, it was due to a decline in the labor force, not to any improvement in the labor market.

The labor force fell by 350,000 in November and the labor force participation rate (the percentage of people employed and those who are unemployed but seeking a job) fell to 63.6% from 63.8% in October.

For perspective, the labor force participation rate was 67.3 in January 2000. Yet, when the recession began in December of 2007, the participation rate had fallen to 66 percent.

This means that in less than 13 years, the percentage of Americans participating in the labor force has dropped from 67.3% to 63.6%, a rather striking decline.

Clearly the long term trends are not good. The unfortunate reality is that discouraged people continue giving up their search for work.

Additionally, the average duration of unemployment was at 40 weeks in November, near historic highs.

The official unemployment figure doesn't include those who have lost their unemployment benefits. Nor does it count those who only have part-time jobs but want full-time work.

None of that is encouraging.

It takes about 125,000 new jobs per month just to keep up with population growth. Though the economy is currently achieving that, we need 250,000 new jobs per month for a year to truly drop the unemployment rate by a little more than 1%. Yet, in order for that to happen, the economy needs to grow north of 3% per year.

However, U.S. gross domestic product increased at an annual rate of 1.3% in the second quarter and by 2.0% in the first quarter. That does not bode well for job creation.

Unfortunately, at this rate, it will take years to create jobs for everyone who wants one.

At the pace of job creation over the past two years, the U.S. would not return to pre-Great Recession employment levels until after 2025, according to the “jobs gap” calculator from The Hamilton Project.

The Great Recession—which officially lasted from December 2007 to June 2009—resulted in massive job losses that the economy is still trying to recover. In 2008 and 2009, the U.S. labor market lost 8.4 million jobs, or 6.1% of all payroll employment. This was the most dramatic employment contraction (by far) of any recession since the Great Depression. By comparison, in the deep recession that began in 1981, job loss was 3.1%, or only about half as severe.

The economy has since recovered four million of those lost jobs, meaning we are only half way to recovery. Yet, that doesn't even begin to address the monthly increase of new entrants into the labor market, which creates a continual need for even more jobs.

Despite the slow but steady state of job creation, here’s the underlying problem: the recovered jobs on average pay a lot less than did the jobs that were lost. Low-wage jobs like retail and food service workers have made up 58 percent of the subsequent job growth. With less income, Americans have less to spend and spending is what expands economies.

Wages in the retail industry remain low compared to other sectors, with the average full-time sales worker making just $21,000 per year, according to the Bureau of Labor Statistics.

Peter Edelman, a law professor at Georgetown University, says the proliferation of low-wage jobs is the single biggest cause of persistent poverty.

"The first thing needed if we're to get people out of poverty is more jobs that pay decent wages," he argued in a July New York Times op-ed. "We've been drowning in a flood of low-wage jobs for the last 40 years… Half the jobs in the nation pay less than $34,000 a year, according to the Economic Policy Institute. A quarter pay below the poverty line for a family of four, less than $23,000 annually."

And wages in the bottom half "have been stuck since 1973, increasing just 7 percent," Edelman noted.

Jeff Faux, a progressive economist who founded the Economic Policy Institute in 1986, argues that by the mid-2020s, even with the most optimistic assumptions about economic growth, current trends indicate that the average American's wages will drop about 20 percent. One big factor is that more and more good jobs will go overseas, leaving even America's best and brightest no alternative but to enter the service industry.

America's dual problems of high unemployment and low-wage jobs will continue to have negative consequences for our consumption-based economy, which is 70% reliant on consumer spending.

Obviously, there is less consumption when fewer people are working and when so many of those with jobs are earning so comparatively little. Ultimately, there is less disposable income being directed back into the economy. It also results in lower tax receipts at both the state and federal levels.

If unemployment remains stubbornly high, wages will also remain stagnant. That will create a negative feedback loop of both lower consumer spending and lower economic output.

As of now, we're still a long way from recovery, and a full recovery is anything but assured.

Japan's bubble economy burst in the late 1980s and, nearly a quarter-century later, it has yet to recover.

That's a horrible precedent for the U.S.

Sunday, December 02, 2012

Fiscal Cliff an Opportunity to Correct Fiscal Imbalances

A point that I've repeatedly made on this site is that the U.S. government has both a spending problem and a revenue problem.

In the last fiscal year, the government collected 15.5 percent of GDP in revenue and spent 22.4 percent. That's a considerable problem and it cannot continue.

Due to high unemployment plus lower incomes and wages, tax revenues have plunged from their historical average of !8 percent of GDP. As a share of GDP, income tax revenues are at their lowest level since 1951, when Harry S. Truman was president.

To offset this lack of private demand, the government increased expenditures to fill the void and undergird the economy. Yet, that has grown the government to excessive proportions, which is not good for the long term health of the economy.

A 1998 Congressional Joint Economic Committee study concluded the optimal size of government to maximize economic growth was about 18% of gross domestic product. The government is now spending well above that.

Washington's profligate ways go back many years.

Over the forty years ending in 2008, federal revenues averaged about 18.3 percent of our economy, while spending averaged over 20.6 percent, resulting in an average deficit of about 2.4 percent. Since 1970, the Federal Government has run deficits for all but four years (1998–2001).

All those deficits have added up to a national debt that now exceeds $16 trillion, and counting. Medicare and defense spending are the biggest drivers of the government’s continual deficits and massive debt.

The U.S. dedicates 18% of GDP to healthcare — the greatest share of any nation in the world and about twice as much as other industrialized nations.

By the end of the Congressional Budget Office’s 10-year budget forecasting period in 2022, Medicare outlays will be more than $1 trillion a year. For the entire ten-year period, 2013-2022, Medicare will cost taxpayers $7.7 trillion.

However, American workers pay a Medicare tax (separate from the income and FICA taxes) that funds the hospital insurance system, which provides medical benefits to eligible individuals upon reaching age 65. That tax may be raised, or benefits lowered, to counter shortfalls. The same is not true with military spending.

Pentagon spending accounts for over 50 percent of all discretionary spending in the federal budget, and overall security spending constitutes two-thirds of the discretionary budget, according to the CBO. Military spending has tripled since 1997. Simply put, the Defense budget is bloated and wasteful.

According to estimates by Nobel Prize-winner Joseph Stiglitz and Professor Linda Bilmes of the Harvard Kennedy School, when all the costs are counted, the Iraq invasion and the Afghan war will each cost US taxpayers $3 trillion dollars. Both were unfunded. In other words, the two wars doubled the U.S. public debt.

When all defense-associated spending is added up — including the Defense Department, Overseas Contingency Operations, the Department of Veterans Affairs and the Department of Homeland Security — all of the mandatory and discretionary programs amount to a whopping $877.9 billion annually, according to the Office of Management and Budget.

And this doesn't even include the money dedicated to the Department of Energy to maintain the nation's nuclear weapons arsenal.

Based on the Government Accountability Office’s latest long-range alternative budget simulation, by the end of this decade our interest payments will become the largest single expenditure in the federal budget. By 2040, all of our federal tax revenues will add up to cover only our two biggest expenses: interest on our debt plus Medicare and Medicaid. Everything else — Social Security, defense, education, road building, you name it — will fail to be funded.

Washington has finally accepted that it has a significant problem that can no longer be ignored and passed on to the next group of legislators. Negotiations are underway to avoid the fiscal cliff. Congress will also have to negotiate another raise of the debt limit. Furthermore, Congress hasn't even passed the fiscal 2013 budget, which was submitted by the White House back on February 13th.

It's worth noting that the fiscal year began on October 1st and runs through next September. So, the government has been operating for more than two months (one-sixth of the year) without a formalized budget.

One of the big sticking points in negotiations to avoid the fiscal cliff is President Obama's insistence that income tax rates go up for the wealthiest Americans. Most congressional Republicans are against that idea.

House Speaker John Boehner claims that raising taxes on the top 2 percent of income earners would be unfair because half of those taxpayers are small business owners who pay their taxes through their personal income tax filing each year.

The Speaker made that assertion again this week. Yet, Boehner has been repeatedly corrected on this by fact-checkers. In fact, the Speaker's office says that he misspoke when he made that claim this week, although it's a misstatement he's made more than once.

Last year, some analysts at the Treasury Department took a closer look at what constitutes a small business, and they defined them as those making up to $10 million.

They excluded all those that were making over $10 million. At the other end, they threw out people who might have a big salary from a day job and then a little small business on the side.

When they narrowed the definition that way, what they found was about one in five taxpayers in those top two brackets is a small business owner. And of all the income in those brackets that would be taxed at a higher rate, only about 7 percent comes from small businesses.

Republicans say that raising tax rates on the highest earners would result in a loss of jobs.

However, when the Congressional Budget Office looked at what the affect of raising those taxes would be on jobs, they found it'd really be pretty tiny — about 200,000 jobs over the course of a decade. That's about as many jobs as the economy has been adding in one or two months.

Additionally, a recent report by the non-partisan Congressional Research Service (CRS) found no correlation between top tax rates and economic growth, a central tenet of conservative economic theory. Specifically, the report found that there is no evidence that tax cuts for millionaires and billionaires leads to improved economic growth. The CRS analysis compared tax policy with GDP patterns over the last 65 years.

The report was first released in September, but was removed from public circulation shortly thereafter because Senate Republicans objected to the findings.

Republicans say any new revenue should be raised by curbing tax breaks.

Given that 45 percent of U.S. households do not pay income tax (either because they don’t earn enough or through credits and deductions) and 3% of taxpayers contribute around 52% of total tax revenues, a major overhaul of the U.S. taxation system is in order. In fact, eliminating tax breaks may ultimately be a better, fairer way to raise more revenue.

The problem is that anti-tax crusaders like lobbyist Grover Norquist, and his Republican adherents in Congress, have insisted that any tax reform which reduces or eliminates write-offs, deductions and exemptions must be revenue-neutral. If that's the case, then what's the point? This cannot be an exercise in futility amounting to nothing more than simply rearranging the deck chairs.

Simply increasing tax rates on the wealthiest Americans would not raise enough revenue to address the nation's fiscal crisis. Additional measures are needed.

If the Bush tax cuts were allowed to expire on couples whose income is over $250,000 and singles over $200,000, it could raise close to $1 trillion over 10 years, according to Tax Policy Center data. Allowing the Bush tax cuts to expire on income over $500,000 ($400,000 for singles) could raise at least $315 billion over a decade. And if the Bush tax cuts were allowed to expire on income over $1,000,000, at least $242 billion could be raised.

As you can see, squeezing additional revenues from only the very wealthiest Americans results in increasingly diminishing returns.

To truly get at the revenue problem, all of the numerous tax loopholes must be closed and deductions eliminated. Lobbyists have spent the past couple of decades getting favored status for their varied interests and layering the tax code with assorted breaks, deductions, write-offs and loopholes.

After all, what's the point of tax brackets if the effective rate people are paying is less than that written into law?

Republican Senator Bob Corker of Tennessee has circulated a proposal to cut the deficit by $4.5 trillion over 10 years. Corker would address entitlements by gradually increasing the age for Medicare and Social Security eligibility and would lower cost of living increases for Social Security.

As for taxes, Corker would not raise rates, but would cap itemized deductions at $50,000. The senator says there are $1.2 trillion in loopholes and deductions in the tax code at present. His hope is to "simplify the code."

Corker says his proposal, "keeps rates where they are but generates revenues from wealthy citizens by closing loopholes."

And he believes that such an idea would popular, telling NPR, "I would say that most Americans would like to see the tax code get rid of all the loopholes that exist there."

He's probably right. What most Americans surely want is fairness. They'd like to know that some taxpayers aren't granted the privilege of special breaks the rest of us aren't privy to. The highest-income households enjoy more than 40% of the benefits of all tax breaks taken every year, according to the Tax Policy Center.

However it is arrived at, the government needs to increase revenue and reduce spending.

Some economists and analysts advance the notion that a country can indefinitely run deficits without endangering its economic survival as long as those deficits remain below its rate of economic growth.

However, the U.S. has a debt that exceeds $16 trillion and is still growing. Though it will be impossible to ever fully repay that debt due to the nature of money itself, it is important to begin continually chipping away at the debt rather than adding to it. Otherwise, the bond market will eventually turn on the U.S., sending interest rates soaring.

The trouble for the U.S. is that we are in a sustained pattern of about 2% economic growth and it is difficult to foresee that changing over the next few years. Any sudden internal or external shocks (economic crisis in Europe or Japan, for example) could easily tip the U.S. into recession.

That's the concern with the fiscal cliff. According to the Congressional Budget Office, the looming combination of tax increases (the end of the payroll tax holiday and the Bush tax cuts) and legislated budget cuts will lead to a recession, shrinking the economy by 1.3% in the first half of 2013.

The upside is that the CBO also says the economy will then expand 2.3% in the second half. There's some pain upfront, but there's some relief in the end.

Congress and the nation are faced with a moment of truth. Though this combination of hikes and cuts will be painful, it is needed nonetheless. Congress needs to swallow this bitter medicine and take a leap off the fiscal cliff.

Yes, it will result in a recession next year, but the long term benefits will make it worthwhile. Congress has avoided these difficult decisions for far too long and to avoid them any further will result in an even worse predicament down the road.

The time for easy choices or good alternatives has long since passed.

Saturday, November 17, 2012

Cost/Benefit Analysis of Fracking Reveals That Risks Outweigh Rewards

The news media was abuzz this week with a new report by the International Energy Association (IEA) saying the U.S. will become the world's largest oil producer by 2020, overtaking current leaders Saudi Arabia and Russia.

The IEA also says the U.S. could become self-sufficient in energy by 2035 and a net exporter of natural gas by 2020.

According to the IEA, this will result in a radical shift that could profoundly transform not only the world's energy supplies, but also its geopolitics.

Such an outcome could prove revolutionary, with the potential to reshape global alliances. It would have enormous implications for foreign policy and the military.

It could also result in the creation of up to 600,000 new jobs, according to the Obama Administration. For a nation struggling with such a stubborn unemployment problem, an expansion of well-paying jobs is much needed.

The prospect of the U.S. becoming energy self-sufficient has long been unimaginable and seemingly the product of wishful thinking. For decades, the U.S. has been the world's No. 1 oil importer.

However, U.S. oil production has undergone a sudden and rapid rise, jumping 15% since 2008, and oil imports are now at their lowest level in two decades.

U.S. production has seen a particularly brisk escalation in just the past year. According to the Energy Information Administration (the statistical and analytical agency within the U.S. Department of Energy), U.S. oil production has increased 7%, to 10.76 million barrels a day, since the IEA's last outlook a year ago.

Oil and petroleum imports have fallen an average of more than 1.5 million barrels per day and domestic crude oil production has increased by an average of more than 720,000 barrels per day since 2008.

"North America is at the forefront of a sweeping transformation in oil and gas production that will affect all regions of the world," said IEA Executive Director Marian von der Hoeven in a statement.

So what's behind this remarkable transformation?

The American shale oil boom.

The global energy map, "is being redrawn by the resurgence in oil and gas production in the United States," the IEA reports.

A technique known as hydraulic fracturing, or "fracking," is allowing the energy industry to develop hydrocarbon resources locked in shale and other tight rock formations.

But though this technique will allow the U.S. to gain a previously unimagined energy independence, there is a darker side to fracking.

Fracking involves pumping large quantities of fresh water, coupled with chemicals and sand, into shale formations to crack the rock and extract the fossil fuels. Studies have revealed that fracking fluids contain a host of toxic substances, including known carcinogens and volatile organic compounds.

Fracking has the documented potential to contaminate drinking water sources, as well as pollute air and land. Additionally, the process can spoil millions of gallons of fresh water used in the drilling process that must then be disposed.

In its report, the IEA warned that the emergence of shale gas has a downside risk, contributing to increased competition for the water resources needed for energy projects. The intensive use of water, "will increasingly impose additional costs," and could "threaten the viability of projects" for shale oil and gas, and also biofuels, the agency said.

The vast amounts of water used in the fracking process are troubling, considering how relatively little fresh water is available. Of all the water on Earth, only 2.5 percent is freshwater, and available freshwater represents less than half of 1 percent of the world's total water stock.

This is problematic for the U.S. since groundwater is being used up at a rate 25 percent faster than it is being replenished, according to the government, which also warns that up to 36 states face near-term water shortages.

In June, 2009, the Obama administration released a 190-page assessment of documented and expected impacts of climate change across the United States. “Water permeates this document,” said co-author Virginia Burkett.

Lead author of the report, Jerry Melillo, added, “Water is going to be a tremendous challenge for energy.”

Fracking has been revolutionary because, unlike conventional drilling, it doesn't just create vertical wells.

Horizontal hydrofracking is a means of tapping shale deposits containing natural gas that were previously inaccessible by conventional drilling. Vertical hydrofracking is used to extend the life of an existing well once its productivity starts to run out, making it a last resort of sorts.

Horizontal fracking differs in that it uses a mixture of 596 chemicals, many of them proprietary (meaning they aren't revealed), and millions of gallons of water per frack. This water then becomes contaminated and must be cleaned and disposed.

Generally, 1 to 8 million gallons of water may be used to frack a well, and a well may be fracked up to 18 times. That's an astonishing use of water.

For each frack, 80 to 300 tons of chemicals may be used. Presently, the natural gas industry does not have to disclose the chemicals used, but scientists have identified volatile organic compounds (VOCs) such as benzene, toluene, ethylbenzene and xylene.

The documentary "Gasland," by film-maker Josh Fox, clearly illustrates the dangers of fracking. According to the Gasland Website:

• Researchers suspect that 65 of the compounds used in fracking are hazardous to human health.

• Over 80,000 pounds of chemicals are injected into the earth's crust to frack each well.

• Over 3.5 million gallons of water are used when fracking a single well.

• Fracking fluid calls for 2 million gallons of water, transported by up to 100 water-haulers.

• Upwards of 70% of fracking fluid remains in the ground and is not biodegradable.

• A loophole in the 2005 Energy Bill exempts gas drillers from EPA guidelines like the Clean Water Act.

In areas where fracking occurs, watersheds have become heavily polluted. A scientific study conducted by four scientists at Duke University found that high levels of methane gas in drinking water wells are linked to flammable drinking water.

The problem is so bad that some homeowners have actually been able to set their tap water on fire.

A recent University of Colorado-Denver School of Public Health study showed that living within a half mile of fracking sites exposes residents to pollutants like trimethylbenzenes, aliphatic hydrocarbons, and xylenes at five times above the U.S. Environmental Protection Agency's Hazard Index.

Those concerns led the residents of Longmont, Colorado, to vote to make their city the first to ban fracking in the state.

Additionally, fracking has been linked to earthquakes. Seismic activity associated with fracking has been reported in Ohio, Oklahoma and Texas. The US Geological Survey says the use of underground wells to dispose of waste water produced by fracking is “almost certainly” behind the surge in earthquakes in the central US in recent years.

Cheap natural gas has also shifted resources away from green energy technologies like solar and wind, which don't have the same environmental concerns. It may also shift attention away from energy conservation and energy efficiency, which have long been deemed crucial.

Then there is the concern of the lifespan of fracked wells. Initially, these wells allow abundant production but can soon decline abruptly. The yield for a typical shale gas well generally falls off sharply after the first year or two.

This is a problem that even industry insiders admit. Bill Kinney of Summit Petroleum Inc. acknowledges the most productive years of a fracked well are usually the first three or four.

This may be leading to a false boom in the natural gas sector, in which we soon discover that fracking does not yield nearly as much fuel as industry proponents claim.

Drilling for natural gas is also an energy-intensive business. It relies on diesel engines and generators running around the clock to power rigs, and heavy trucks making hundreds of trips to drill sites before a well is completed. So far, few companies are using natural gas itself to power the process, meaning that it relies heavily on conventional oil supplies.

It's evident that the benefits of energy independence, and the well-paying jobs associated with it, come at a steep cost that must be weighed against all of the tremendous risks.

So while the recent IEA report may be greeted by some as a panacea for our nation's energy conundrum, the numerous concerns associated with fracking may ultimately prove that its risks greatly outweigh the rewards.

Wednesday, October 31, 2012

Middle Class Battered, Social Mobility Declining

More than five years after the start of the Great Recession, its lingering after-effects continue to diminish the standard of living of the once-thriving American middle-class.

Median household income, after adjusting for inflation, fell 1.5 percent last year to $50,054, according to the Census Bureau's annual report on income and poverty, which was released in September. Meanwhile, the poverty rate, at 15 percent, remained stuck at the highest level since 1993.

The erosion of the middle-class has been a long and continual process. Median household income, adjusted for inflation, has been steadily dropping for 13 years.

While the median income slipped last year, those at the top of the income ladder continued to move ahead. The top 5 percent of incomes rose by 5.3 percent last year, according to government data.

The fact that the rich continue to get richer should surprise no one. What may be a surprise, however, is that the notion that hard work can lead a person from rags to riches is largely a fantasy. The famed Horatio Alger stories were, after all, works of fiction from the 19th Century.

The U.S. has less economic mobility than Canada and much of Western Europe, according to economic research cited by The New York Times. Seven in ten Americans that start out in the bottom fifth of family income stay in the lower class as adults, and more than six in ten Americans that start out in the top family income quintile stay in the upper class as adults, according to a July report by the Pew Charitable Trusts.

In other words, if you are born rich or poor you are likely to remain that way throughout your lifetime. America is simply not the "land of opportunity" that many believe it is.

A new report from the Organization for Economic Co-Operation and Development (OECD) finds that America is 10th in social mobility between generations, dramatically lower than in nine other developed countries. This means that America is now 10th in the world in the American dream.

Just 35 percent of American households can be classified as upwardly mobile, meaning they have a higher household income than their parents at the same age and are at a higher point in the income distribution ladder than their parents had been.

This means that roughly two-thirds of Americans are financially stagnant and will not have a higher standard of living than their parents, which was the norm for generations.

Work and income are the means by which most people historically extricated themselves from the lower classes — not inheritance and not the lottery. However, such a rise up the social ladder is becoming increasingly difficult.

Entry-level wages for high school graduates are actually lower than they were in the 1970s. For college grads, starting wages are below what their counterparts pocketed in the late 1990s. Today, the average wage for all these young adults, no matter education level, is about $15 an hour.

How can a young person start a family or buy a house on that income?

Out of 34 industrialized countries, the U.S. had the highest share of employees toiling away at low-wage work in 2009, according to OECD data.

Remarkably, one in four U.S. employees were low-wage workers in 2009, according to the OECD. That is 20 percent higher than in the number-two country, the United Kingdom. Low-wage work is defined as earning less than two-thirds of the country's median hourly wage.

Low-wage jobs are replacing jobs that can sustain a middle-class lifestyle, according to a new study by the National Employment Law Project. Most of the jobs lost during the recession paid middle wages, while most of those gained during the recovery are low-wage jobs.

However, while the lower and middle-classes continue to struggle and even fade, the wealthiest Americans continue to prosper.

The U.S. now has the biggest income disparity gap of any industrialized country in the world

According to a recent study by University of California economist Emmanuel Saez, based on an analysis of American tax returns, in 2010, 93 percent of all new income growth went to the top 1 percent of American households. Everyone else, the bottom 99 percent, divided up the remaining 7 percent.

Clearly, the problem of wealth inequality in America continues to worsen. The evidence abounds.

American CEOs saw their pay spike 15 percent last year, after a 28 percent pay rise the year before. That's in line with a trend that dates back three decades.

CEO pay spiked 725 percent between 1978 and 2011, while worker pay rose just 5.7 percent, according to a study by the Economic Policy Institute released in May. That means CEO pay grew 127 times faster than worker pay.

Last year, CEOs earned 209.4 times more than workers, compared to just 26.5 times more in 1978. That disparity is mind-boggling and it is indicative of the way in which incomes have been siphoned off to the richest Americans and away from the common workers.

"We've always had inequality, but the magnitude of our inequality has actually increased dramatically," says Nobel Prize-winning economist Joseph Stiglitz. "The fraction of the income that goes to the upper 1 percent has doubled since 1980. The fraction that goes to the upper .1 percent has almost tripled since 1980. So yes, we've always had inequality, but not of this magnitude.

"The United States has become the most unequal country among the advanced industrial countries," says Stiglitz. "Some people have said, 'We don't care about equality of outcome, what we really care about is equality of opportunity. America's the land of opportunity.' We have less opportunity than not only the countries of all of Europe, but any of the advanced industrial countries for which there's data. And what that means is very simple: The life chances of an individual are more dependent on the income and education of his parent than in other countries. And an implication of that is people born in the bottom, who unfortunately chose the parents who were poor or not well-educated, will be more likely not to be able to live up to his potential."

Yet, this is more than just a matter of inequality. It has implications that effect the broader economy.

Rising income inequality is resulting in lower levels of economic growth. In a consumption-based economy, the masses must have adequate resources to maintain the economy. Consumer spending represents 70 percent of U.S. GDP, which is plainly unsustainable given current trends.

Undoubtedly, having a healthy middle class is a requisite to having a healthy economy.

But an abundance of low-wage jobs will not get us there. The vast majority of Americans are in long term economic decline. It should surprise no one that our economy is following right along.

"The tidal wave of low-wage jobs is dragging us down and the wage problem is not going to go away anytime soon," says Peter Edelman, director of the Georgetown Center on Poverty, Inequality and Public Policy.

Our gross inequality will lead to social instability. Obviously, those at the top are heavily invested in maintaining the status quo. But eventually that will lead to societal breakdown.

The American dream is falling further and further out of reach for far too many Americans, and our once-great economy is suffering for it. As that suffering works its way up the economic pyramid, there will be a critical mass, a mass movement for change. But by then it will be too late.

The America that our parents and grandparents grew up in will be irrevocably altered, for the worse.

Friday, October 19, 2012

U.S. Economic Growth Has Been Slowing For Many Years

With the global economy decelerating and much of Europe already in recession, the focus has shifted to China, where a series of recent indicators reveal that the world's second largest economy is also slowing.

For example, Chinese manufacturing contracted in September for the 11th consecutive month, according to the HSBC purchasing manager's index (PMI). The HSBC PMI was 47.9 for September, slightly up from 47.6 in August. The index measures manufacturing activities on a 100-point scale, on which numbers below 50 show a contraction. The August reading was the lowest level since March 2009 — a 41 month period.

China's National Bureau of Statistics reported Thursday that gross domestic product grew 7.4% in the third quarter compared to a year earlier, slowing from the second quarter’s 7.6%. It marked the slowest pace of growth since the first quarter of 2009.

However, though China's growth is indeed slowing, it is still extraordinary by any measure.

What's truly remarkable is that a growth rate of 7.4% is actually part of a slowing trend. Such a reading in the U.S. would be historically exceptional and greeted with national jubilation.

From 1948 through to 2009, the United States economy grew by an average of 3.28% per year.

The last time the U.S. economy grew at least 7.4% over the course of a full year was 1951, when it expanded 7.7%. But that kind of growth is now a distant memory in the U.S.

The best year for the U.S. economy since 1948 came in 1950, when the economy managed to expand by 8.7%.

Here are the top five years of GDP growth since 1948:

1950, 8.7%
1951, 7.7%
1955, 7.2%
1959, 7.2%
1984, 7.2%

As you can see, it's been three decades since the U.S. economy grew at a pace even resembling China's, which is currently slowing.

Yet, since 1973, the U.S. economy has experienced slower growth, averaging 2.7% annually. Meanwhile, household incomes increased by just 0.3% annually over that period.

That stagnation, coupled with persistent inflation, has hurt growth and lowered the standards of living for millions of Americans.

After contracting in 2009, the U.S. economy expanded 2.8% in 2010 and 1.7% in 2011. This year, U.S. GDP increased 2.0% in the first quarter and 1.3% in the second quarter.

At the same time, the ballooning national debt now exceeds $16 trillion. Typically, the US would attempt — or hope — to grow its way out debt. However, that seems to be an impossibility at this point with the rates of growth and debt moving in opposite directions. The federal debt will continue to increase at a faster pace than the economy can grow.

If not for all the government spending in recent years, the U.S. economy would still be in recession. Excluding the government's unbridled deficit spending, real GDP has been flat for 15 years. In fact, without the growth in government debt, the U.S. would likely be experiencing a depression.

Advanced economies are mature economies, and therefore harder to grow. The sad reality is that growth has been rather slow for a number of years and we may have now entered a long-term period of lower growth and higher unemployment.

Since the second quarter of 2006, there has only been one quarter in which GDP was at least 4% — the fourth quarter of 2009. Yet, that 5.6% growth rate was largely the result of government stimulus spending.

The problem is that economic growth needs to be at least 2.5% to improve the nation's dismal unemployment situation. Anything lower won't even keep up with population growth.

The U.S. economy needs to create 250,000 new jobs per month for a year to drop the unemployment rate by a little more than 1%. However, in order for that to happen, the economy needs to grow north of 3% per year. That kind of expansion is proving to be increasingly difficult.

According to a recent McKinsey Global Institute study, the economy is likely to remain slow for decades to come.

McKinsey argues that the economy is likely to remain slow because as labor force participation drops—as more and more baby boomers retire and the number of new women entering the workforce slows—Americans who do work will have to support the increasingly large proportion of Americans who don’t.

Moreover, the decline in spending associated with the progressive retirement of the Baby Boomers will reverberate through the economy and create a major drag on growth.

The lack of adequate job creation conflates with our nation's slowing growth. In fact, the two are creating a feedback loop. Job creation has been slowing for decades and that's a very bad omen.

According to the Economic Cycle Research Institute, during periods of American economic expansion in the 1950s, ’60s and ’70s, the number of private-sector jobs increased at about 3.5 percent a year. But during expansions in the 1980s and ’90s, jobs grew just 2.4 percent annually. And during the last decade, job growth fell to 0.9 percent annually.

And it's taking longer and longer to recover from each successive recession. The last time the jobless rate reached double digits, in the early 1980s, it took six years to bring it down to normal levels.

The historical precedents and current trends make it very difficult to feel optimistic about the future.

For decades, the U.S. has been losing jobs to developing nations (i.e. China) due to their lower labor costs. This off-shoring has particularly decimated the manufacturing sector and led to a massive trade imbalance.

Since 1976, the US has sustained trade deficits with other nations. Simply put, we buy more from abroad than we sell abroad. This is largely because exports account for just 12 percent of GDP and manufacturing just 11 percent of GDP.

A trade deficit acts as a drag on economic growth because it means the U.S. is earning less on overseas sales of American-produced goods while spending more on foreign products.

Such an imbalance has been able to exist for 36 years only because the U.S. has run a surplus in the trade of services (tourism, financial services, telecommunications, etc.). However, the overall trade deficit is unsustainable in the longer term.

These problems are not easy to rectify. They can't be fixed in a quarter, a year, or even during a president's term. These are structural problems, not merely cyclical ones. They have been decades in the making and at this point they seem to be baked into the cake.

The growth of the U.S. economy over the past 30-plus years was all funded by unsustainable consumer debt. Those days are over.

The reality is that you can forget the notion of the U.S. growing its way out of debt. Economic growth simply can't keep up with new federal debt. But that's almost besides the point.

Based on the very nature of our monetary system, perpetual debt is a way of life. All money is loaned into existence. But only the principle — not the interest — is created. The entire system is out of balance from the outset.

To offset weak levels of growth, there has been an exponential expansion of the monetary base (the money supply), courtesy of our central bank. All of this freshly created money erodes the value of the dollars in our pockets and bank accounts. It's a matter of too much money chasing too little demand for goods and services — the byproducts of a slow economy.

The central bank has also forced near-zero interest rates upon us. Federal Reserve policy has forced millions of Americans — including retirees — to make big gambles with their life savings. Low rates have pushed them into buying risky assets in the quest for returns that will beat inflation.

What is going on in the U.S. is a massive reordering; a historic, economic correction that has the potential for an eventual monetary collapse.

While our economic growth trend has been slowing for many years, China's has taken off like a rocket.

Yes, China's growth rate is unsustainable. But even if its growth falls to 6% annually — a major decline from current levels — it would still be more than twice the present U.S. growth rate.

The major story of our era is that the United States, which has dominated the world’s economy for several lifetimes, is in relative decline. According to International Monetary Fund calculations, the U.S. is on track to lose its status as the world’s biggest economy — when measured in real, purchasing-power terms — to China by 2017.

That would be a stunning development, but not an unforeseen one. We've already been warned.

Wednesday, September 26, 2012

Derivatives Market a $1.2 Quadrillion Time Bomb

Financial jargon is often arcane and perplexing to the average person. While even casual observers have surely heard of derivatives, most are unlikely to know what exactly they are.

Derivatives, or swaps, are basically bets between companies and banks that are designed, in essence, to be insurance policies.

The problem with derivatives is that since they often involve highly leveraged bets, they can be very dangerous. A small change in market conditions can mean huge losses.

Such losses can occur because derivatives use extraordinary leverage, or borrowing. Derivatives allow investors to earn large returns from small movements in the underlying asset's price. However, investors can also lose large amounts if the price of the underlying asset moves against them significantly.

In fact, derivatives were used to conceal credit risk from third parties while protecting derivative counterparties, which contributed to the financial crisis in 2008.

That threat still lingers today. If interest rates were to rise unexpectedly, for example, it could result in a financial bloodbath on Wall Street.

Derivatives are used to make the really big money on Wall St. They can be many things, but are basically contracts or bets that derive their value from the performance of something else — an interest rate, a bond or stock, a loan, a currency, a commodity, virtually anything.

For traders, derivatives are a perfect product. They can also be highly lucrative to financial institutions. Over the last five years, banks earned an estimated $20 billion selling derivatives just to school districts, hospitals, and scores of state and local governments across the country.

Yet, as Warren Buffett famously stated, derivatives are "financial weapons of mass destruction."

The global derivatives market is highly complex, totally unregulated and freakishly large. According to one of the world’s leading derivatives experts, Paul Wilmott, who holds a doctorate in applied mathematics from Oxford University, the so-called notional value of the worldwide derivatives market is $1.2 quadrillion.

A quadrillion is an incomprehensibly massive figure: 1,000 times a trillion. The market's notional value is 20 times the size of the global economy.

The annual gross domestic product of the entire planet is between $50 trillion and $60 trillion.

Even if Congress decided to regulate the stunningly massive derivatives market, regulators wouldn't be able to assess the risks of derivatives because they don't understand them. Congress doesn't understand them either.

That's by design. The whole market is set up to be incomprehensible to anyone other than those who arranged it, making it beyond regulation.

Insured U.S. banks and savings institutions held $222 trillion worth of derivatives in the second quarter of 2012, according to the Office of the Comptroller of the Currency. Yet, the total U.S. economy is approximately $15 trillion.

Most disturbingly, another financial crisis is inevitable because the causes of the previous one have never been resolved.

The "Big Six" U.S. banks (Goldman Sachs, Morgan Stanley, JPMorgan Chase, Citigroup, Bank of America, and Wells Fargo) now possess assets equivalent to approximately 60 percent of America's gross national product. If that doesn't sound healthy, it's because it isn't.

If any of these six banks fails, the repercussions to the U.S. and global economies would be disastrous.

What is particularly troubling — and appalling — is that the Dodd-Frank law places taxpayers as the backstop behind Wall Street derivatives trading.

As the Wall Street Journal reported:

Little noticed is that on Tuesday Team Obama took its first formal steps toward putting taxpayers behind Wall Street derivatives trading — not behind banks that might make mistakes in derivatives markets, but behind the trading itself. Yes, the same crew that rails against the dangers of derivatives is quietly positioning these financial instruments directly above the taxpayer safety net...

The authority for this regulatory achievement was inserted into Congress’s pending financial reform bill by then-Senator Chris Dodd...

Specifically, the law authorizes the Federal Reserve to provide “discount and borrowing privileges” to clearinghouses in emergencies.

To get help, they only needed to be deemed “systemically important” by the new Financial Stability Oversight Council chaired by the Treasury Secretary.

So, once again, American taxpayers have been set up as the bailout agents for Wall St. banks and the wider financial industry.

The question is, given the size of our economy relative to the derivatives market, where will all the necessary bailout money come from when that market eventually implodes?

Undoubtedly, the Fed will just print it. That has always been its solution to every crisis.

Friday, September 21, 2012

Rigged Markets Have Driven Out Retail Investors

"You could buy and hold a company for 15 years and then have everything you've built up disappear in five minutes. No one can take that kind of risk anymore. There's no such thing as a widows-and-orphans stock anymore." — Professor Perry Glasser, in the Wall St. Journal

Over the past few years, a series of alarming incidents and events have eroded — if not completely destroyed — the average investor's trust in the stock markets. This is a critical development since markets are founded on trust, and they don't function very well without it.

Historically, transparent markets helped raise capital, build business and create jobs. But that system, which had worked fairly well for more than a century, has been jeopardized by recent events.

Most of them have been caused by high-frequency trading, in which supercomputers trade more than a billion shares a day at lightning speed. These trades have obliterated the age old strategy of "buy and hold." High-frequency trading is about buying and then quickly selling in a matter of minutes, seconds, or even mili-seconds.

By some estimates, "high frequency trading" is responsible for close to 70% of all volume in US markets. Computers can track hot stocks and immediately buy up all available shares. Since volume moves markets, this is quite advantageous. Almost instantly, these shares are then sold at higher prices. Millions of shares can be dumped in just milli-seconds.

High frequency trading has tripled market volume, giving a false sense of the size and activity of markets.

In August, the investment firm Knight Capital Group lost $440 million and was brought to the brink of bankruptcy due to erroneous trades caused by a software malfunction. Knight's trading algorithms went haywire, creating twice the normal volume the New York Stock Exchange. It was just the latest example of high-frequency trading gone awry.

In May, a technical error at Nasdaq (caused by high-speed trading) delayed the start of trading for Facebook’s initial public offering, limiting the ability of some investors to identify whether they had successfully purchased or sold their shares. Moreover, the offering price had also increased to $38 from an initial target of $28 - $31. Additionally, the number of shares had increased by 25 percent just days before the offering, diluting overall share value.

Ultimately, Facebook saw its stock collapse 32 percent in just 12 trading days.

Though top investors got word that research analysts at the banks underwriting the IPO had all cut their earnings estimates for Facebook just days before the stock went public, that news didn't reach the average investor until it was too late.

High frequency trading also helped drive the liquidity crisis and set in motion the ‘Flash Crash’ that rattled the markets worldwide in May 2010. In a matter of minutes, the Dow Jones Industrial Average plummeted a jaw-dropping 1,000 points.

But high-frequency trading isn't the only concern. There's also the matter of collateralized debt obligations (CDOs), credit default swaps (CDSs), interest rate swaps and derivatives. Credit default swaps were the things that got Wall St. behemoth JP Morgan Chase into so much trouble last spring.

In May, JPMorgan Chase suffered a multi-billion dollar trading loss that shook investor confidence. A single trader at the bank's chief investment office in London took huge positions in credit default swaps that resulted in massive losses. The threat of systemic risk in the banking sector was once again on full display, a reminder of its threat to the wider economy.

Each of these events undermined the essence of the markets; investor confidence. But cumulatively, they have had a most pernicious effect.

In June, the TABB Group, a financial research and advisory firm, released a report indicating that 31 percent of those polled said they had "weak" or "very weak" confidence in the stock market, compared to 15 percent after the Flash Crash.

In TABB's survey, a group of "market participants," including hedge funds, investment managers, exchanges and brokers, were asked to pick which recent market snafu did the most damage to the confidence of mom-and-pop investors in the stock market. Thirty-seven percent picked the Facebook IPO. Thirty-nine percent picked the Flash Crash.

Not surprisingly, retail investors have abandoned the stock market, moving their money into savings accounts, bond funds and annuities. Over the last few years, all of their suspicions have been confirmed that the stock market is a rigged game and they have largely refused to play anymore.

This is no small matter. Investors have been fleeing the stock market in droves due to a loss of confidence. The Investment Company Institute says that investors are pulling billions out of stock mutual funds on a weekly basis. In fact, investors have been consistently pulling money out of stock funds for five years running.

During the week ended Sept. 5, U.S. stock mutual funds bled another $2.9 billion, according to the Investment Company Institute, bringing the 2012 outflow total to more than $79 billion. By comparison, those funds lost in the neighborhood of $70 billion during the first eight months of 2011, and just $52 billion during the first eight months of 2010.

Vast numbers of Americans no longer understand the stock market and they certainly don't trust it. People would rather hide their money under the mattress than hand it over to Wall St.

According to the June Fed survey, just 15.1% of American families had any stock holdings in 2010, down from a peak of 21.3% in the 2001 survey. And just 8.7% of families had direct ownership of pooled investment funds (mostly mutual funds) in 2010.

Clearly, the ballooning stock market is not a reflection of the financial well-being of the vast majority of Americans. Most of them aren't even invested. The markets are simply Wall Street's betting games.

Joseph Saluzzi, a founder of the institutional brokerage firm Themis Trading, has long been an outspoken critic of high-frequency trading. In fact, Saluzzi thinks the practice is ruining the stock markets. He says it has created a loss of confidence that is scaring off mom-and-pop investors.

Here's what Saluzzi told the Huffington Post:

"The purpose of the stock market is supposed to be capital raising and capital formation. Investors are supposed to come, see what’s going on and say, "You know what, I like that company, I can invest and I’m going to hold the stock." Fifteen or 20 years ago, that’s what you had. Now ... the whole model for capital formation has gotten twisted into a short-term trading [system] where an average holding period for a high-frequency trader is seconds, not days or years... It turns it into a casino... You’ve lost the whole point of what a stock exchange is supposed to do. Which is identify undervalued assets, identify stocks that you think are going to grow... [The result is] a continued loss of trust and confidence in the stock markets. And that is the worst thing you can do. Because you don’t build trust and confidence overnight, but when you lose it, it goes quick."

The problem has been brought to the attention of Congress, yet nothing has been done to curb high-frequency trading and other risky practices that place undo risk on retail investors and the economy as a whole.

SEC Commission chair Mary Schapiro told a House Oversight subcommittee in June that investors have a "concern about the integrity of the marketplace," and U.S. markets are currently threatened with "an unwillingness [on the part of investors] to ever engage in the markets again."

People are unsure "whether they're getting accurate and honest information from [companies looking to list on exchanges]," Schapiro said, and unsure "whether the market structure itself is tilted against the individual investor and in favor the institutional investor." She added, "At the end of the day, investor confidence is the oxygen markets survive on, and if we lose it, it is extraordinarily hard to regain it."

Rather than curbing risky practices, government regulators are allowing them to spread. High frequency traders are now moving into currency and commodity markets.

This is an ominous development. Capitalism requires transparency and truly free markets to function properly. What we have, instead, are rigged markets.

Wall Street's intention has been to make the capital markets so opaque and so complex that no one — not even the regulators — can understand them. It's all been by design, and they've succeeded.

In the view of Wall St. bankers, they are the Masters of the Universe and no one should dare question them. They claim to know things the rest of us will never even understand. But in truth, their game is so convoluted that it's become incomprehensible even to them. They wrote the rules to this game and made it far too complex for anyone to follow or comprehend — even themselves.

Millions of individual investors have paid for that, and the price has been their savings — as well as their faith in the markets. That's a shameful development.

Tuesday, September 11, 2012

Our Economy Was Just an Illusion of Prosperity, Fueled by Debt

The U.S. continues to be burdened by the fallout from the 2008 financial meltdown. That collapse, and the subsequent recession, took many people by surprise because, aside from the bursting of the dot-com/internet bubble in 2000, the economy had appeared to be humming along quite smoothly.

But that appearance was the byproduct of a lot of smoke and mirrors.

Much of the growth in corporate profits leading up to our economic collapse was driven by the financial sector. After-tax corporate profits in the financial sector were considerably better than the non-financial sector from 1997 to 20007. So the supposed "economic boom" during this period was largely limited to the financial sector, which doesn't produce anything — other than debt.

As a result, all of that financial sector growth was a sham. Our economy was nothing more than a paper tiger. Wages were stagnant for many years and Americans lived on cheap and easy credit (or debt) to make up for that fact. It made people feel prosperous, as if we were all benefitting from the supposed "economic boom."

From 1948 to 1985, the financial sector accounted for around 12 percent of American corporate profits, never reaching 20 percent nor dipping below 5 percent. After 1985, however, the profits of the sector rose dramatically, going from 19 percent in 1986 to 41 percent in 2000.

That meant that more than 40 cents out of every corporate dollar of profit was paper profit, not created by actual wealth-generating activity, but by monetary inflation and corporate gambling.

The earnings of typical Americans couldn't (and still can't) keep up with the rate of inflation. From 1914 until 2010, the average inflation rate in United States was 3.38 percent. This means that inflation has been running at roughly 33 percent per decade over the past century.

Since wages weren't keeping up in recent decades, the only way to maintain consumer spending — the engine of our economy — was to continually expand available credit, putting Americans into ever deeper debt.

With the cost of living outstripping wage and salary increases, Americans began draining their savings just to keep up. During the previous decade, the U.S. savings rate reached its lowest level since the Great Depression and actually turned negative for a couple of years. The cost of living had simply exceeded incomes.

According to Census figures, the median annual income for a male, full-time, year-round worker in 2010 was $47,715. Adjusted for inflation, that was less than in 1973, when it was $49,065. This means that the American male's income is now negative after four decades.

Yet, the problem seems to be accelerating.

Across the country, in almost every demographic, Americans earn less today than they did in June 2009, when the recovery technically started. As of June, the median household income for all Americans was $50,964, or 4.8 percent lower than its level three years earlier, when the inflation-adjusted median income was $53,508.

That's nearly double the 2.6 percent drop during the recession, which means that — when it comes to incomes, at least— our supposed recovery has been even worse than the recession.

The decline looks even worse when comparing today’s incomes to those when the recession began in December 2007. Then, the median household income was $54,916, meaning that incomes have fallen 7.2 percent since the economy last peaked.

This decline is critical because 70 percent of all U.S. economic activity (GDP) is the result of consumer spending, and retail sales account for about half of that.

For many years, Americans used credit to buy whatever they couldn't afford — including houses — which masked the decline in incomes. But now that the bubble has burst, the lingering hangover remains debilitating.

Falling home prices have slashed home equity 49 percent, from $13.2 trillion in 2005 to $6.7 trillion early this year. One-third of homes with a mortgage are underwater. And roughly 27 million workers—or about one out of every six U.S. workers—are either unemployed or underemployed.

All of this is killing demand and consumption.

Decades of easy credit resulted in significant increases in the American standard of living. But the reality is that all of those debts need to be serviced. However, there isn't enough income to do that while also maintaining past rates of spending. Consequently, less disposable income is being directed back into the economy, which is stunting economic growth.

The Federal Reserve was well aware of all of this. The Fed is responsible for the erosion of the dollar and the average American's savings by continually creating money from nothing and holding interest rates at historically low levels. That's because it has to keep us all spending in order to uphold the economy.

So, lending practices were loosened and money made cheap and easy. People were made to feel affluent by going ever further into debt, spending money they didn't actually have. But the sobering reality it that all of those debts eventually need to paid back — with interest.

This is how the masses, the common folks, were allowed to participate in the consumption economy along with the truly affluent. It was simply an illusion of wealth for millions. Accompanying the continual expansion of credit/debt was the seemingly perpetual increase in home prices.

However, all of it has now finally, depressingly, come to a crushing end. There is no re-inflating the debt bubble that propped up our phony economy. The lifestyle we maintained for more than a quarter of a century was simply unsustainable, and our crash inevitable. To double-down on our debt binge would only be an attempt to forestall the necessary de-leveraging of our economy and be even more crippling in the long run.

A recent report from the Federal Reserve Bank of New York shows that total household debt declined from nearly $12.7 trillion in 2008 to $11.4 trillion as of the first quarter of 2012. Yet, much of that has been due to foreclosures and defaults. If you default on your mortgage, you no longer have that liability, which makes total household debt look better.

Mortgage debt makes up the vast majority of Americans' household debt, so a decline in home ownership means less debt, even though it also results in a drag on the economy, as salable homes sit empty.

Yet, this decline in household debt hasn't stopped the Fed and its fellow banker cronies from trying to reinflate the bubble. The federal funds rate has been held at a range of between zero to 0.25 percent since 2008. Most incredibly, total outstanding consumer credit has increased to $2.7 trillion from $2.55 trillion when the financial crisis struck in 2008.

Economic growth is predicated on debt, so unless Americans keep on borrowing the economy will move from stagnation back to recession. The standard of living for millions of Americans has already declined considerably over the past four years. Considering the long term decline in wages and salaries, something has to give.

Either Americans realize they can never repay all of their incurred debt and stop adding to it, or they try to forestall an even lower standard of living by attempting to borrow their way into a false prosperity once again.

For many years, our national economic growth has been fictitious — an illusion of prosperity rooted in debt.

We've consumed more than we produced. We've imported more than we exported. We've borrowed more than we saved.

We've done all this for a quarter-century, and now we remain mired in day of reckoning that just won't end.

Friday, August 17, 2012

Don't Expect Justice in a Corporatocracy

For any society to survive, much less thrive, it must be rooted in trust. The citizenry must trust the government and, most importantly, the justice system. It also helps if the people trust the banks that hold their money and finance their nation's economy.

However, that sort of trust is now virtually non-existent in our society.

According to a Gallup poll, only 18% of Americans — an all-time low — have confidence in banks. And a Pew Research survey found that Americans' trust in government is only marginally higher, at 22%.

Perhaps Americans have come to the conclusion that their government is colluding with the banks against their best interests. The examples are far and wide. In fact, they are so numerous that listing them all would be tedious, and reading them all would be cumbersome.

But, just to make the point, here are a few less than shining examples:

The SEC charged Wells Fargo with selling products tied to risky mortgage securities, causing municipalities and non-profits to suffer substantial losses as a result.

In response, Wells Fargo, the nation’s biggest consumer bank, recently agreed to pay a $6.5 million fine for these offenses without admitting or denying the charges.

Wells Fargo reported second-quarter pre-tax profits of $8.9 billion. This means that Wells Fargo will cough up a $6.5 million penalty from the nine-thousand-million dollar profit it made in just the second quarter of this year alone. That's about 0.07 percent of a single-quarter's profit.

Does this sound like justice to you? Will such a fine cause Wells Fargo to change its behaviors and practices? That's a rhetorical question.

A Senate report issued in July found that a "pervasively polluted" culture at HSBC allowed the bank to act as financier to clients moving shadowy funds from the world's most dangerous and secretive corners, including Mexico, Iran, Saudi Arabia and Syria.

The report said large amounts of Mexican drug money was likely to have passed through the bank. HSBC's U.S. division provided money and banking services to some banks in Saudi Arabia and Bangladesh that are believed to have helped fund al-Qaida and other terrorist groups.

The U.S. unit of the London- based HSBC, Europe’s biggest bank, “offers a gateway for terrorists to gain access to U.S. dollars and the U.S. financial system,” according to the report.

Laundering money for criminal enterprises, including drug cartels, is nothing new for the Big Banks.

In 2010, Wachovia Bank (now owned by Wells Fargo) paid $160 million to resolve a criminal probe that Mexican cartels were using currency-exchange firms to launder cash through the bank.

British bank Standard Chartered recently agreed to a settlement of $340 million with New York’s top banking regulator, Benjamin Lawsky, over claims that it laundered hundreds of billions of dollars in tainted money for Iran and lied to regulators in the process.

The New York Department of Financial Services charged that the bank schemed with Iran for nearly a decade to hide from regulators 60,000 transactions worth $250 billion.

Lawsky’s office threatened to revoke the bank’s state license at a hearing scheduled this week, prompting Standard Chartered to settle. Such a move would have been a death knell for the bank.

For a bank that announced record profits of $6.78 billion in 2011, a $340 million fine is nothing more than a slap on the wrist. In fact, it amounts to just 5 percent of last year's profits. That sort of expense is simply calculated into the cost of doing business.

According to the New York Times, a trove of e-mails and memos detail an elaborate strategy devised by the bank’s executives to mask the identities of its Iranian clients and to thwart American efforts to detect money laundering.

In light of all this, it's tough for anyone to reasonably claim that justice was served because Standard Chartered paid a $340 million fine. Sadly, that sort of outcome is the rule, rather than the exception.

The report issued by the Financial Crisis Inquiry Commission nearly two years ago found that, by 2006, Goldman Sachs traders knew that they were selling dangerous investments packed with subprime home mortgages. Goldman was making big profits on these toxic investments, which they privately characterized as "junk," "dogs," "big old lemons" and "monstrosities."

These mortgage investment products eventually collapsed in value, bringing down the housing market and very nearly the American economy along with it.

Despite misleading investors about the risks of a mortgage-backed investment product known as Abacus (which Goldman was in fact betting against), Goldman Sachs was allowed to settle with the Securities and Exchange Commission for just $550 million.

Goldman had revenue of $28.8 billion and net income of $4.44 billion in 2011. Once again, the fine was merely a slap on the wrist that will not dissuade or prevent the Wall St. bank from similar behavior in the future. Such a penalty is merely calculated into its cost of doing business.

The SEC has also dropped its investigation into Goldman Sachs over a $1.3 billion mortgage bond known as Fremont Home Loan Trust 2006-E, even though it indicated earlier this year that charges were likely. Moreover, the Federal Housing Finance Agency had filed a lawsuit against Goldman alleging that it knew that Fremont, a subprime lender, was selling it mortgages certain to fail.

The Department of Justice also announced that it is ending its own Goldman investigation, launched after a congressional investigation chaired by senators Carl Levin (D-Mich.) and Tom Coburn (R-Okla.) issued a report that found Goldman Sachs sold investments "in ways that created conflicts of interest with the firm’s clients and at times led to the bank's profiting from the same products that caused substantial losses for its clients.”

In May, the SEC dropped its probe of Lehman Brothers, even though an independent examiner appointed by the bankruptcy court of the defunct bank concluded that there were "actionable claims" against senior Lehman officers for using an accounting tool known as Repo 105 to book billions of dollars in phony sales to disguise the true extent of the bank's financial woes.

These are just the latest indications that the federal government has been neutered by Wall St. The revolving door between Washington and Wall St. has created a good old boys network, a corporate/political alliance that now controls our government. Our alleged leadership has been bought and paid for.

Regulation is dead. The industry's complaints about the burden of regulatory rules are absurd and fantastical.

Accountability and an adherence to the law are no longer expected from the Banksters. They do whatever they wish, gutting laws, ripping off their clients and paying meager fines to continue their perverted business as usual. Justice is only for regular people.

Ethics, scruples and moral decency are wholly absent. The government refuses to enforce its own laws and it allows bank lobbyists to water down others until they are meaningless.

More than 2,500 banking lobbyists are swarming the halls of Congress each week, fighting reform, meaning that the Big Banks now have five lobbyists for every member of Congress.

The Justice Department refused to pursue cases against Angelo Mozilo, the former head of the defunct mortgage giant Countrywide and Joseph Cassano, who ran the financial products division at AIG. These two men were central figures in the financial collapse, which led to the crisis that continues to destabilize our economy. And yet they remain free men.

I could go on and on with examples of paltry fines, dropped charges and cases that were never even opened. It's all so disgusting and disheartening. How can this nation claim to observe the rule of law when it refuses to uphold and enforce its laws?

How did the mega banks and corporations become exempt?

This nation's Supreme Court has upheld the absurd notion that corporations are people, due all the same rights under the law. While such a suggestion is absurd on its face, the deeper problem is that corporations — such as banks — are afforded an entirely separate set of rights and privileges that are not afforded to real, living, breathing, human citizens.

This nation's judicial, executive and legislative branches of government are all corrupt. How can anyone reasonably expect Wall St. or big business in general (Big Media, Big Energy, Big Agriculture, Big Pharma, Big Insurance, etc. ) to be otherwise? They are all part of the corruption.

The heart of the problem is that corporate financing of political campaigns has led to corporate control of our country. Corporations have bought our government and they now own it. They control the country and the government.

This nation is now a corporatocracy. We are officially the United States of Corporate America.

Wednesday, August 08, 2012

First Deflation, Then Inflation

American workers have seen a 0.5 percent decline in the inflation-adjusted value of their paychecks over the past year. That decline is a worrisome development since the Consumer Price Index increased 1.7 percent over the 12 months ending in June.

Both data points are indicators of a struggling economy and raise the specter of deflation.

Though the inflation rate averaged 2.35 percent over the first six months of the year, the rate has gone down each and every month, dropping from 2.93 percent in January to 1.66 percent in June. That decline has paralleled the slowdown of the economy.

The inflation rate was below 2 percent in both May and June, a slower pace than the Federal Reserve would like. Historically, from 1914 to 2012, the United States inflation rate has averaged 3.36 percent.

Europe is already in recession, the U.S. economy has been slowing for six months, and the larger global economy is gradually losing steam right along with it. Recessions are, by definition, deflationary. That's the primary concern of the Federal Reserve at present.

While the falling prices associated with deflation might not seem like such a bad thing to the average consumer, falling wages are another thing altogether. Falling wages make debt repayment all the more difficult, and Americans are still saddled with onerous debts. Though total household debt fell from $12.7 trillion in 2008 to $11.4 trillion as of the first quarter of 2012, it is still enormous by any measure.

Given that the Fed has pumped trillions into the economy and banking system over the past few years, the typical concern should be price inflation. Yet, it is rather tame at the moment and is, in fact, declining.

To fend off signs of a double-dip recession, the Fed will continue to print money — lots of it. And it will continue buying Treasuries as well — lots of them. QE3 is just a matter of time. Through its purchases of additional government debt, the Fed hopes to prevent money from draining out of the financial system in a deflationary spiral.

But after lowering short-term rates to nearly zero, funneling oodles of money into the Big Banks and buying enough mortgage-backed bonds to drop mortgage rates to record-low levels, the question is, What more can the Fed do?

Even if money is made cheap and readily available, the Fed cannot force Americans to borrow. People with huge debts, falling wages, no jobs, or the fear of becoming unemployed, will not be persuaded to borrow.

And therein lies the problem: our entire economy is predicated on borrowing and lending for economic growth to occur. Money is created through borrowing. Without borrowing, there is less money and no growth. Absent growth, there are no jobs. And without jobs, there is no recovery.

The fear of so many economists is that the U.S. might be following Japan's path into a "lost decade" of our own.

That is a disturbing and worrisome possibility.

At some point, the Fed will have to mop-up, or extract, all those trillions of dollars in excess liquidity from the economy. If it is unable to do that quickly enough, and at will, then the focus will shift back to inflation — perhaps lots of it.

Tuesday, July 31, 2012

Deflation: Making Sure "It" Doesn't Happen Here

The trend is abundantly clear; the U.S. economy has been slowing for more than six months and is perilously close to contraction.

After growing at a robust 4.1% clip in the last three months of 2011, gross domestic product fell to 2% growth rate in the first quarter, before falling again to 1.5% in the second quarter.

Using monetary policy, the Federal Reserve has made repeated attempts to stimulate the economy and raise it from its listless state. The Fed has held short term rates at a remarkably low level of between 0% and 0.25% since December 2008. It has also purchased nearly $3 trillion worth of Treasuries and housing-related assets to lower long-term interest rates and try to spur the economy.

If these efforts have worked at all, they have so far averted a double-dip recession. Yet, these extraordinary measures have not resulted in an economic recovery. To the contrary, things are getting worse.

Clearly, the economy is contracting, or deflating. Recessions are technically defined by two consecutive quarters of contracting GDP. Though we aren't there yet, the current trend is worrisome. Recessions are, by definition, deflationary. Above all else, the Fed fears deflation; it is harder to control than inflation and once it takes hold, deflation can be crippling.

The U.S. economy is built on a perpetual growth model. Deflation aside, even stagnation is debilitating. Growth is imperative.

The Fed likes inflation because it makes debts easier to repay. But inflation also devalues the money in everyone's pockets and bank accounts.

At a rate of three percent annual inflation, your money loses 30 percent of its buying power over the course of a decade. For example, inflation was 27% from 2000 to 2010. That's a hidden tax on all Americans, young and old, rich and poor. So, inflation is also a pernicious thing.

With that in mind, what follows are highlights from a speech given by Ben Bernanke on Nov. 21, 2002. This is the infamous speech that earned Bernanke the moniker "Helicopter Ben."

As you read the speech, bear in mind that it was given a full six years before the financial collapse, which led to the federal funds rate being reduced to its present level of 0% to 0.25%. It was also four years prior to Bernanke being nominated as chairman of the Federal Reserve.

As you'll see, Bernanke had a plan, a vision and a philosophy — all of which explains what is going on today, monetarily. You can see Bernanke's utter fear of deflation. Concerns about inflation? They hardly exist. In fact, Bernanke makes clear that central banks seek an inflation rate between 1 and 3 percent per year.

Bernanke also outlines the "special problems" that central banks face when the federal funds rate reaches zero due to deflation. This should cause the reader to wonder how bad the problem could become, considering that the rate is already effectively zero. As Bernanke notes, a zero interest rate places a "limitation on conventional monetary policy."

However, in Bernanke's view, even when the interest rate has been forced down to zero, the Fed "has most definitely not run out of ammunition."

There is a singular strategy always at the Fed's disposal, according to Bernanke, providing it "considerable power to expand aggregate demand and economic activity" and allowing it "to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero."

What is that strategy, you are surely asking?

Printing money.

The problem is that printing large sums of money, without any relation to a corresponding increase in the amount of goods and services in the economy, devalues all of the money in circulation.

"By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so," said Bernanke, "the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."

Note: The bolded areas are my emphasis. The italicized areas are Bernanke's.

Deflation: Making Sure "It" Doesn't Happen Here

The Congress has given the Fed the responsibility of preserving price stability (among other objectives), which most definitely implies avoiding deflation as well as inflation. I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief.

Before going further I should say that my comments today reflect my own views only and are not necessarily those of my colleagues on the Board of Governors or the Federal Open Market Committee.

The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand — a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending — namely, recession, rising unemployment, and financial stress.

However, a deflationary recession may differ in one respect from "normal" recessions in which the inflation rate is at least modestly positive: Deflation of sufficient magnitude may result in the nominal interest rate declining to zero or very close to zero. Once the nominal interest rate is at zero, no further downward adjustment in the rate can occur, since lenders generally will not accept a negative nominal interest rate when it is possible instead to hold cash. At this point, the nominal interest rate is said to have hit the "zero bound."

Deflation great enough to bring the nominal interest rate close to zero poses special problems for the economy and for policy. First, when the nominal interest rate has been reduced to zero, the real interest rate paid by borrowers equals the expected rate of deflation, however large that may be. To take what might seem like an extreme example (though in fact it occurred in the United States in the early 1930s), suppose that deflation is proceeding at a clip of 10 percent per year. Then someone who borrows for a year at a nominal interest rate of zero actually faces a 10 percent real cost of funds, as the loan must be repaid in dollars whose purchasing power is 10 percent greater than that of the dollars borrowed originally. In a period of sufficiently severe deflation, the real cost of borrowing becomes prohibitive. Capital investment, purchases of new homes, and other types of spending decline accordingly, worsening the economic downturn.

Although deflation and the zero bound on nominal interest rates create a significant problem for those seeking to borrow, they impose an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. This burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing (perhaps rapidly increasing) real value.

Beyond its adverse effects in financial markets and on borrowers, the zero bound on the nominal interest rate raises another concern — the limitation that it places on conventional monetary policy. Under normal conditions, the Fed and most other central banks implement policy by setting a target for a short-term interest rate — the overnight federal funds rate in the United States — and enforcing that target by buying and selling securities in open capital markets. When the short-term interest rate hits zero, the central bank can no longer ease policy by lowering its usual interest-rate target.

Because central banks conventionally conduct monetary policy by manipulating the short-term nominal interest rate, some observers have concluded that when that key rate stands at or near zero, the central bank has "run out of ammunition"— that is, it no longer has the power to expand aggregate demand and hence economic activity. It is true that once the policy rate has been driven down to zero, a central bank can no longer use its traditional means of stimulating aggregate demand and thus will be operating in less familiar territory. The central bank's inability to use its traditional methods may complicate the policymaking process and introduce uncertainty in the size and timing of the economy's response to policy actions. Hence I agree that the situation is one to be avoided if possible.

However, a principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition. As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero.

There are several measures that the Fed (or any central bank) can take to reduce the risk of falling into deflation. First, the Fed should try to preserve a buffer zone for the inflation rate. That is, during normal times it should not try to push inflation down all the way to zero. Central banks with explicit inflation targets almost invariably set their target for inflation above zero, generally between 1 and 3 percent per year.

Under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning.

U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

In the United States, the Department of the Treasury, not the Federal Reserve, is the lead agency for making international economic policy, including policy toward the dollar; and the Secretary of the Treasury has expressed the view that the determination of the value of the U.S. dollar should be left to free market forces. Moreover, since the United States is a large, relatively closed economy, manipulating the exchange value of the dollar would not be a particularly desirable way to fight domestic deflation, particularly given the range of other options available. Thus, I want to be absolutely clear that I am today neither forecasting nor recommending any attempt by U.S. policymakers to target the international value of the dollar.

Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.

Each of the policy options I have discussed so far involves the Fed's acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money.