A PENNY FOR YOUR THOUGHTS;  THE CURRENCY ISSUE (DOLLAR), STABILITY, AND FREEDOM IT AFFORDS US.  HOW'S THAT AGAIN?
 Detail from a dollar billYuan and dollar notes


A Risk Once Unthinkable
By JAMES B. STEWART, NYTIMES
December 9, 2011

Are customer accounts at brokerage firms safe?

Until the collapse of MF Global, that’s a question I thought I’d never have to ask.

Brokerage firms are required by law to maintain segregated accounts holding all client assets, including stocks, bonds, mutual funds, money market funds and cash. The law was passed after the 1929 crash, in the depths of the Depression, to make sure that customer assets were there at all times, ready to be disbursed even if everyone asked for their money at once.

This obligation to protect customer assets “is considered sacrosanct,” Robert Cook, director of the division of trading and markets at the Securities and Exchange Commission, told me this week. “It’s considered a sacred obligation.”

Lehman Brothers may have engaged in many foolhardy practices, but even in the firm’s last days, when officials were desperate for cash, no one dared touch customer assets, which remained safely segregated despite the firm’s collapse.

And then came the revelation that an estimated $1.2 billion in customer assets had vanished at MF Global, the large brokerage and futures trading firm headed by Jon S. Corzine, the former Goldman Sachs executive and Democratic politician, that collapsed in late October after a catastrophic bet on European sovereign debt.

How could such a thing happen? I had always assumed it was impossible and that strict internal controls existed at all brokerage firms so that firm officials couldn’t tap segregated customer funds even if they were willing to break the law. Thanks to MF Global, it’s now apparent that isn’t necessarily true. “If people are determined to misuse customer funds, they will misuse them,” said Ananda Radhakrishnan, the director of the division of clearing and risk at the Commodities Futures Trading Commission.

That’s because the commodities and securities industry is mostly self-regulating, and self-regulation ultimately depends on the integrity of the regulated. Broker-dealers — securities firms that execute trades of stocks, bonds and other assets for customers — are overseen by the S.E.C., while futures commission merchants, which trade commodities, derivatives and futures, are regulated by the C.F.T.C. Like most large brokerage firms, MF Global was both a broker-dealer and a futures commission merchant, though its primary business was commodities futures trading.

The federal regulators issue and enforce the rules, but day-to-day oversight for securities firms is delegated to the Chicago Board Options Exchange, a for-profit company, and the Financial Industry Regulatory Authority, or Finra, a nonprofit organization financed by the brokerage industry. For commodity dealers, it’s the National Futures Association and the Chicago Mercantile Exchange. They conduct periodic examinations and audits and, in addition, member firms are required to have internal controls and compliance mechanisms to make sure that customer assets remain safely segregated at all times.

Typically, this requires transfers from segregated accounts (other than at the customer’s request) to be approved by multiple officials, including in many cases, the firm’s chief financial officer and chief compliance officer.

“It’s not a low-level functionary,” a regulator said. “It’s someone who has real standing. Most customer assets are held at the biggest firms and they have scores of people involved in this process.”

Susan Thomson, a spokeswoman for Merrill Lynch, the nation’s largest brokerage firm, said that any transfer from segregated accounts there required “at least three checks and possibly more.” Officials from operations, regulatory reporting and collateral are usually involved and sometimes compliance officials, as well. “There are multiple streams of responsibility. You have management accountability in each of those streams on a daily basis,” she said.

MF Global also had internal controls and a chief compliance officer, which raises the question: How did the customer assets ever leave the segregated accounts to begin with? In testimony on Capitol Hill on Thursday, Mr. Corzine only added to the mystery. He said that transferring customer funds was “a complex process” and, asked who could execute such a transfer, said “I wouldn’t know probably who that person is.”

While Mr. Corzine said he had “no intention” of authorizing any transfer of segregated funds and “didn’t intend to break any rules,” he left open the possibility that someone might have thought he did. Others at MF Global surely know. A spokeswoman for MF Global Holdings, the holding company for the broker-dealer, said “there was an approval process” for moving segregated funds, but said she was unable to provide more details.

There are legitimate reasons to move assets from segregated accounts, the most common being that they are overfunded. Commodities firms are required to reconcile customer assets with the amounts in segregated accounts every day, and must report any shortfall to the C.F.T.C.

For securities firms, the requirement is only once a week, but many firms do it every day. They are required to report shortfalls to Finra. If there’s an excess (many firms deliberately overfund the segregated accounts to make sure there is never an inadvertent shortfall), they can transfer the excess funds. But that usually requires high-level approval from someone like the chief financial officer, and then the transfer can’t exceed the amount of the excess. So that wouldn’t explain the missing $1.2 billion at MF Global.

The law also allows commodities firms like MF Global to use segregated customer funds as a source of low-cost financing for their own operations, but they are required to replace any customer assets taken from segregated accounts with supposedly ultrasafe collateral of the same value, typically United States Treasuries, municipal obligations and obligations whose payments of principal and interest are guaranteed by the government.

This week, the C.F.T.C. issued new rules restricting how client assets can be invested, which had grown under C.F.T.C. interpretations to include sovereign debt and transactions known as “in-house repos,” or repurchase agreements, in which a firm contracts with itself to use customer assets as, in effect, interest-free loans to finance its inventory of Treasury bonds. MF Global was apparently a heavy user of in-house repos, and before his firm collapsed, Mr. Corzine had argued strenuously against the C.F.T.C.’s proposal to ban them.

Making bad bets on European sovereign debt — like making bad bets on United States mortgage-backed securities — isn’t a crime, but improperly transferring segregated customer assets is a potential criminal violation of the securities laws and a relatively straightforward one at that. (The United States attorney’s office in Manhattan is in the early stages of investigating the removal of customer assets from MF Global.)

I spoke this week to several people involved in the MF Global investigation. No one has reached any firm conclusions about how the assets were transferred, but possible innocent explanations have dwindled to almost none. And James B. Kobak Jr., a lawyer for the MF Global trustee, said in court on Friday that there were “suspicious” trades made from customer accounts. If that’s the case, there may have been a deliberate and concerted effort to override MF Global’s internal controls to gain access to segregated customer assets, and if that can be proved, those responsible should be prosecuted and, if convicted, go to jail.

Unfortunately for MF Global’s customers — and future victims of similar crimes, if that’s what it turns out to be — there’s no easy remedy and it will most likely be months or even years before they recover their money. The Securities and Investor Protection Corporation explicitly warns that it’s “not uncommon for delays to take place when the troubled brokerage firm or its principals were involved in fraud.”

SIPC will replace up to $500,000 of securities and cash (but not futures contracts) missing from customer accounts at member firms. A measure of the magnitude of the problem is that since its creation in 1970, SIPC has advanced $1.6 billion to make possible the recovery of $109.3 billion in assets for an estimated 739,000 investors (through the end of 2010).

Meanwhile, the C.F.T.C.’s enforcement capabilities, like the S.E.C.’s, have been starved for lack of funding. “Our funding has declined to such an extent that three to four years ago, just as the industry was taking off, we had less than 500 employees,” Mr. Radhakrishnan said. But even with more resources, “We can’t be at every firm overseeing every activity. We have to expect people to understand the rules and adhere to them.”

S.&P. Downgrades U.S. Long-Term Debt
NYTIMES
By BINYAMIN APPELBAUM and ERIC DASH
August 5, 2011

WASHINGTON — Standard & Poor’s removed the United States government from its list of risk-free borrowers on Friday night, citing concern about the rising burden of the federal debt.

The nation’s rating was reduced to AA-plus for its long-term debt, one notch below the top rating of triple-A.

S.& P., one of the three major agencies that assign grades the credit of companies and governments, had threatened the downgrade if the government did not act to reduce the federal debt by at least $4 trillion over the next decade. Earlier this week, Congress instead passed a plan to reduce the debt by at least $2.1 trillion.

Treasury Department officials said that the S.& P. announcement was delayed after Treasury found a serious mathematical error in a draft of the downgrade announcement, which was provided to the government Friday afternoon. The officials said that S.& P. inadvertently added $2 trillion to its projection of the federal debt, significantly overstating the problem confronting the government.

Treasury said that S.& P. conceded the problem after about an hour of discussion.

The other rating agencies, Moody’s and Fitch, have said they have no immediate plan to downgrade the country’s credit rating, giving the government more time to make progress on debt reduction. The split verdict limits the impact of the S.& P. downgrade as many consequences would be set off only by a reduction by two agencies.

The company did not return a call for comment.

The lowering of the country’s rating could rattle confidence and raise borrowing costs for the government and consumers, impeding the already fragile recovery.

Even so, some White House strategists and independent analysts have concluded that the economic impact would be modest, despite the embarrassing blow to the global financial standing of the United States.

The announcement by S.& P. came after a week of turmoil on Wall Street not seen since the days of the financial crisis. After plunging around 5 percent on Thursday, stocks bounced up and down Friday and closed relatively flat.

Even with the rating agencies split, S.& P.’s downgrade could become an election-year liability for President Obama. Fair or not, critics are likely to point to it as evidence of his failure to get the government’s finances under control.

There is also a financial cost. The federal government makes about $250 billion in interest payments a year. So even a small increase in the rates demanded by investors in United States debt could add tens of billions of dollars to those payments.

In addition, the credit rating agencies have said that a downgrade of government debt would probably be followed by downgrades of other entities backed by the government. For example, the said, Fannie Mae and Freddie Mac, the government-controlled mortgage companies, would be downgraded, raising rates on home mortgage loans for borrowers.

Dozens of counties and even a handful of states — including Maryland, Virginia, and New Mexico — might also be downgraded because of their local economies’ strong ties to Washington.

The United States has maintained the highest credit rating for decades. S.&P. first designated it AAA in 1941, reflecting a steadfast belief that the richest nation in the world would not default on its debt payments. The rating was also bolstered by the role of the dollar as the world’s leading currency, ensuring that demand for American debt securities would remain strong in spite of burgeoning deficits.

But the recent turmoil, in which the government came to the brink of default in a showdown between Democrats and Republicans, has shaken that confidence. Although there is little doubt about the United States government’s ability to pay back its debts, the political stalemate over the recent negotiations raised questions about Washington’s willingness to pay.

The credit rating agencies also face competing pressures as they evaluate America’s credit rating.

On the one hand, they have been trying to restore their credibility after missteps leading up to the financial crisis. A Congressional panel called them “essential cogs in the wheel of financial destruction,” after their wildly optimistic models led them to give top-flight reviews to complex mortgage securities that later collapsed. A downgrade of United States debt could show they are willing to take harsh action, even if it was not profitable or popular.

 On the other hand, the rating agencies are aware of the intense government scrutiny that a ratings downgrade would bring. They have already faced criticism from European officials after they lowered the ratings on the debt of Greece and several other countries in the run-up to several bailouts. Now, they are likely to see the political heated turned up in Washington as well.

S.& P. officials said previously that the changing timetables reflected the belief that if the current political atmosphere in Washington was so toxic that lawmakers could not reach a deal, they were unlikely to do so in the future.

“What’s changed is the political gridlock,” said David Beers, S.& P.’s global head of sovereign ratings, in an e-mail several days before a debt ceiling agreement was announced.
The true trouble with America's credit
NYPOST
By STEPHEN B. MEISTER
Last Updated: 3:25 AM, July 18, 2011
Posted: 10:24 PM, July 17, 2011

Most reports have treated the latest warnings about Uncle Sam's credit rating as driven by the danger that Congress won't raise the federal debt limit before Treasury Secretary Tim Geithner's Aug. 2 deadline. In fact, both Standard & Poor's and Moody's say the real threat to the US government's AAA rating comes from Washington's refusal to start living within its means.

The big problem: President Obama's (and Democrats', in general) ideological resistance to spending cuts.

S&P's analysts cautioned that they "may lower the long-term rating on the US by one or more notches . . . if we conclude that Congress and the administration have not achieved a credible solution to the rising US government debt burden."

The big worry: The "government debt-to-GDP ratio . . . is currently nearing 75 percent" and on course to hit "84 percent of GDP by 2013."

It's called the "debt trajectory": The feds are borrowing more than five times faster than GDP is growing -- issuing IOU's for $5.5 billion while the economy only grows $1 billion every business day.

Moody's echoed the sentiment: "The outlook . . . would very likely be changed to negative . . . unless a credible agreement is achieved on a budget that includes long-term deficit reduction."

Obama has goosed federal spending 30 percent above the modern norm. For the 60 years before he took office, it averaged 19 percent of GDP, but now it's over 25 percent -- and 43 cents of every dollar he's now spending is borrowed.

Nor are the agencies buying into Obama's fiscal-hawk pose. His demand for a $2.4 trillion raise in the debt cap, even with a "grand bargain" involving trillions in cuts, belies his true intentions: If the cuts were real, hiking the cap by 16 percent of GDP wouldn't be necessary to bridge him until the election.

Indeed, the president's concrete offers to cut spending so far add up to just $2 billion -- about what the US borrows every three hours. His major "contributions" to the debate are all posturing -- threatening to shoot his hostages by not issuing Social Security checks, the endless demagoguing of a corporate-jet tax break that he himself expanded, etc.

Meanwhile, House Republicans insist on no tax increases -- leaving the rating agencies understandably worried, as S&P put it, of "an increasing risk of a substantial policy stalemate."

Not that tax hikes would do much good. Set aside the wisdom of raising rates on job creators when unemployment is 9.2 percent; Uncle Sam has never been able to collect much more than 19 percent of GDP, no matter how high lawmakers took the marginal rates.  So spending cuts are the only solution. Government just has to be reined in to pre-Obama-era levels -- which will require real reforms to Social Security, Medicare and Medicaid, among other changes.

Without a major course correction, America will soon owe more than it can afford -- and raters see Obama and the Democrats as unwilling to make big cuts, even if the GOP caves on tax hikes.

Bottom line: Lawmakers raising the debt ceiling without making big cuts won't stop a downgrade.

A downgrade will drive up the interest rates the Treasury pays, now at historic lows. Interest, budgeted at $430 billion in 2011, will rise by $143 billion for every 1 percent more that the Treasury pays; and rates could turn on a dime. For now, US debt is a safe haven only compared with European sovereign debt.

State and local governments will suffer, too. Because they hold Treasury bonds, a downgrading will drive their own ratings down and their borrowing costs up. Ditto for Fannie Mae, Freddie Mac, the Federal Home Loan Banks and thousands of other financial institutions and insurance companies. The effects will ripple through trillions in debt, including credit-card and mortgage rates, a blow that our housing sector can ill afford.

Judgment day is upon us. It doesn't require a default, just a rating downgrade. Obama isn't responsible for the entire public debt (he's only raised it 53 percent so far), but he alone "owns" the 25-percent-of-GDP government. Until he truly admits to that tragic mistake and embraces a balanced budget, he has locked us into a path to fiscal Armageddon.

TAX SHELTER DEPARTMENT HERE



$120 trillion: The shocking true size of our nation's debt
NYPOST
By MICHAEL D. TANNER
Last Updated: 3:54 AM, June 26, 2011
Posted: 10:59 PM, June 25, 2011

The Congressional Budget Office released a new report this week showing that the federal government’s publicly held debt would top 101% of GDP by 2021, more than the value of everything produced in this country over the course of a year. Think of it like owing more on your credit cards than your entire family income. By 2035, the publicly held debt, CBO says, could top an almost unfathomable 190% of GDP.

And that was the good news.

The federal government actually has three different types of debt. Debt held by the public, which generated the headlines in the CBO report, is the type of government bonds that you — or the Chinese government — might own. Economists worry a lot about this type of debt because the government has to borrow the money from private credit markets. The government borrowing competes with investment in the nongovernmental sector, leaving less money available for private investment in such things as factories and equipment, research and development, housing, and so on. Growing levels of publicly held debt can drive up interest rates in the long-run, and may already be choking off interbank lending.

But that’s not the only type of government debt. For example, there is “intragovernmental” debt, which is essentially debt that the federal government owes to itself, such as debt it owes to the so-called Social Security Trust Fund. If publicly held debt is like the money you borrowed from a bank, intragovernmental debt is like the money you swiped from your kid’s piggy bank. It may not be on your credit report, but you still have to pay it back.

Today, intragovernmental debt exceeds $4.6 trillion. The good news here is that intragovernmental debt is not projected to grow much in the future. The bad news is that that is because both Social Security and Medicare are already running deficits — there’s nothing left to steal.

As if that’s not enough, there is also a third category of government debt: “implicit debt.” This represents the unfunded obligations of programs such as Social Security and Medicare — the amount that those programs owe in benefits in excess of the amount of taxes that they expect to take in. Think of it as bills you know are going to come in next month but haven’t been delivered yet.

According to the annual report of the Social Security system’s trustees, that program’s unfunded liabilities now exceed $18 trillion. Medicare is in even worse shape. The most recent estimate of its finances, also released this week, warns that Medicare owes $36.8 trillion more in benefits that it is expected to be able to pay for. And that is the optimistic outlook: It assumes that all the projected savings from President Obama’s health care reform actually happen as promised, something that even Medicare’s own actuaries are deeply skeptical of. If those savings don’t materialize, Medicare’s debt could actually top $90 trillion!

Add it all up, and total US debt actually exceeds 900% of GDP. That’s somewhere in excess of $120 trillion. We are beginning to talk real money here.

The CBO also contains bad news for those who believe that we can fix this problem simply by cutting “fraud, waste and abuse.” As CBO points out, the projected growth in the debt “is attributable entirely to increases in spending on several large mandatory programs: Social Security, Medicare, Medicaid, and (to a lesser extent) insurance subsidies that will be provided through [Obamacare].” There is simply no way to deal with our debt problems without reforming those entitlement programs.

Finally, the CBO report makes it clear that we have a debt problem because spending is too high, not because taxes are too low. In fact, even though taxes are currently at a near historic low as a proportion of the economy, that is largely a result of the recession. If the economy returns to normal growth rates (a big “if”), federal revenues will not only rise, but will actually be higher than the postwar average percentage of GDP by the end of the decade. In fact, this will happen even if the Bush tax cuts are extended and the Alternative Minimum Tax AMT continues to be patched.

GOP lawmakers who left negotiations with Obama this week over his unwillingness to pledge no new taxes understand this. The problem is the money going out, not coming in.

We face a simple choice: Cut spending or face fiscal catastrophe. The question is: Is Washington listening?
The Future of American Prosperity
Spending cuts, not tax increases, are the solution to our debt crisis.
NATIONAL REVIEW ONLINE        
May 9, 2011 4:00 A.M.

Members of both parties agree that Washington’s present fiscal course is dangerously unsustainable. We’re now borrowing 40 cents for every dollar we spend. This profligacy continues to weaken the dollar, threatening its status as the global reserve currency and fostering anxiety in the bond markets. Last month, Standard & Poor’s delivered a sobering wake-up call when it revised its outlook on the U.S. long-term credit rating from “stable” to “negative.”

No question, our accounts must be brought into balance — but not at the expense of economic growth. Those who advocate gigantic tax increases are short-sighted. Amid a sluggish recovery, abrupt tax hikes could drive the economy back into recession. (That’s what happened in Japan during the late 1990s.) Moreover, it will be impossible to generate sufficient revenue without robust growth. A rapidly expanding economy creates new jobs and income for investment in wealth-creating enterprises. Some of that wealth flows back to the government and can be used to reduce the debt.

The policy tools we use to restore fiscal stability will go a long way toward shaping the future of American prosperity and promoting the economic expansion we need. Will we impose tax hikes that discourage investment and punish job creation? Or will we make the tax system more efficient and conducive to growth?

As these and other questions are debated, policymakers should consult the evidence from other industrialized countries, which overwhelmingly suggests that spending cuts, not tax hikes, are the best way to close massive budget gaps and help produce economic growth. Indeed, after studying large-scale fiscal adjustments by wealthy, developed countries between 1970 and 2007, Harvard economists Alberto Alesina and Silvia Ardagna determined that “spending cuts are much more effective than tax increases in stabilizing the debt and avoiding economic downturns.” Moreover, they found “several episodes in which spending cuts adopted to reduce deficits have been associated with economic expansions rather than recessions.”

Goldman Sachs economists Ben Broadbent and Kevin Daly recently undertook a similar study that reviewed every major fiscal correction in wealthy nations since 1975. They found that “decisive budgetary adjustments that have focused on reducing government expenditures have (i) been successful in correcting fiscal imbalances; (ii) typically boosted growth; and (iii) resulted in significant bond and equity market outperformance. Tax-driven fiscal adjustments, by contrast, typically fail to correct fiscal imbalances and are damaging for growth.”

Broadbent and Daly pointed to successful fiscal adjustments in Ireland (1987–89), Sweden (1994–98), and Canada (1994–97). In each case, the adjustment was driven primarily by cuts in public spending. Sweden in particular is famous for the generosity of its welfare state. Yet, when faced with a crisis, Swedish officials were able to trim the size of government substantially. If Stockholm could do it back in the mid-1990s, Washington can do it today.

Reducing the short-term deficit and stabilizing the long-term debt are critically important to American prosperity and living standards. But studies show that if fiscal consolidation relies heavily on tax increases, it will stifle economic growth and prove counterproductive.

This is the lesson we must apply as we try to forge a genuine bipartisan compromise to deal with our debt crisis.

— Jon Kyl is the Senate Republican Whip and serves on the Senate Finance and Judiciary committees.
Downgrade, Default, and the Messy Economic Situation
Weekly Standard
Irwin M. Stelzer
April 23, 2011 12:00 AM

So the sovereign debt of the American government has been downgraded. Not last week by Standard & Poor’s, which merely put it on negative watch. But last November, by Dagong, China’s rating agency, which down-rated it from AA (its highest rating) to A+, and rated its outlook “negative.” Of course, the folks at Dagong had special reasons of their own: The Chinese regime, sitting on $1.2 trillion of U.S. government IOUs, wants to warn that it might stop buying Treasuries if we threaten to pay our debts in depreciated dollars.

But the Chinese regime also used the occasion to take a few swipes at “the serious defects in the US economic and development management model”—those inherent contradictions of capitalism that so disturbed Karl Marx—and to argue that America’s problems cannot be solved by a move by their agreement to allow the renminbi to rise from the undervalued level at which they have been maintaining it—a policy they are reviewing since it is contributing to the inflation that is causing the regime such difficulties.

Not that S&P was acting out of some sudden flashing of a danger signal by its economic model, if it has one. The rating agencies have been widely criticized for lavishing AAA ratings on securities backed by subprime mortgages, and missing the fact that Greece’s fiscal condition is more than a little different from Germany’s. So here was a chance to issue a warning: If it proved prescient, if the president and the Congress could not bring the deficit under control, the S&P raters could indulge in a “we warned you.” And if the politicians do finally move to rein in the Obama deficits, they can say, “We frightened them into action.” Win-win for the agency, which also avoids another charge of sleeping at the switch should things turn ugly on the deficit scene.

There is, of course, no possibility that we will default on our debt, as that term is generally understood. But there is a real possibility that we will pay our creditors back in trillions of newly printed dollars of shrunken value. After all, in the face of a deficit that clocks in at or close to double digits, President Obama submitted a budget for next year that actually increased spending and the deficit. Now a born again deficit cutter, he has since abandoned his own budget. No surprise: his reading of the political tea leaves tells him the voters want the deficit brought under control, although they are quite uncertain just how they want that done. A new poll shows that 44 percent of all voters definitely intend to vote against the president next year, 37 percent say they definitely will vote for him, and 18 percent are undecided. In a head-to-head poll with Mitt Romney, generally regarded as the most plausible Republican candidate—even though The Donald trumps him in polls of Republican voters—Obama’s 15-point lead in January has shriveled to a single percentage point.

So the president, now on a national tour to raise the $1 billion he says he needs to finance his reelection campaign—a trifle when you consider that we will spend twice that much on candy this Easter season. And he is promising to bring the deficit under control largely by taxing the rich, sometimes referred to as “millionaires and billionaires.” Unfortunately, there aren’t enough of those to make a dent in the deficit even if they are hit with a 100 percent tax rate. Meanwhile, the Paul Ryan-led Republicans say they will close the budget gap by converting Medicare, the government health care plan, into a subsidized insurance-cum-voucher system for future entrants into the system, a truly sensible proposal, but too easily demagogued to be counted on to win voter enthusiasm.

Squabbling notwithstanding, we are on track to a quasi-resolution in the next month or so. The government will soon hit the legal limit of its borrowing power, and it will take a congressional vote to allow it to borrow more. Otherwise, we will default after a few budgetary tricks to conceal our inability to pay our bills and the interest on our massive debt, which is now estimated by the International Monetary Fund to be “worse than some troubled European countries.” Obama, who when in the Senate voted against lifting the then much lower debt ceiling because that would demonstrate an absence of “leadership,” now wants the ceiling raised, no strings attached. The Republicans are busily attaching strings to their vote to raise the ceiling, and Treasury secretary Tim Geithner and Vice President Joe Biden are shuttling back and forth from the Hill to the White House to fashion a compromise. Which they will: neither party wants to be tagged with the label of defaulter in chief.

All of this has unnerved the markets, at least those markets that rely on a stable dollar. The prospect of dollar depreciation to avoid default, along with increased demand, is driving commodity prices through the roof. It is also leading to renewed interest in the use of other currencies to settle international transactions, with China pushing its renminbi as the alternative currency of choice. Last year only 0.5 percent of China’s trade was settled in the Chinese currency; in the first quarter of this year it was 7 percent.

Meanwhile, the world economy continues to grow despite the problems in the U.S. and in euroland, where default by at least Greece, Ireland, and Portugal is more or less accepted as the solution that once dared not speak its name. In America, the recovery continues, haltingly and at a slower pace than is necessary to bring unemployment down rapidly, but continues nevertheless. There are signs that a new wave of Schumpeterian innovation might be about to persuade the nation’s CEOs to begin to tap the $2 trillion cash pile salted away in their U.S. and overseas vaults. Earnings reports from Apple, IBM and Intel all suggest that consumers continue to lust after the new, innovative gadgets that seem to hit the market every week, and that business spending on IT is being driven forward by investment in the big data centers that are needed to facilitate the shift to “cloud computing,” hailed as the next stage in the development of the Internet. Equally robust reports from GE, United Technologies, and Honeywell suggest that the manufacturing sector is in full recovery mode and might just grow the economy at a more rapid rate than the 2.5-3 percent economists are expecting the rest of this year and in 2012.

Growth, of course, produces tax revenues that make it easier to bring deficits under control. And a political settlement will give business and consumer confidence a shot in the arm, an important aid to growth. My own guess  is that we will see a two-step settlement despite the ill will generated by the president’s intemperate attack on his opponents as people who want to let “children with autism or Down’s syndrome… fend for themselves.” (Recall: Sarah Palin has a Down syndrome child.) First, the debt ceiling will be raised as part of a package of some spending cuts—these can always be found or manufactured by accounting wizards, as the recent deal to avoid a government shutdown proves—and a deal to set broad spending limits, details to follow. Then the parties will tell the voters just how they intend to refashion the role of government so that it can live within those limits. Democrats will press for tax increases, Republicans for spending cuts. The winners will return to Washington in January of 2013 and eventually agree to a mix of both, the weight accorded cuts and taxes determined by which party wins the White House. Messy, but democracy often is.


The Disappearing Dollar:  How much longer can it remain the world’s currency standard?
National Review
Mark Steyn
April 23, 2011 6:00 A.M.

Congressman Paul Ryan, one of the least insane men in Washington, has a ten-year plan.

President Obama, one of the most insane spenders in Washington, has a twelve-year plan.

After hearing the president’s plan, Standard & Poor’s downgraded the U.S. sovereign-debt outlook to “negative.” Ah, the fine art of understatement. In 1940, after the fall of France and the evacuation from Dunkirk, presumably they downgraded Britain’s outlook to “spot of bother.”

At the world’s first “Presidential Facebook town hall meeting” on Wednesday, even Obama had a hard time taking his “plan” seriously. Sometimes he referred to it as a twelve-year plan, sometimes ten years, sometimes saving four trillion, sometimes saving two trillion. So will the Obama plan save four trillion over twelve years or two trillion over ten?

For the answer let’s go to next week’s first presidential Twitter town hall meeting:

OMG!!! LOL!!!!!!! ROFLMAO!!!!!!!!!

Overly Massive Government!!! Legislating Official Largesse!!!!!!! Requiring Offering Foreign Lenders More American Ownership!!!!!!!!!

The president’s plan is to balance the budget by climbing into his Little Orphan Obammie costume and singing: “The sun’ll come out tomorrow / Bet your bottom dollar that tomorrow there’ll be sun.” We’ve already bet our bottom dollar and it’s looking like total eclipse. But Obammie figures if we can only bet Daddy Warbucks’s bottom dollar, the sun will shine. The “rich” don’t have enough money to plug the gap: As a general principle, whatever the tax rates, the Treasury can never take in more than about 19 percent. Since Obama took office, the government’s spent on average 24.4 percent of GDP. That five-point gap cannot be closed, and it’s the difference between the possibility of a future and the certainty of utter ruin. Hence, outlook “negative.”

By the way, if you were borrowing (as the United States government does) 188 million dollars every hour, would your bank be reassured by a 12-year plan?

That’s 2023. Go back 12 years. That’s 1999. Which, if any, politicians in that year correctly identified the prevailing conditions in the America of 2011? Most of our problems arise from the political class’s blithe assumptions about the future. European welfare systems assumed a mid-20th-century fertility rate to sustain them. They failed to foresee that welfare would become a substitute for family and that Continentals would simply cease breeding. Bismarckian-Rooseveltian pension plans assumed you’d be living off them for the last couple of years of your life. Instead, citizens of developed nations expect to spend the final third of their adult lives enjoying a prolonged taxpayer-funded holiday weekend.

What plans have you made for 2023? The average individual attempts to insure against future uncertainty in a relatively small number of ways: You buy a house because that’s the surest way to preserve and increase wealth. “Safe as houses,” right? But Fannie/Freddie subprime mumbo-jumbo and other government interventions clobbered the housing market. You get an education because that way you’ll always have “something to fall back on.” But massive government-encouraged expansion of “college” led Americans to run up a trillion dollars’ worth of student debt to acquire ever more devalued ersatz sheepskin in worthless pseudo-disciplines. We’re not talking about the wilder shores of the stock market — Internet start-ups and South Sea bubbles and tulip mania — but two of the safest, dullest investments a modestly prudent person might make to protect himself against the vicissitudes of an unknown future. And we profoundly damaged both of them in pursuit of fictions.

I don’t claim absolute certainty about what the world will be like in 2023, but I know what our governing class is telling us. At Tufts University, Nancy Pelosi urged her “Republican friends” to “take back your party, so that it doesn’t matter so much who wins the election — because we have shared values about the education of our children, the growth of our economy, how we defend our country, our security and civil liberties, how we respect our seniors. Elections shouldn’t matter as much as they do.”

The last line attracted a bit of attention, but the “shared values” — i.e., the fetid bromides of conventional wisdom — are worth decoding, too: “Education of our children” means more spending on an abusive and wasteful unionized educrat monopoly; “growth of our economy” means more spending on stimulus funding for community-organizer grant applications; “how we defend our country” means more spending on defense welfare for wealthy allies; “our security and civil liberties” means more spending on legions of crack TSA crotch fondlers; “how we respect our seniors” means more spending on entitlements for an ever more dependent citizenry whose sense of entitlement endures long after the entitlement has ceased to make any sense.

Nancy Pelosi fleshed out the Obama plan: More spending. More more. Now and forever. That’s what S&P understands. The road to hell is paved with stimulus funding.

The world has started to listen to what Obama is telling us. In that respect, let me make a single prediction for 2023 — that by then the dollar will no longer be the global reserve currency. Forty years ago, U.S. Treasury Secretary John Connally told Europe that the dollar is “our currency but your problem.” The rest of the world is now inverting the proposition: The dollar is our problem but, in the end, it’s your currency, not ours. In Beijing, in Delhi, in Riyadh, in Rio, the rest of the planet is moving relentlessly toward a post-dollar regime.

What will America look like without the dollar as global currency? My old boss Conrad Black recently characterized what’s happened over the last half-century as a synchronized group devaluation by Western currencies. That’s a useful way of looking at it. What obscured it was the dollar’s global role. When the dollar’s role is ended, the reality of a comatose “superpower” living off a fifth of a billion in borrowed dollars every single hour of the day is harder to obscure.

In the absence of responsible American leadership, the most important decisions about your future will be made by foreigners for whom fatuous jingles about “shared values” have less resonance. If you don’t want the certainty of a poorer, more decrepit, more diseased, more violent America, you need to demand your politicians act now — or there won’t be a 2023.

— Mark Steyn, a National Review columnist, is author of America Alone. © 2011 Mark Steyn.
Is Anyone Listening to the S.&P.?
The ratings firm lowered the outlook on U.S. debt to negative from stable. Should we worry?

No Real Risk of Default
Barry Ritholtz is chief executive of Equity Research at Fusion IQ, an online quantitative research firm and writes The Big Picture blog. He is the author of "Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy.”
Updated April 19, 2011, 07:36 AM

What does Standard & Poor's action lowering the U.S. outlook to "negative" mean? What are the likely ramifications of the U.S. deficit and debt? I do not want to conflate two completely different issues, so let's take each in turn.

First, I have stopped paying any attention to anything that S.&P. says or does. Its performance over the past decade has revealed it to be incompetent and corrupt – it sold its AAA ratings to the highest bidder. It is the broker who lost all your money, the girlfriend who cheated on you, the partner who stole from you. Since the portfolios we run never rely on its judgment or analysis, we simply do not care what it says about credit ratings.

But big bond managers like Bill Gross of Pimco do matter – he invests hundreds of billions of dollars. We pay close attention when smart managers like him announce they are out of the Treasury market, which he did last month.

Many people misunderstand the U.S. deficit. First, it is stimulative to both the economy and the markets. Look at what happened under Reagan and Obama and most of Bush II – the economy recovered from recession and the markets rose along with the deficit.

Second, Social Security is fine. Sure, the retirement age will go higher, there will be means testing, and the income cutoff for contributions ($106,000) will likely double. But it will remain solvent. Medicare is much trickier, as the United States pays two times what most countries pay for health care but gets lesser care.

The current debate about deficits looks like more politics. Look at the voting records of those posturing about the debt. The “deficit peacocks” voted for new entitlements (the prescription drug benefit -- Medicare Part D), went along with a trillion-dollar war of choice in Iraq, and supported (for the first time in U.S. history) a major tax cut during wartime. I find it hard to take their deficit noise as a bona fide fiscal concern.

After Standard & Poor’s missed the greatest collapse in history – indeed, they helped create it by rating junk mortgage backed securities Triple AAA – they are now over-compensating. As I mentioned on The Big Picture, there is an old Wall Street joke about analysts: “You don’t need them in a Bull Market, and you don’t want them in a Bear Market.” That especially seems apt with regard to S.&P.

The deficit has been with us for a long time. Since investors are continuing to lend money to Uncle Sam at exceedingly low rates, there does not appear to be any real fear of a default. That is what matters most to bond buyers -- and it why I never care what S.&P. thinks on this.
S&P cuts long-term outlook for US debt to negative
YAHOO
By PAUL WISEMAN, AP Economics Writer
18 April 2011
 
WASHINGTON – Standard & Poor's Ratings Service downgraded its outlook Monday on the United States' sovereign debt, expressing unprecedented doubts over the ability of Washington to bring the massive federal budget deficits under control in the next three years.

The agency lowered the long-term outlook to "Negative" from "Stable," saying there is a one in three chance it will downgrade the rating on the debt in the next two years.  S&P reaffirmed its investment-grade credit ratings on the U.S. long- and short-term debt itself. But it said the ratings are at risk from the country's growing deficit.

It has little confidence that the White House and Congress will agree on a deficit-reduction plan before the fall 2012 elections, the agency said. By that time, the measures won't go into effect until the fiscal year 2014.  The government is on pace to run a record $1.5 trillion deficit this year, the third consecutive deficit exceeding $1 trillion. President Barack Obama and congressional Republicans are sparring over how to reduce the nation's red ink. Their differences over where to cut have put a crucial decision over raising the nation's debt limit in jeopardy.

"We see the path to agreement as challenging because the gap between the parties remains wide," said Standard & Poor's credit analyst Nikola G. Swann.

Stocks plunged after the rating agency lowered its outlook The Dow Jones industrial average fell more than 200 points in early-morning trading.  S&P said the U.S. has a high-income, diversified and flexible economy that has helped it to encourage growth while containing inflation.  But the country's ballooning deficit could offset those positives over the next two years.

The agency noted that the deficit grew to 11 per cent of gross domestic income in 2009. That is much higher than the average of two per cent to five per cent in the previous six years.  Mary Miller, the assistant Treasury secretary for financial markets, said S&P "underestimates the ability of America's leaders to come together to address the difficult fiscal challenges facing the nation."

The president and Congress are working on ways to reduce budget deficits over the long term, she said.  The fight over the deficit and next year's budget is threatening the government's ability to borrow. Analysts say S&P is warning the two parties not to play politics with the debt ceiling.

Treasury Secretary Timothy Geithner said Sunday that Republican leaders have privately assured the Obama administration that Congress will raise the government's borrowing limit in time to avoid an unprecedented default on the nation's debt.  But a top Republican quickly pushed back and said there was no guarantee the GOP would agree to increase the $14.3 trillion debt ceiling without further controls on federal spending.

Geithner has said that the government will hit its current limit no later than May 16. But Geithner said it will be able to avoid an unprecedented default on the national debt through various accounting maneuvers for possibly another two months.
From reprint in the Weekly Standard
A budget for the 21st century
Washington Post
By Paul Ryan, Thursday, April 14, 2:42 PM

This week the House of Representatives will take the first real step in addressing our looming fiscal crisis by bringing “The Path to Prosperity,” a budget resolution for next year and beyond, to the House floor. This budget offers a clear contrast to the president’s speech on Wednesday.

It offers a contrast in credibility. Unlike the president’s speech, which was rhetorically heated but substantively hollow, our budget contains specific solutions for confronting the debt and averting the most predictable crisis in our nation’s history. It also offers a contrast in visions. Unlike the speech, our budget advances a vision of America in which government both keeps its promises to seniors and lives within its means.

Two months ago, President Obama submitted a budget for fiscal 2012 that did not deal with the major sources of government spending while calling for much higher taxes on American businesses and families. This budget was widely panned as lacking seriousness.

Now comes a deficit speech that doesn’t even rise to the level of a plan. Missing was a credible way to curb out-of-control spending. Instead, the president called for greater reliance on government price controls, which would strictly limit the health-care options of current seniors while failing to control costs. The president would couple this approach with $1 trillion in tax increases, which would destroy jobs and hurt the economy.

We cannot accept an approach that starts from the premise that ever-higher levels of spending and taxes represent America’s new normal. We have an obligation to fulfill the mission of health and retirement security for current retirees and future generations. We have a historic commitment to limited government and free enterprise. And we have a duty to leave the next generation with a more prosperous nation than the one we inherited.

The House Republican budget keeps America’s promises to seniors and those near retirement by making no changes to their current arrangements. It keeps America’s promises of health and retirement security for future generations by saving and strengthening our most important programs. And it keeps a promise that is implicit in our form of government: that a government instituted to secure our rights must be a limited government.

That is why “The Path to Prosperity” prevents spending and taxes from rising steadily to unprecedented levels, as they are currently projected to do. Doing otherwise would leave our children a nation that is less prosperous, less free and much deeper in debt.

If you are someone who agrees with the president that we cannot avoid this outcome without resorting to large tax increases, know this: No amount of taxes can keep pace with the amount of money government is projected to spend on health care in the coming years. Medicare and Medicaid are growing twice as fast as the economy — and taxes cannot rise that fast without a devastating impact on jobs and growth.

If you believe that spending on these programs can be controlled by restricting what doctors and hospitals are paid, know this: Medicare is on track to pay doctors less than Medicaid pays, and Medicaid already pays so little that many doctors refuse to see Medicaid patients. These arbitrary cuts not only fail to control costs, they also leave our most vulnerable citizens with fewer health-care choices and reduced access to care.

And if you believe that we must eliminate waste, fraud and abuse in these programs, know this: Eliminating inefficient spending is critical, but the only way to do so is to reward providers who deliver high-quality, low-cost health care, while punishing those who don’t. Time and again, the federal government has proved incapable of doing that.

Medicare is projected to go bankrupt in just nine years unless we act to curb the relentlessly rising cost of health care. This cannot be done with across-the-board cuts in Washington. It has to be done by giving seniors the tools to fight back against skyrocketing costs. That’s why our budget saves Medicare by using competition to weed out inefficient providers, improve the quality of health care for seniors and drive costs down.

The president’s proposals are aimed more at empowering government than strengthening the free market. He continues to prove he’s not up to the challenging work of reforming government to meet 21st-century needs. If he gets his way, the nation will endure huge tax hikes, seniors’ access to health care will be reduced — and we will experience an epic collapse of our health and retirement programs that would devastate our nation’s most vulnerable citizens.

House Republicans are fighting to prevent this. Our budget offers a compassionate and optimistic contrast to a future of health-care rationing and unbearably high taxes. We lift the crushing burden of debt, repair the safety net, make America’s tax system fair and competitive, and ensure that our health and retirement programs have a strong and lasting future. These issues are too important to leave to the politics of the past. If President Obama won’t lead, we will.

The writer, a Republican from Wisconsin, is chairman of the House Budget Committee.
Raise America’s Taxes
By NICHOLAS D. KRISTOF, NYTIMES
April 13, 2011

President Obama in his speech on Wednesday confronted a topic that is harder to address seriously in public than sex or flatulence: America needs higher taxes.

That ugly truth looms over today’s budget battles, but politicians have mostly preferred to run from reality. Mr. Obama’s speech was excellent not only for its content but also because he didn’t insult our intelligence.

There is no single reason for today’s budget mess, but it’s worth remembering that the last time our budget was in the black was in the Clinton administration. That’s a broad hint that one sensible way to overcome our difficulties would be to revert to tax rates more or less as they were under President Clinton. That single step would solve three-quarters of the deficit for the next five years or so.

Paradoxically, nothing makes the need for a tax increase more clear than the Republican budget proposal crafted by Representative Paul Ryan. The Republicans propose slashing spending far more than the public would probably accept — even dismantling Medicare — and rely on economic assumptions that are not merely rosy, but preposterous.

Yet even so, the Republican plan shows continuing budget deficits until the 2030s. In short, we can’t plausibly slash our way back to solid fiscal ground. We need more revenue.

Kudos to Mr. Obama for boldly stating that truth in his speech — even if he did focus only on taxes for the very wealthiest. I also thought he was right to say that we need spending cuts — including in our defense budget. Mr. Obama didn’t say so, but the United States accounts for almost as much military spending as the entire rest of the world put together.

As I see it, there are three fallacies common in today’s budget discussions:

• Republicans are the party of responsible financial stewardship, struggling to put America on a sound footing.

In truth, both parties have been wildly irresponsible, but in cycles. Democrats were more irresponsible in the 1960s, the two parties both seemed care-free in the ’70s and ’80s, and since then the Republicans have been staggeringly reckless.

After the Clinton administration began paying down America’s debt, Republicans passed the Bush tax cuts, waded into a trillion-dollar war in Iraq, and approved an unfunded prescription medicine benefit — all by borrowing from China. Then-Vice President Dick Cheney scoffed that “deficits don’t matter.”

This borrow-and-spend Republican history makes it galling when Republicans now assert that deficits are the only thing that matter — and call for drastic spending cuts, two-thirds of which would harm low-income and moderate-income Americans, according to the Center on Budget and Policy Priorities. To pay for tax cuts heaped largely on the wealthiest Americans, Republicans in effect would gut Medicare and slash jobs programs, family planning and college scholarships. Instead of spreading opportunity, federal policy would cap it.

• Low tax rates are essential to create incentives for economic growth: a tax increase would stifle the economy.

It’s true that, in general, higher taxes tend to reduce incentives. But this seems a weak effect, often overwhelmed by other factors.

Were Americans really lazier in the 1950s, when marginal tax rates peaked at more than 90 percent? Are people in high-tax states like Massachusetts more lackadaisical than folks in a state like Florida that has no personal income tax at all?

Tax increases can also send a message of prudence that stimulates economic growth. The Clinton tax increase of 1993 was followed by a golden period of high growth, while the Bush tax cuts were followed by an anemic economy.

• We can’t afford Medicare.

It’s true that America faces a basic problem with rapidly rising health care costs. But the Republican plan does nothing serious to address health care spending, other than stop paying bills. Indeed, Medicare is cheaper to administer than private health insurance (2 percent to 6 percent administrative costs, depending on who does the math, compared with about 12 percent for private plans). So the Republican plan might add to health care spending rather than curb it.

The real challenge is to control health care inflation. Nobody is certain how to do that, but the Obama health care law is testing some plausible ideas. These include rigorous research on which procedures work and which don’t. Why pay for surgery on enlarged prostates if certain kinds of patients turn out to be better with no treatment at all?

Ever since Walter Mondale publicly committed hara-kiri in 1984 by telling voters that he would raise their taxes, politicians have run from fiscal reality. As baby boomers age and require Social Security and Medicare, escapism will no longer suffice. We need to have a frank national discussion of painful steps ahead, and since I’m not a politician, let me be perfectly clear: raise my taxes! 
Dooming the dollar
By GEORGE F. WILL, Washington Post
Last Updated: 4:16 AM, April 14, 2011
Posted: 10:39 PM, April 13, 2011

KANSAS CITY, MO.

THE lobby of the Federal Re serve Bank building here contains a money museum where a sign offers visitors "Free Money." It is an amusing anomaly, considering the views of the man in charge of the building.

The free money in the lobby consists of shredded currency in small plastic bags. The free money that distresses Tom Hoenig, in his 20th and final year as president of one of the Federal Reserve's 12 regional banks, is being pumped into the economy by two policies of the Federal Reserve in Washington -- very low interest rates and a second "quantitative easing" (printing money).

As the global recovery gains strength, the prices of three things will rise: oil, food and money. David Rosenberg of Gluskin Sheff in Toronto reports that in the last three months, 100 percent of the $55 billion increase in aggregate US wages and salaries has been matched by increased grocery and gasoline prices. They are absorbing 22 percent of wages and salaries, a portion matched only twice in the last two decades -- both times presaging recessions.

Under the $600 billion QE2, which ends in June, the Fed has been buying about 70 percent of the Treasury's new issues of debt. What interest rate might be required to attract buyers to fill the space left when the Fed withdraws from the market? Interest rates are the prices of money, and Hoenig says: "Tell me one product, one service, that trades well" -- he means, is put to efficient use -- "at a price of zero."

Hoenig notes that cheap-money policies predated the recession. He says the real federal-funds rate (after discounting inflation) was negative about 40 percent of the time in the '70s and the 2000s. In 2003, he says, interest rates were reduced to 1 percent because unemployment was too high. It was only 6.3 percent. Today it is 8.8 percent in the aftermath of the housing bubble and recklessness fueled by virtually free money.

Last year was Hoenig's last as a voting member of the Federal Open Market Committee, which sets the money supply and interest rates. Eight times the committee voted to hold rates low; each time, Hoenig was the lone dissenter.

He was at home one Sunday morning when he received a phone call from an 85-year-old woman in Connecticut. She said she and her late husband had lived frugal lives so they could get by in retirement on interest from their savings. Such people are among the losers under low-interest policies that mock the virtue of saving. The winners include the 20 percent of Americans who own 93 percent of the equities.

One purpose of the policy of protracted rock-bottom interest rates is to stimulate credit-sensitive sectors of the economy, especially housing. In January, for the sixth consecutive month, housing prices plunged, almost to the trough of the 2009 recession.

Perhaps the primary purpose of low rates is to send money flooding into the stock market in search of higher returns. The resulting run-up of equities' values supposedly will produce a "wealth effect," making fortunate people feel even more flush and eager to spend and invest.

Hoenig, an Iowa native, says the provinces have not cornered the market on provincialism. He warns "end the Fed" advocates to be careful what they wish for. The Fed will not go away; under "reform," regional banks such as his might. This, he says, would make the New York-Washington financial axis more powerful relative to "this part of the country."

Would, he asks, America be better off if it were more like Canada, with most credit controlled by five major banks?

His answer is that America's innovative dynamism is related to the existence of thousands of community and regional banks attuned to local needs. He thinks the biggest threat to the economy is the existence of too-big-to-fail financial institutions:

"In 1999, the five largest US banking organizations controlled $2.3 trillion in assets, or about 38 percent of all banking industry assets. Currently, Bank of America by itself . . . has the same level of assets -- $2.3 trillion . . . and the top five now have 52 percent of all banking industry assets. . . . Creditors and uninsured depositors at too-big-to-fail organizations believe that there is almost no chance that they will have to take a loss."

With all this, could we ever get back to capitalism? "Not," he says, "in my lifetime."

georgewill@washpost.com


Hoover Institute thinking - you remember, Herbert Hoover (President in 1929)
Budget Crisis Rhetoric:  Bankruptcy reveals what bailouts conceal.
National Review
Thomas Sowell
January 18, 2011 12:00 A.M.

Government-budget crises can be painful, but the political rhetoric accompanying these crises can also be fascinating and revealing. Perhaps the most famous American budget crisis was New York City’s  during the 1970s. When Pres. Gerald Ford was unwilling to bail it out, the famous headline in the New York Daily News read, “Ford to City: Drop Dead.”

President Ford caved and bailed them out, after all.

The rhetoric worked. That is why so many other cities and states — not to mention the federal government — have continued on with irresponsible spending, and are now facing new budget crises, with no end in sight.

What would have happened if President Ford had stuck to his guns and not set the dangerous precedent of bailing out local irresponsibility with the taxpayers’ money?

New York would have gone bankrupt. But millions of individuals and organizations go bankrupt without dropping dead.

Bankruptcy conveys the plain facts that political rhetoric tries to conceal. It tells people who depended on the bankrupt government that they no longer can. It tells the voters who elected that bankrupt government, with its big-spending promises, that they made a bad mistake that they would be wise to avoid making again in the future.

Legally, bankruptcy wipes out commitments made to public-sector unions, whose extravagant pay and pension contracts are bleeding municipal and state governments dry.

Is putting an end to political irresponsibility and legalized union racketeering dropping dead?

Politics being what it is, we are sure to hear all sorts of doomsday rhetoric at the thought of cutbacks in government spending. The poor will be starving in the streets, to hear politicians and the media tell it.

But the amount of money it would take to keep the poor from starving in the streets is chump change compared to how much it would take to keep on feeding unions, subsidized businesses, and other special interests who are robbing the taxpayers blind.

Letting armies of government employees retire in their fifties, to live for decades on pensions larger than the income they made while working, costs a lot more than keeping the poor from starving in the streets.

Pouring the taxpayers’ money down a thousand bottomless pits of public and private boondoggles costs a lot more than keeping the poor from starving in the streets.

Bankruptcy says: “We just don’t have the money.” End of discussion. Bailouts say: “Give the taxpayers a little rhetoric, and a little smoke and mirrors with the bookkeeping, and we can keep the party rolling.”

One of the political games that is played during a budget crisis is to cut back on essential services like police departments and fire departments, in order to blackmail the public into accepting higher tax rates. Often, a lot more money could be saved by getting rid of runaway pension contracts with public-sector unions.

Bankruptcy can do that. Bailouts cannot.

What the public needs are current policemen and current firemen, not retired policemen and retired firemen, much less bureaucrats retired on inflated pensions.

The political temptation to create extravagant pensions is always there, not only at state and local levels, or at the federal level, but in countries around the world. Why? Because pensions are benefits that can be promised for the future, without raising the money to pay for them.

Politicians get the votes of those to whom pensions are promised, without losing the votes of taxpayers — and they leave it up to future government officials to figure out what to do when the money is just not there. It is a sure-fire guarantee of political irresponsibility.

All of this works politically only so long as the voting public accepts budget crisis rhetoric at face value, without bothering to stop and think about what it means and implies.

– Thomas Sowell is a senior fellow at the Hoover Institution. © 2011 Creators Syndicate, Inc.

America's coming collapse
New York Post editorial
Last Updated: 12:54 AM, January 4, 2011
Posted: 10:23 PM, January 3, 2011

White House Council of Economic Ad visers Chairman Austan Goolsbee is warning of cataclysmic results if the new Republican House majority holds back on raising the nation's debt limit.

"I don't see why anybody's playing chicken with the debt ceiling," he says. "If we get to the point where we damage the full faith and credit of the United States, that would be the first default in history caused purely by insanity."

Blah, blah, blah.

Or, taken another way, a collapse is coming -- but what kind of collapse?  Not raising the debt ceiling could cause a default. But so, eventually, will trillions in new borrowing every year.  The national debt today sits at $13.9 trillion and could hit the $14.3 trillion ceiling -- approved just last February -- as early as this summer.

The GOP insists on serious spending cuts before the ceiling is raised again.  Which is exactly right.  As the November elections proved, no issue unites Republicans, Tea Party activists and ordinary Americans more than opposition to the out-of-control spending of the last two years.

Goolsbee might listen to the sage words of a senator from 2006:

"[The vote to raise] America's debt limit is a sign of leadership failure. It is a sign that the US government can't pay its own bills [and] that we now depend on ongoing financial assistance from foreign countries to finance our government's reckless fiscal policies . . . "

An insane Republican?

No, that was then-Sen. Barack Obama explaining his vote against raising the debt ceiling -- to "only" $9 trillion.

The party is going to stop.  The only question is: When?  Republicans would be insane not to force the issue. We wish them well.

The Economic Year in Review:  Say goodbye to 2010.
Weekly Standard
Irwin M. Stelzer
December 24, 2010 11:00 AM

As we look back on the year that is limping to an end, there is little—not nothing, just little—to cheer about. The year opened with the headline unemployment rate at 9.7 percent, and the rate including workers too discouraged to look for work or involuntarily on short-time (the U-6 rate, in the jargon of the trade) at 16.5 percent of the work force. It is closing with the headline rate close to 10 percent and the U-6 rate at 17 percent. The number of workers unemployed for 27 weeks or longer has jumped during the year from about 6 million to 6.3 million. All of this despite the expenditure of about $1 trillion on an economic stimulus.

Republicans and conservatives take these numbers as final proof that the reputation of John Maynard Keynes should remain in the graveyard of fallen economists, while President Obama and his team claim that without the heavy dose of Keynes’s medicine, a demand-side stimulus, the jobs situation would be much worse. Only the federal government has survived job cuts—the number of employees on the federal government payroll has increased a bit. And these are what liberals call “good paying jobs”: the average annual salary of federal workers is close to $118,000, and in comparable jobs is about 10 percent higher than private-sector pay.

One thing is beyond dispute. The year saw what must be the most rapid peace-time deterioration in the nation’s financial position. Obama inherited a budget surplus running at 2.37 percent of GDP in 2000, converted it into a deficit of 3.18 percent in 2008 and a staggering 9.91 percent last year. This year it will be closer to 11 percent than to 10 percent. Yes, some of this is the natural effect of the recession. But some comes from the president’s decision to allow congressional Democrats to dust off spending plans long gathering dust. For them, Santa Claus came early this year, and stayed right through the latest deal agreed by Republicans: taxes on the so-called wealthy will not go up, a big win say conservatives who argue that the $100 million increase in taxes on the wealthy would have thrown us back into recession. But the price for that concession was agreement to spend another $1 trillion on some favorite Obama programs, increasing the deficit—something conservatives say will throw us back into recession!

The U.S. government now owes its creditors almost $14 trillion, up from less than $6 trillion when George W. Bush was packing to return to Texas. And the total is headed up, and will rise even faster if the recent increase in interest rates proves to be only the first round of rate rises.

Despite a pick-up in mood as a result of the demonstration that the president could forge a working relationship with Republicans—the tax deal was followed by passage of his START treaty and his bill to end Don’t Ask, Don’t Tell—Gallop pollsters find Americans troubled about the economy. The four most troubling issues are the economy (mentioned by 30 percent of respondents), unemployment (24 percent), dissatisfaction with government (13 percent), and the deficit (10 percent). Add the following from poll-takers at the Pew Research Center: only 35 percent of Americans rate their personal financial situation as either excellent (5 percent) or good (30 percent), 65 percent say jobs are difficult to find, and well over half (67 percent) feel we are losing ground in the fights to reduce the budget deficit, to close the rich-poor gap (58 percent), to compete internationally (55 percent), and to fix social security and Medicaid (64 percent and 51 percent, respectively). These worries are exacerbated by weak house prices, rising foreclosures, and the unavailability of credit for the few prospective home buyers who believe the market has hit bottom.

All of which explains two important developments—the rise in the price of gold, and the sweeping gains by Republicans in the congressional elections. Gold opened the year at under $1,100 per ounce and is closing it at close to $1,400 per ounce. Despite substantial slack in production capacity, inflation expectations rose, and investors became worried about the long-term value of the dollar. Indeed, some economists are talking about the end of the era of fiat money and a return to the gold standard. The Federal Reserve Board is again printing money, and promises to print more if needed. With unemployment high, and the printing presses running at a rate that just might result in inflation down the road, talk of a return to the bad old days of Jimmy Carter and stagflation, or of a double dip recession, was heard in some boardrooms.

Nervousness about the economy also resulted in what might be the most consequential event of 2010—a political upheaval. According to the Rasmussen, Congress’s approval rating dropped from a skimpy 23 percent in the middle of last year to 11 percent, about as close to zero as you can get in a poll such as this. No surprise that the much-misunderstood Tea Party, consisting of a turn-the-rascals-out contingent upset with the rising deficit and size of government, proved to have such impact in 2010. Republicans regained control of the House of Representatives, and increased their minority in the Senate sufficiently to raise their party’s contingent from impotence to a force to be dealt with. Many of the old Republican war horses who were complicit in the explosion of spending, and in giving government so much larger a role in the health care industry, have been returned to the private sector, where they will be reduced to spending only money they personally can earn, many of them by lobbying former colleagues rather than, as promised, returning home to spend more time with their families.

Lest we forget that 2010 saw more than economic developments, let’s record that it was the year in which Iran moved closer to obtaining a nuclear weapon; in which China continued to acquire Western technology to reduce its reliance on American, British, French and German companies; in which all the talk about electric cars had no discernible effect on oil consumption; and in which serial financial crises in the eurozone exposed the weakness of a single currency trading in an area in which individual nations controlled their own fiscal policies. Oh, yes, there seems to have also been an oil spill in the Gulf of Mexico.

There’s more, but you get the idea, economic gloom for most, political gloom for Democrats. Only  investors, who saw the equities market move up some 13 percent during the year, are smiling, albeit nervously. Everyone else, say goodbye to 2010 without a nostalgic tear in your eye.

----

The next report will be in the new year, containing guesses as to what is in store for us in 2011. I cannot conclude this year’s reporting without thanking all of you who share your views with me, and acknowledging the invaluable assistance of my Hudson Institute colleague Diana Furchtgott-Roth, who provides much of the data that lend these pieces any authority they might command.

Obama tax deal could lessen the sting of state tax increase
CT MIRROR
Keith M. Phaneuf and Mark Pazniokas
December 9, 2010

If there's one Democrat in Connecticut who has reason to be thrilled with the tax compromise President Obama struck this week with congressional Republicans, it should be Gov.-elect Dan Malloy.

Malloy, who will be asking state legislators to February to adopt a tax increase that could be the largest in two decades, might otherwise be doing so amidst a major federal income tax increase, were it not for Obama willingness to extend the Bush-era tax cuts.

For good and bad, Malloy sees Obama's new stance as shading how his own expected mix of tax increases and spending cuts will play in Connecticut.

"I've been thinking about that over the last 24 hours," Malloy said. "It helps and it hurts. It's like everything."

Malloy has made no secret of his intention to rely on both tax increases and spending cuts to erase a deficit projected as high as $3.67 billion for the 2011-12 fiscal year.

That gap is more than triple the deepest level of budget cuts either of the last two governors achieved in any single year.

So if higher state taxes have to be a part of the state's solution - a reality Malloy impressed upon House Democrats during a meeting this week - is it easier to face the task with Washington not asking for any more right now?

"It helps, but obviously it's an argument that if the president didn't think it was time to raise taxes, then how do you raise taxes?" Malloy said.

Of course, the difference is that the state is not allowed unfettered deficit spending, unlike the federal government.

The compromise, which extends Bush income tax cuts for two years, effectively retains the break for middle- and low-income families built into last year's stimulus measure by shaving 2 percentage points off Social Security taxes and restores the federal estate tax at 35 percent, would be financed by adding a projected $900 billion to the national debt over two years.

But Malloy still expects someone to compare a state tax increase unfavorably to Obama extending tax cuts.

"Some member of the press will report it that way. Between now and February 5, somebody will say that," Malloy said, laughing. "You want to have a bet?"

If Malloy had wagered on legislators drawing parallels between Connecticut and Washington, he would have won by mid-day on Wednesday.

State Sen. Andrew Roraback of Goshen, the ranking Republican on the tax-writing Finance, Revenue & Bonding Committee, said the comparison is valid regardless of the prohibition against deficit-budgeting in the state Constitution.

"The recognition by the president and leaders on both sides of the aisle in Congress that now is a particularly inopportune time for anyone to be thinking about raising taxes ought to be a lodestar for our conversations in Hartford," Roraback said. "Any conversation about increasing revenue has to follow and not precede conversation about controlling the runaway costs of government in Connecticut."

Since the deal's announcement on Monday, the president has taken heat from fellow Democrats for extending tax breaks for individuals earning more than 200,000 and couples earning beyond $250,000 - a bargain Obama said had to be struck to ensure tax breaks for those earning less didn't expire at month's end.  Majority Democrats in the state legislature have had to make similar compromises in recent years to accommodate not only Republican Gov. M. Jodi Rell, but some of their own members from affluent shoreline districts.

Rell agreed to raise the marginal rate on income above $1 million to 6.5 percent in 2009, in exchange for a reduction in the tax on wealthy estates.

"I thought that the president made an extra good bargain and there's no doubt that without it, our job would be more difficult," state Sen. Edward Meyer, a Guilford Democrat, said, noting that more than half of Connecticut's $6.8 billion in annual income tax receipts comes from households earning more than $200,000, according to budget records.

"I think people would have felt they were under siege" if faced simultaneously with major tax increases from both levels of government, state Senate Majority Leader Martin M. Looney, D-New Haven, said. "They would have said the state is just piling on. That would have been a real complicating factor trying to put a budget together."

That's due in large part to the scope of the deficit Malloy faces. Equal to nearly one-fifth of this year's $19 billion budget, the shortfall is generally recognized as too large to be solved solely with tax hikes on the wealthy and the governor-elect has been preaching the necessity of "shared sacrifice" to solve the crisis.  That deficit also represents the largest gap in terms of overall budget share since 1991, when then-Gov. Lowell P. Weicker Jr. pressed lawmakers into enacting the state income tax.

And while the fiscal challenges are similar, so are the opportunities to enact major fiscal reform, according to lobbyist Tom D'Amore, former chief of staff and political confidante to Weicker. Without the pressure of new federal tax hikes to sap state legislators' political will, a strong governor could accomplish a lot, he said.

"It will, in some respects, make the burden less here. You would have to be living on another planet to think otherwise," D'Amore said. "Dan Malloy is showing great leadership so far. I think he could rightly make the case that we should clean up our house now.  This will be ugly and painful."

Emerging Markets Report
Cooperation called for amid ‘currency war’
By Carla Mozee, MarketWatch
Oct. 9, 2010, 11:33 a.m. EDT

LOS ANGELES (MarketWatch) — The so-called “currency war” may see five emerging markets ramp up efforts to curb currency advances, say analysts, as pressure to keep exports competitive overrides official warnings that such interventions could frustrate a flagging global recovery.

The chatter about currency war has grown louder in recent weeks and was a hot topic during the annual meeting of the International Monetary Fund and the World Bank this weekend in Washington. See more about the IMF/World Bank meetings.

“We are seeing so much intervention because countries do not want to lose competitiveness,” said Ousmène Mandeng, a former IMF economist who heads public-sector investment advisory services at Ashmore Investment Management in London.



Central banks that have already intervened to slow currency gains include those in Colombia, South Korea, Peru and Taiwan.

Further actual or verbal intervention efforts are likely to come from the Czech Republic, Poland and South Africa, wrote Arko Sen, analyst with Bank of America/Merrill Lynch’s emerging EMEA group, in a note last week.

Israel, which was also on the list, has said it will continue buying dollars to stem the rise of its shekel.

In a separate Bank of America note, Chile was named as an intervention candidate, as the peso’s valuation was overextended, wrote analyst Alberto Boquin, noting that the peso (U.S.:USDCLP)  had gained about 15% in the year to date against the U.S. dollar.

In Chile, President Sebastián Piñera has already said the central bank should clamp down on the peso’s advance. Late Friday, Chile’s finance minister said in Washington that the country won’t impose capital controls to cool the peso’s rise, according a Bloomberg News report.

Intervention by Brazil, whose Finance Minister Guido Mantega asserted the world is in a currency war, has included a doubling of tax, to 4%, on certain foreign investments to curb the rise of its currency, the real (U.S.:USDBRL) . The real rose roughly 6% against the dollar during the third quarter. Gains in the currency cut into Brazilian exports in August.

For emerging markets, any single one doesn’t want to “see their currency become stronger vis-à-vis their main competitors in a third market, say in the U.S. or Europe,” said Mandeng. “They don’t want to be the only one appreciating. And that is a problem.”

Emerging markets “want to stem the flow of hot money and keep their currency stable,” said Mark McCormick, currency strategist at Brown Brothers Harriman.

The intervention environment is ripe, with the Group of 4 economies experiencing weak growth, he said, adding that they are facing fiscal contraction from the expiration of stimulus packages. IMF says developed economies to slow.

At the same time, the Federal Reserve is trying offset those weaknesses by increasing liquidity, with much speculation about the U.S. central bank and so-called quantitative easing.

“And, unfortunately, in an environment when interest rates are zero-bound in most major developed countries,” money from those countries is being borrowed by investors who are then selling it to invest in higher-yielding emerging-market stocks, bonds and currencies, said McCormick.

Meanwhile, quantitative easing by the U.S. central bank is “tantamount to an intervention,” said Mandeng. The Fed’s “printing so many dollars that it effectively changes the relationship between the amount of dollars in circulation and other currencies.”

Outright exchange-rate intervention, monetary policy and capital controls all serve as ways to make it more difficult for investors to access currencies, he said.

Japanese authorities in mid-September intervened in the foreign-exchange market for the first time since 2004, as the greenback (U.S.:USDYEN)  hit a fresh 15-year low against the yen — below the ¥83 mark. Earlier this month, the central bank said it will take additional easing measures, including a new temporary fund on its balance sheet to buy various assets. See previous story about Japan’s stimulus efforts.

But market players aren’t just giving into central banks’ desires to cool their currencies. Brazil’s real continued to climb despite twice-daily auctions, and had recently closed at its highest level since just before the collapse of Lehman Brothers, the U.S. financial-services giant, in September 2008.

Japan’s yen, meanwhile, has moved below the level of where the central bank intervened on Sept. 15, noted Richard Ross, global technical strategist at Auerbach Grayson.

Intervention, “might work overtime, but in the short term, you can’t stem the tide when it’s that pervasive,” he said.

Peace and cooperation?

The ramped-up intervention worldwide prompted IMF managing director Dominique Strauss-Kahn to warn any currency war would have the effect of reducing cooperation efforts between countries to aid the global economy. Decreased cooperation poses a threat, he said, because “there’s no domestic or national solution to [a] global problem.” Read about Strauss-Kahn’s warning about currency war risks.

But the IMF chief also said he didn’t believe there was momentum for a Plaza Accord-type deal on currencies. The 1985 agreement was made among major industrial nations to devalue the U.S. dollar in relation to the Japanese yen and German deutsche mark.

Strauss-Kahn’s warning came a day after U.S. Treasury Secretary Timothy Geithner effectively blamed China for stoking a currency war. The world’s largest emerging market is facing pressure at the IMF’s meeting to slow pace of yuan appreciation.

The head of China’s central bank said Friday that an alternative “shock therapy” approach on the currency would be dangerous, but that China is committed to gradual exchange-rate reform.

Meanwhile, France’s finance minister called for currency “peace.” France will hold the Group of 20 presidency in November. Read more about Christine Lagarde’s remarks.

Scenarios

Bank of America/Merrill Lynch highlighted what it calls 10 key parameters to capture the motivation for intervention based on valuation; the costs versus benefits of having a cheaper currency; and affordability of interventions in an effort to gauge which countries need or want a cheaper currency and can afford to intervene.

On an affordability basis, the Czech Republic and Israel remain best positioned, according to the Bank of America analysis: “The interest rate differential versus core markets provides a simple measure of the cost of sterilizing interventions.”

The Czech Republic “has been quiet of late” in light of the performance of exports and foreign direct investment so far this year, the broker wrote. More verbal intervention could follow if appreciation in its currency reaches the upper end of its comfort level. Israel is likely to maintain the status quo with ad hoc interventions targeted at speculators, the broker said.

Meanwhile, recent comments by Poland’s central bank suggest “a more tolerant stance for now,” in light of limited nominal effective exchange-rate appreciation, and recovery in exports and growth since April, when the central bank had intervened.

A recent Polish central bank survey of exporters puts their “pain level” for the rate between the euro and Poland’s zloty at 3.72. “A rapid move toward this is likely to alarm the [central bank] and potentially spark some intervention,” said Bank of America.

Hungary was left off Bank of America’s list of intervention candidates, citing its open foreign-exchange position.

Vladimir Milev, portfolio strategist at Metzler/Payden Emerging Europe Fund (NASDAQ:MPYMX) , said that Hungary’s currency, in general, is worth watching.

“The dynamic of Hungarian lending was driven very strongly” by loans made in foreign currencies, particularly the Swiss franc, before the financial crisis, Milev said. When the forint was sliding earlier this year, “all of a sudden, your mortgage is 20% more expensive,” so those consumer-oriented concerns still carry weight, he said.

Further south, Bank of America estimated that South Africa bought roughly $3 billion this year, and that its style of “ad hoc and low profile” interventions is likely to remain so.

“Recent comments from policy makers suggest a cautious approach given portfolio flows dominate [balance of payments] financing, “ the broker wrote. “Still this remains a topical issue for South African policy, and more rather than less talk/action is likely going ahead if rand strength continues.”


FINALLY SOMEONE ASKS MY QUESTION!
Columbia Nobel Prize economist asks for explanation of "very strange policy."  Dark pool to jump in from a high diving board? 

A Rush to Assess S.& P. Downgrade of Credit Rating
NYTIMES
By NELSON D. SCHWARTZ and BINYAMIN APPELBAUM
August 6, 2011

WASHINGTON — A day after Standard & Poor’s took the unprecedented step of downgrading the credit worthiness of the United States government while offering criticism of the “political deadlock” in Washington, American lawmakers and political leaders overseas scrambled to assess the impact of the move on the already troubled world economy.

Democrats and Republicans both claimed to find validation for their policies in the decision by the ratings agency, which on Friday downgraded the nation’s long-term credit rating one notch, to AA+, even as the Obama administration and some of its allies questioned the significance of the decision. The administration mocked S.& P. for making a mathematical error, caught by the Treasury Department, that caused the company to delay its announcement of the downgrade for several hours on Friday. The administration noted that investors had flocked to Treasury securities in recent weeks as among the world’s safest investments.

Congressional leaders in both parties said that the announcement underscored the need for reforms — even as they disagreed about which reforms.

“Unfortunately, decades of reckless spending cannot be reversed immediately, especially when the Democrats who run Washington remain unwilling to make the tough choices required to put America on solid ground,” Speaker John A. Boehner, an Ohio Republican, said in a statement.

Senate Majority Leader Harry Reid said the decision should set the tone for a committee created last week to create a plan for reducing the federal debt by $1.5 trillion. He said it affirmed the need for the Democratic approach, which would combine spending cuts with tax increases.

The decision, he said, “shows why leaders should appoint members who will approach the committee’s work with an open mind — instead of hardliners who have already ruled out the balanced approach that the markets and rating agencies like S.& P. are demanding.”

News of the downgrade reverberated across the world. Chinese leaders weighed in with a attack on the country’s free-spending ways while European officials voice skepticism of the rating agency’s rationale for the ratings decision.

China, the largest foreign holder of United States debt, said on Saturday that Washington needed to “cure its addiction to debts” and “live within its means,” just hours after the rating agency Standard & Poor’s downgraded America’s long-term debt. Though Beijing has few options other than to continue to buy United States Treasury securities, Chinese officials are clearly concerned that China’s substantial holdings of American debt, worth at least $1.1 trillion, are being devalued.

“The U.S. government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone,” read the commentary, which was published in Chinese newspapers.

While Europeans had girded for a possible downgrade, the news that Standard & Poor’s had actually yanked the United States’ AAA rating was nonetheless received with a degree of alarm in the corridors of power across the Continent. Finance Minister François Baroin of France questioned the move Saturday, noting that the figures used by Standard & Poor’s didn’t match those of the Treasury, and overstated the federal debt by about $2 trillion.

Standard & Poor’s defended its decision in a lengthy statement issued late Friday and deployed a spokesman onto national television to make its case. It described the decision as a judgment about the nation’s leaders, writing that “the gulf between the political parties” had reduced its confidence in the government’s ability to manage its finances. In its statement, the agency said the recent deficit-cutting that accompanied the raising of the debt ceiling “fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged.” It also said that “elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt.”

The downgrade puts new pressure on the super committee created by Congress to handle the next phase in deficit reduction. It could also lead investors to demand higher interest rates from the federal government and other borrowers, raising costs for governments, businesses and home buyers. But many analysts say the impact could be modest, in part because the other ratings agencies, Moody’s and Fitch, have decided not to downgrade the government at this time.

Underlying the ratings decision, economists say, is he failure of the United States and Europe to make progress in resolving the fundamental problem, that their economies are weighted down by debtors who cannot afford to pay what they owe and creditors who cannot afford to walk away.

The great hope of governments on both sides of the Atlantic, and of many investors, was that renewed growth would resolve the problems, allowing some debts to be paid and others to be forgiven.

The oscillations of financial markets over the last few weeks, driven by jolts of grim economic news, suggest that this hope is starting to lose its hold on the imagination of investors.

The movements of markets are collective predictions about future prosperity. They are echoing now what some economists have been saying for years, that the debt crisis cannot be bypassed, and resolving it is a lengthy and painful process.

There is no surplus of economic strength to throw at the problem. The United States and Europe ran up great debts in the years of plenty, living well and promising to pay later, even as they made expansive promises to aging populations about future spending.

And there appears to be little confidence in the capacity of political leaders to perform the necessary work of allocating losses, either in the United States, where lenders are pitted against homeowners, or across the Atlantic, where lenders are pitted against the nations of southern Europe.

“The restorative forces of the economy are very weak and the immediate forces that will be in place are worsening the problem,” said Joseph E. Stiglitz, an economist at Columbia University. “We already know it’s not going to be a V-shaped recovery. I had said in my book that it would be more of an L-shaped, slow recovery. I think the answer now is a Japan-style malaise.”

The weakness of the American economy is most evident in the lack of jobs. Only 55 percent of working-age adults held full-time jobs in July, the lowest level in modern times. Some 25 million American adults want but cannot find full-time work, the government said Friday. The unemployment rate fell slightly, but mostly because 193,000 people stopped searching for jobs.

Consumer spending makes up 70 percent of the nation’s economic activity, and people without jobs spend less money. For more than a year the government has reported that the economy was expanding more quickly than employment, seeding hope that hiring would follow. But last week the government said in a new estimate that it was mistaken, and that the economy actually expanded at an annual rate of only 0.8 percent during the first half of the year — about the rate of population growth.

Kenneth Rogoff, an economist at Harvard University, said that forecasters had been consistently upbeat over the last year, only to be perpetually disappointed by the data. “This recession has been pulling away the football from forecasters like Lucy and Charlie Brown,” he said.

Liz Alderman contributed reporting from Paris, Jack Ewing from Frankfurt and David Barboza from Shanghai.


Andrew Harrer/Bloomberg News The gold-starred European Union flag outside the Davos Congress Center on opening day of the World Economic Forum.

As Europe Toils on Debt, U.S. and Japan Watch Nervously
NYTIMES
By LIZ ALDERMAN, "Deal Book"
January 26, 2011, 5:23 am

DAVOS, Switzerland — The fiscal crisis in Europe may be only the beginning.

The debt debacle that erupted last year in Greece and Ireland threatens not just Europe’s economic stability. It has also revived longstanding questions about whether the United States and Japan, weighed down by their own debt, are heading for a moment of truth.

For all their differences, the big, rich economies of the world are confronted by stark similarities. Each has a mountain of debt that is proving harder and harder to support, given the way their societies are structured.

Trapped by aging populations, underfunded pensions and social security commitments, their dilemma is in sharp contrast to the current vigor and youth of emerging economies. China and India may have growing pains — but debt is not one of them.

This contrast is on display in Davos, where the annual World Economic Forum has brought together a confident group of representatives from emerging economies and the exceptionally comfortable but increasingly worried members of the Western world’s elite.

“Between debts and pensions, everyone should realize that this can’t go on forever,” said Kenneth S. Rogoff, an economics professor at Harvard University in Massachusetts and a former chief economist of the International Monetary Fund. “‘We’ll be lucky if it can go on another five to 10 more years.”’

Until recently, debt was hardly a dirty word, especially in Western countries that borrowed to finance economic growth. But few of them managed to shrink their debt when times were good, and instead promised richer pensions and welfare benefits.

In the case of the United States, the surpluses built during President Bill Clinton’s tenure turned into huge deficits during the administration of President George W. Bush.

Now, after bailouts in Greece and Ireland, the unthinkable is becoming more probable. As a result, investors are scrutinizing nearly every country with high debt — with potentially bewildering consequences.

“I could envisage them focusing on California debt in one moment, and in the next on another European country,” said Joseph E. Stiglitz, a Nobel laureate in economics.

“So I could see a series of rolling crises for an extended period of time,” he continued, in which investors “try to bring about the adverse results they anticipate.”

While investors’ immediate targets are countries like Portugal that are easy to pick off, they could yet challenge the United States and Japan, as debt levels continue to rise.

This month, two ratings agencies warned that the triple-A rating for the United States could be reviewed in a couple of years if the country’s national debt kept growing.

A downgrade is unlikely to happen as long as the United States economy and the dollar retain their dominance on the global economic stage.

But more people are sounding the alarm as Congress prepares to raise the debt ceiling this spring and politicians lock horns over how to forestall a debt crisis.

At the same time, several states, particularly Illinois, are feared to be on the brink of insolvency, possibly requiring a bailout. The burden has mushroomed so quickly that some policy makers are asking Congress to consider the once-unthinkable possibility of allowing states to file for bankruptcy. That may be the only way, advocates of this approach argue, to alleviate overwhelming debts, including huge pension obligations that are siphoning money from education and other state services.

The risk is that the mere talk of such measures could destabilize investors’ faith in United States municipal bond markets.

As in Europe, the most troubled states are pushing deep spending cuts — and, to some extent, tax increases — to narrow their budget gaps, leading to more layoffs and slowing economies. Although the United States economy is showing signs of a revival two years after the recession ended, and the stock market is roaring back, a downturn among big states could weigh on the recovery, stymieing broader efforts to reduce the national debt and deficit.

At the same time, financial players are watching for any hidden bombs that might explode, like greater losses in state pensions than have been reported, analysts said.

While the United States is no Greece, “these things turn on a dime,” Mr. Rogoff said. “Nothing seems to be happening, then boom, you’re slammed over the head when interest rates rise, debt hits a certain level or something shakes global markets.”

Japan is more of a question mark. The Japanese prime minister, Naoto Kan, has warned that the nation faces a financial crisis of Greek proportions if it does not tackle a debt that is expected to rise to 210 percent of the country’s gross domestic product next year.

The country has struggled to revive its economy for more than a decade, hobbled by deflation and a rapidly aging population. Japanese savers hold nearly all of the debt, making it less vulnerable to the market’s activities. But the concern is that retirees may begin to cash in their bonds, which would make the government look abroad for financing.

“Japan is a debt time bomb that is waiting to explode,” said Paul De Grauwe, a professor of international economics at the Catholic University of Leuven in Belgium.

If global interest rates start to rise, that could affect Japan’s ability to service its debt, “and then Japan will be hit by a debt crisis,” he said. Once the nation heads down that path, “it doesn’t mean much if the debt is held domestically or by foreigners — everyone sells, including the patriots.”

Analysts say that, as with the United States, any reckoning in Japan could still take years or even decades to unfold.

The more immediate concern is how to keep the debt crises in small European countries on the periphery from rocking Europe at its core.

European finance ministers have been working on ways to protect the euro and are focusing on whether to bolster a rescue fund for the Union. But the survival of the euro cannot be taken for granted if policy makers fail to resolve underlying problems.

Some countries are taking steps to avert disaster. Spain, feared to be one of the next countries after Ireland to need a bailout, is casting its net wide for buyers of its bonds, which it is shopping to China, Japan, Qatar and Russia.

These nations have as big a stake in Europe’s economic stability as the West, because the European Union is one of their biggest markets.

To the extent international buyers are shunning their debt, governments are trying to compel domestic institutions to load up on it. Ireland, for instance, has passed legislation to encourage Irish pension funds to hold more Irish government bonds and dump lower yielding, but safer, German bonds.

In the meantime, something that would help all these countries reduce their debt is a revival of economic growth. But one lesson emerging from the European debt crisis is that imposing harsh austerity to mend finances risks feeding a downward economic spiral. Spending cuts are stunting economies, causing governments to borrow more at higher interest rates and piling debt upon debt.

“‘We know from historical experience if debt levels are high and remain high you will pay the price in terms of lower growth,” said Pier Carlo Padoan, chief economist at the Organization for Economic Cooperation and Development, the association of free-market democracies. “All countries face the need, first, to stop debt levels from growing, and second, to start bringing them down.”
QE2 fragmenting global markets: Stiglitz
YAHOO
10 Dec. 2010

SANTIAGO (Reuters) – The Federal Reserve's QE2 bond-buying plan is leading to the fragmentation of global markets, and a second U.S. stimulus package is needed for the U.S. economy, Nobel Prize winning economist Joseph Stiglitz told a conference in Chile on Friday.

Fed, ECB throwing world into chaos: Stiglitz
YAHOO
5 October 2010

NEW YORK (Reuters) – Ultra-loose monetary policies by the U.S. Federal Reserve and the European Central Bank are throwing the world into "chaos" rather than helping the global economic recovery, Nobel Prize winning economist Joseph Stiglitz said on Tuesday.

A "flood of liquidity" from the Fed and the ECB is bringing instability to global foreign exchange markets, Stiglitz told reporters after a conference at Columbia University.

"The irony is that the Fed is creating all this liquidity with the hope that it will revive the American economy," Stiglitz said. "It's doing nothing for the American economy, but it's causing chaos over the rest of the world. It's a very strange policy that they are pursuing."

Taking On China
NYTIMES
By PAUL KRUGMAN
September 30, 2010

Serious people were appalled by Wednesday’s vote in the House of Representatives, where a huge bipartisan majority approved legislation, sponsored by Representative Sander Levin, that would potentially pave the way for sanctions against China over its currency policy. As a substantive matter, the bill was very mild; nonetheless, there were dire warnings of trade war and global economic disruption. Better, said respectable opinion, to pursue quiet diplomacy.

But serious people, who have been wrong about so many things since this crisis began — remember how budget deficits were going to lead to skyrocketing interest rates and soaring inflation? — are wrong on this issue, too. Diplomacy on China’s currency has gone nowhere, and will continue going nowhere unless backed by the threat of retaliation. The hype about trade war is unjustified — and, anyway, there are worse things than trade conflict. In a time of mass unemployment, made worse by China’s predatory currency policy, the possibility of a few new tariffs should be way down on our list of worries.

Let’s step back and look at the current state of the world.

Major advanced economies are still reeling from the effects of a burst housing bubble and the financial crisis that followed. Consumer spending is depressed, and firms see no point in expanding when they aren’t selling enough to use the capacity they have. The recession may be officially over, but unemployment is extremely high and shows no sign of returning to normal levels.

The situation is quite different, however, in emerging economies. These economies have weathered the economic storm, they are fighting inflation rather than deflation, and they offer abundant investment opportunities. Naturally, capital from wealthier but depressed nations is flowing in their direction. And emerging nations could and should play an important role in helping the world economy as a whole pull out of its slump.

But China, the largest of these emerging economies, isn’t allowing this natural process to unfold. Restrictions on foreign investment limit the flow of private funds into China; meanwhile, the Chinese government is keeping the value of its currency, the renminbi, artificially low by buying huge amounts of foreign currency, in effect subsidizing its exports. And these subsidized exports are hurting employment in the rest of the world.

Chinese officials defend this policy with arguments that are both implausible and wildly inconsistent.

They deny that they are deliberately manipulating their exchange rate; I guess the tooth fairy purchased $2.4 trillion in foreign currency and put it on their pillows while they were sleeping. Anyway, say prominent Chinese figures, it doesn’t matter; the renminbi has nothing to do with China’s trade surplus. Yet this week China’s premier cried woe over the prospect of a stronger currency, declaring, “We cannot imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs.” Well, either the renminbi’s value matters, or it doesn’t — they can’t have it both ways.

Meanwhile, about diplomacy: China’s government has shown no hint of helpfulness and seems to go out of its way to flaunt its contempt for U.S. negotiators. In June, the Chinese supposedly agreed to allow their currency to move toward a market-determined rate — which, if the example of economies like Brazil is any indication, would have meant a sharp rise in the renminbi’s value. But, as of Thursday, China’s currency had risen about only 2 percent against the dollar — with most of that rise taking place in just the past few weeks, clearly in anticipation of the vote on the Levin bill.

So what will the bill accomplish? It empowers U.S. officials to impose tariffs against Chinese exports subsidized by the artificially low renminbi, but it doesn’t require these officials to take action. And judging from past experience, U.S. officials will not, in fact, take action — they’ll continue to make excuses, to tout imaginary diplomatic progress, and, in general, to confirm China’s belief that they are paper tigers.

The Levin bill is, then, a signal at best — and it’s at least as much a shot across the bow of U.S. officials as it is a signal to the Chinese. But it’s a step in the right direction.

For the truth is that U.S. policy makers have been incredibly, infuriatingly passive in the face of China’s bad behavior — especially because taking on China is one of the few policy options for tackling unemployment available to the Obama administration, given Republican obstructionism on everything else. The Levin bill probably won’t change that passivity. But it will, at least, start to build a fire under policy makers, bringing us closer to the day when, at long last, they are ready to act.

Bernanke to Offer Outlook as Fed Weighs Bolder Steps
NYTIMES
By SEWELL CHAN
August 25, 2010

WASHINGTON — With fresh signs that the housing market is weakening, the Federal Reserve chairman, Ben S. Bernanke, on Friday will offer his outlook on the economy, explain the Fed’s recent modest move to halt the slide and possibly outline other actions.

Mr. Bernanke’s speech, at an annual Fed symposium in Jackson Hole, Wyo., will be his first public comments since the Fed announced it would invest proceeds from its holdings of mortgage bonds to buy more long-term Treasury securities to prop up the recovery.

It is not known what Mr. Bernanke will say, but some insight may come from an episode in his past: his concern, soon after he became a Fed governor, that the economy was at risk of deflation as the nation gradually recovered from the dot-com bust a decade ago.

Mr. Bernanke’s worry then is similar to what troubles the Fed now, and his views will have no small bearing on the Fed’s course of action. These days the Fed confronts the combination of persistently high unemployment and an inflation rate so low that it worries economists.

Whether policy makers should take big steps to tackle the economic doldrums — by printing even more money and buying even more assets — will be the dominant question at the symposium and at the Fed’s next meeting on Sept. 21.

Within the central bank, several officials are alarmed at the threat of the economy falling into a dangerous cycle of declining demand, wages and prices not experienced since the Depression. They say that a deflationary, double-dip recession is unlikely, but want to formulate concrete steps to ward it off.

Other officials contend the economic indicators, while dismaying, do not represent an immediate threat, and worry that additional monetary stimulus by the Fed could erode the already shaky confidence of the markets, or even backfire by eventually spurring uncontrolled inflation.

The Fed has not confronted the risk of deflation since 2003. An examination of transcripts from the deliberations of the Fed’s policy-making group, the Federal Open Market Committee, during that spring sheds some light on the challenges Mr. Bernanke faces in maintaining a consensus in the committee as it approaches the problem today.

In a confidential briefing before the committee’s meeting on May 6, 2003, Fed economists estimated that there was a 35 percent chance that the fragile economy, still recovering from the 2001 recession, would face deflation by the end of 2004.

Mr. Bernanke, who had joined the Fed’s board of governors just nine months earlier, warned about the potential danger of deflation, according to the 2003 transcripts, which were made public last year. He said that “for the first time in many decades” the Fed faced greater danger from the risk of its inflation estimates being too high, rather than too low.

He wanted the Fed to draft “a plan for how we might proceed seamlessly from standard rate-cutting to more nonstandard operations should such operations become necessary.”

It would be five more years — and one boom-and-bust cycle later — before the Fed would have to apply that advice.

In the meantime, Mr. Bernanke’s perspective appeared to influence that of Alan Greenspan, then the Fed chairman.

“In my view we cannot avoid the fact, as Governor Bernanke pointed out, that we face an asymmetry,” Mr. Greenspan said at the May 2003 meeting. “We know what to do with inflation when it rises. The committee has taken action to counter it many times and has succeeded in doing so many times. We haven’t confronted the problem of potential deflation in a very long time.”

That view was echoed by several other committee members, even among those who pointed out that disinflation, a slowing of the rate of inflation, was not the same as deflation.

Robert T. Parry, then president of the San Francisco Fed, said, “It’s best to move sooner rather than later when the economy is within range of deflation and the zero bound.” He was referring to the challenge the Fed would face if it had to reduce short-term rates to nearly zero and could no longer cut them any further — a situation the Fed has faced since 2008.

Others were skeptical. George C. Guynn, then president of the Atlanta Fed, said the situation was not comparable to the Depression. “We clearly have experienced significant external shocks,” he said. “But the real economy is recovering, albeit slowly. It is not contracting.”

To prop up the economy after the dot-com boom’s collapse, the Fed lowered its benchmark short-term rate — the federal funds rate, at which banks lend to each other overnight — to 1.25 percent in November 2002, from 6.5 percent in January 2001.

On June 25, 2003, it reduced the rate even further, to 1 percent, the lowest level in decades. In the meeting where that decision was reached, Mr. Bernanke wondered “whether or not it would make sense tactically to say publicly that we are willing to lower the federal funds rate to zero if necessary.” He said it would help expectations because “there would no longer be a feeling in the market that we had reached the end of our rope.”

The threat of deflation did not come to pass, and a year later, the Fed began to raise interest rates and tighten monetary policy, a process that would continue until 2006 as housing prices soared across most of the country. Some critics have said the Greenspan Fed helped abet the housing bubble by leaving rates too low for too long, an interpretation Mr. Bernanke has rejected.

Mark W. Olson, who was a Fed governor from 2001 to 2006, said the Fed’s worry about deflation in 2003 was appropriate in hindsight. The committee had only two historical episodes to look to — the Depression of the 1930s and the Japanese deflation that began in the 1990s — and was determined to avoid either outcome, he said.

“It would have been irresponsible for us not to take it into consideration,” Mr. Olson said. “It wasn’t much ado about nothing.”

Of the Fed committee members who weighed the threat of inflation in 2003, four are still on the committee today: Mr. Bernanke; Donald L. Kohn, a Fed governor; Thomas M. Hoenig of the Kansas City Fed; and Sandra Pianalto of the Cleveland Fed. There is little doubt that the Fed’s last deflation debate has been on their minds as they confront an even more perilous economic outlook today.

This article has been revised to reflect the following correction:

Correction: August 25, 2010

Because of editing errors, a previous version of this article misstated the Fed's benchmark short-term rate after the dot-com boom's collapse, and also misstated the current title for Donald L. Kohn.


What to do when you are in a bind?  Form a committee - story here!

China raises interest rates amid inflation worries
YAHOO
25 December 2010

BEIJING – China increased interest rates Saturday for the second time in little more than two months as the government steps up its fight against rising inflation that could threaten political stability.

Those worries about inflation in the world's second-biggest economy meant the move by The People's Bank of China had been expected by the end of the year or early next year.

Effective from Sunday, the benchmark 1-year lending rate will climb 25 basis points to 5.81 percent, while the 1-year deposit rate will go up the same amount to 2.75 percent, the central bank said on its website.

Earlier this month, China's leaders wrapped up an annual economic planning meeting with a pledge to cool surging inflation while shifting the economy toward more stable, balanced growth.

Inflation is especially sensitive in a society where poor families spend up to half their incomes on food. Rising incomes have helped to offset price hikes, but inflation undercuts economic gains that help support the ruling Communist Party's claim to power.

Inflation jumped to 5.1 percent in November, a 28-month high despite a crackdown on speculation and repeated moves to curb a flood of money circulating in the economy from massive stimulus spending and bank lending.

Chinese banks lent a total of 7.45 trillion yuan ($1.1 trillion) in January-November and are certain to overshoot the government's official lending target of 7.5 trillion yuan.

While a frenzy of lending over the past two years has helped China rebound quickly from the global crisis, combined with bad weather and rising global commodity prices, it has complicated efforts to cool inflation.

November's rate was way above the government's original target of 3 percent.

The rate increases, which follow similar moves Oct. 19, also highlight the divergence of China's robust economic expansion from the United States, Europe and Japan, which still are trying to shore up growth.

China's rapid economic growth eased to 9.6 percent in the three months ending in September from a post-crisis high of 11.9 percent in the first quarter. It is expected to fall further in coming months but to remain strong.

Mindful of the political turmoil linked to past bouts of inflation, Beijing has already sought to reassure the public it has prices under control.

Earlier this month it raised banks' reserve requirement ratio — meaning they have to hold more deposit funds in reserve rather than lending them out _for the sixth time this year to help curb the surge in lending.



Trade deficit rises, demand for exports slips -  full story here.
YAHOO
By MARTIN CRUTSINGER, AP Economics Writer

WASHINGTON – The U.S. trade deficit rose to the highest level in 16 months as exports fell for the second time in three months, a potentially worrisome sign that Europe's debt troubles are beginning to crimp American manufacturers.

The Commerce Department said Thursday the trade deficit widened to $40.3 billion in April, up by 0.6 percent from March. U.S. exports dropped 0.6 percent while imports declined by 0.4 percent.

U.S. manufacturing has been a standout performer as the U.S. recovers from the worst recession in decades. But the concern is that Europe's debt crisis will slow growth in that part of the world and dampen demand in a key U.S. export market...

Some lawmakers are pushing legislation that would impose stiff trade sanctions on China unless it allows its currency, the yuan, to start rising in value against the dollar. However, Treasury Secretary Timothy Geithner and Secretary of State Hillary Rodham Clinton made no headway on the currency issue during high-level talks in Beijing late last month.

The deficit with the European Union dropped 18.9 percent to $5.7 billion as U.S. exports fell by 9.4 percent while U.S. imports from the EU were down 11.8 percent.

DECKER: Ditching the dollar, a horror story

LOSING CONTROL: THE EMERGING THREATS TO WESTERN PROSPERITY
By Stephen D. King
Yale University Press, $30, 279 pages
Reviewed by Brett M. Decker (in the Washington Times, 6-3-10)

Stephen King has a scary new book out that will have you hiding under the sheets afraid to take a peek at what's outside. What's really horrifying is that this new release wasn't penned by the bestselling thriller novelist from Maine but the chief economist for the HSBC Group in London. The monster lurking outside the window isn't a vampire or a werewolf but our Frankenstein economy run amok.

The sometimes friendly ghost in this tale is globalization. Despite the impressive ability to accelerate wealth creation by maximizing efficiencies across borders, vulnerability is inherent to the global economy. In the wake of globalization, "individual nations are struggling to cope with some of its other effects: greater economic instability, heightened income inequality and financial market turmoil," Mr. King explains. Because so many diverse economies are so interconnected, a hiccup in one place can cause cardiac arrest somewhere else. The global chain is only as strong as the precarious state of its weakest links.

The euro zone offers a heart-stopping case study in that the economic health of a powerhouse like Germany is chained down by a basketcase like Greece. German Chancellor Angela Merkel initially was dead-set against any bailout package to stave off a Greek collapse but was forced to flip-flop out of fear that a Greek default would start dominoes falling that could knock down the European Union. Such disruptions do not only travel upstream, as tweaks to large economies have a disproportionately negative impact on weaker systems, especially in regards to inflation.

For context, the author takes a brisk jog through the history of globalization. One surprisingly candid observation is that the West's growth and dominance cannot be credited to free-market forces alone. "Western nations became wealthier because they were increasingly able to rig the global economy to suit their own aims, using a combination of economic, political and military power," Mr. King writes. He cites the British East India Company's use of mercenary military forces to conquer markets in India and China to show that coercion was as important as consumer choice for the West to become prosperous.

The reality of state capitalism is that parochial interests always will be in conflict with what sometimes is vaguely referred to as the "greater global good." Some of the most powerful tools in this conflict are monetary instruments. "The Federal Reserve's decisions have a direct impact on many emerging economies precisely because these countries link their currencies to the dollar," Mr. King states, while positing that such dependency is a bad thing. A view of the sprouting Shanghai skyline provides the British economist an opportunity to comment on the symbolic and literal explosion of the Chinese economy in recent years and the unnecessary danger of China's symbiotic relationship to the U.S. dollar.

The author argues that one way to protect against dollar fluctuations is to diversify capital holdings to lessen the influence of the American greenback. Until recently, it was hoped that the euro would serve as a stable alternative to the dollar, but the euro's flameout has global monetarists looking for love in new and unlikely places - most notably the Middle Kingdom. Mr. King acknowledges the numerous flaws in having the Chinese yuan serve as a reserve currency, but he waves them off. Contrary to his nonchalance, the communist government's lack of transparency, pathetic rule of law, strict capital controls and prejudice against private property will make China's currency unreliable for trade and capital-market transactions long into the future.

In the end, in Mr. King's estimation, one of the biggest threats to Western prosperity is the United States and the American penchant for living beyond our means. U.S. debt is definitely a mounting problem. But more people have been brought out of poverty since the 1980s than any time in history largely because more nations followed a previously responsible U.S. economic model, which can make a comeback. Progress was also possible because of the relative stability provided by a Pax Americana. Displacing America as the lone superpower and undermining the supremacy of the dollar will only lead to more political and financial conflict.

"Losing Control" is not all doom and gloom. It's just that the scary parts are enough to keep you awake at night.

Brett M. Decker is editorial page editor of The Washington Times.

© Copyright 2010 The Washington Times, LLC. Click here for reprint permission.

For an intelligent comment from France...
As Governments Borrow, Many People Save
By CASEY B. MULLIGAN, NYTIMES
June 2, 2010, 6:00 am

Casey B. Mulligan is an economics professor at the University of Chicago.

Government deficits have stabilized in recent months, and so has private savings. It is likely that the private sector dampens the effects of government borrowing.

By definition, the government runs a deficit when its spending exceeds its revenue. It typically finances the difference by borrowing. Of course, future governments are burdened with paying the principal and interest on the government debt created today, which is why many critics of deficit spending conclude that such deficits leave us worse off in the future.

Before the recession, which officially began at the end of 2007, the amount of government dissaving (combined for federal, state and local governments) was about zero. Thanks in large part to federal government actions, quarterly public dissaving increased to $400 per person in the first two quarters of the recession and by an additional $400 per person in the first two quarters of 2009. Since then, public dissaving has stabilized at $700 to $800 per person.

National savings — the sum of public and private savings — is ultimately what matters in shaping living standards in the future; the government deficit matters only to the extent that is affects national
savings. To the degree that private saving offsets public dissaving, public dissaving leaves no negative legacy.

The chart below graphs public dissaving versus private saving, both measured by the Bureau of Economic Analysis and expressed in inflation-adjusted dollars per person for each of the 10 quarters since the end of 2007.



The more recent points are furthest to the right in the chart, because of the historically large government deficits. But they are also at the top of the chart, because the private savings rate has been unusually high. In fact, the chart shows a strong positive correlation between the amount of public dissaving and the amount of private savings.

Earlier this year, I blogged about Prof. Robert Barro’s theory that the private sector responds to public borrowing by saving, because the private sector anticipates that its taxes will be higher in the future in order to service today’s public debt.

Readers, and many economists, were dubious that private savers think about future taxes or give them much importance in their saving decisions. But the association of more public dissaving with more private saving continues to be confirmed with data from recent quarters, so that correlation needs to be explained.

I also pointed out that the private sector seems to love government debt, as evidenced by the fact that government debt sells in the marketplace for such high prices (that is, investors accept such low rates of interest when the federal government borrows). Thus, another possible explanation for the pattern shown in the chart is that a surge in private saving pushes down government bond yields and encourages the government to borrow more.

A related explanation is that both the private and public sectors are reacting to the recession, with the public sector borrowing and the private sector saving.

That the private sector would save, rather than borrow, in a recession seems odd, especially later in the recession when employment and incomes reached their lows. Yet it seems they do.

Thus, regardless of whether government borrowing harms or hurts the economy, the effects of government borrowing are dampened, if not largely offset, by private sector responses.


-----------------------

Disappointed
France
June 2nd, 2010
8:43 am
I'm afraid that this analysis is rather incomplete. It is undoubtedly true that to some extent private savings can “dampen the effect” of national deficits. Japan may be a case in point. However, Professor Mulligan has taken a snapshot of the current situation and has apparently concluded we don't have a serious problem because current private savings are (partially) offsetting current national deficit spending. On this point, it seems, he is in company with Larry Summers and Paul Krugman. Unfortunately, this also conjures up an image in my mind of Mad magazine’s freckled-faced Alfred E. Newman whose motto was “What, me worry?” But, they have failed to consider the following:

--According to the Bureau of Economic Analysis, the net public and private savings deteriorated from a net $280 billion saving to a net $363 billion dissaving in 2009. If we have "stabilized" at the latter level, we’re in trouble.

--Merely looking at the private saving and public deficit spending to arrive at an overall saving or dissaving number is the equivalent of using the cash rather than the accrual method of accounting. We require corporations to use the latter method, and for good reason. Mulligan's cash method of accounting ignores the huge unfunded liabilities the government is incurring that are not taken into account in the deficit numbers. If we were to properly accrue for these in our national accounting, the picture would be much worse.

-- People are not saving today because they fear higher taxes later. They are saving because they fear for the future and for their jobs. Mulligan seems to assume that the national debt problem can be solved by confiscating those private savings in the future by taxation. This is not likely to be politically feasible. Just look at Greece.

--The public dissaving rate is understated today by the low interest rate environment. This is partially due to the recession and partially due to the fact that money has no other place to go than the relative safety of Treasury obligations. Our national debt (gross or otherwise) will continue to grow. When we are required to pay higher interest on that national debt, which is inevitable, our dissaving rate will explode.

--I’m afraid that the net private saving number may be exaggerated by the housing crisis. A not insignificant amount of this “savings” may be attributable to persons who are not spending money to keep current on their mortgage and other debt and the corresponding losses on the corporate profits side has not yet been taken into account in their accounting.


Fear of Unknown Unknowns Trumps Good Economic News
Weekly Standard
BY Irwin M. Stelzer
May 29, 2010 12:00 AM

Economists call them exogenous shocks. Then-Prime Minister Harold Macmillan called them “Events, dear boy, events.” Former U.S. secretary of defense Donald Rumsfeld called them “unknown unknowns.” Investors care less about the precise label than the fact that the world seems a scary place. Never mind that almost all of the economic news in America is good: corporate profits are up and mortgage rates are down; retailers can be heard humming a happy tune as first quarter profits clock in at 26 percent above last year’s level, and bankers try to stay below the radar but have difficulty concealing their glee at the best quarterly profit performance in two years; home sales and building are up and property developers are snapping up land that has infrastructure in place in anticipation of new construction; inflation is at a 44-year low; and the Chinese are again buying U.S. government IOUs.

Yet all is not for the best in this best of all possible worlds. The happy economic news is accompanied by disturbing news on a variety of fronts. Israel is increasingly nervous at the inability of America and its partners to contain Iran’s nuclear weapons program, and is considering the feasibility of an attack that would delay the regime’s acquisition of the bomb it has promised to use to destroy “the Zionist entity.” South Korea has responded to North Korea’s torpedoing of one its vessels by blocking passage of that regime’s ships through its waters, a decision that might trigger a war with an increasingly bellicose and emboldened North: hostilities would certainly involve the U.S. troops stationed on the border -- unless President Obama pulls them out as part of his plan to “engage” the North Koreans. The war on terror goes on, with New York and its financial center certainly among the leading targets, and sheer luck so far preventing a disaster. Worst of all, America now seems so impotent that its former allies, Turkey and Brazil, feel they had better sign up with what Osama bin Laden calls “the strong horse," which seems to include anti-Americans from Hugo Chávez to Mahmoud Ahmadinejad. The picture of the leaders of Turkey, Brazil, and Iran holding grasped hands aloft in triumph at a deal aimed at derailing sanctions is, to put it mildly, unsettling.

In short, now that the world’s policeman has left the international beat, there is no telling what might happen. Worse still, that cop has decided to patrol the domestic beat, without too much regard for the possible consequences of his inability to distinguish the good guys from the bad.

The financial overhaul bill wending its way to the president’s desk, whatever its virtues, and there are several, will likely lower bank profits and their credit ratings, forcing them to be even stingier with potential borrowers. The Securities and Exchange Commission has adopted new rules that will make it more difficult for money market funds to continue providing about one-third of European bank’s wholesale funding lest they run afoul of a plethora of new regulatory investment criteria.

Congress is about to take up the cap-and-trade bill that will drive up energy costs, and is planning to impose new taxes on multinational businesses, investment managers, and hedge fund operators. Markets loath uncertainty, and these laws and regulations provide more uncertainty than investors can comfortably confront. No one can predict their effect, least of all the congressmen who vote for them and freely admit they haven’t read them -- these bills typically run close to 2,000 pages, and their advocate, House Speaker Nancy Pelosi, says you can’t know what’s in them until we pass them. 

Then there are the problems in euroland. We have known since the financial crisis hit that some institutions are too big to fail. When Greece was (at least for now) bailed out by a combination of its eurozone colleagues, the European Central Bank, and the International Monetary Fund, we found that there are countries too small to fail. With Spain experiencing difficulties, we are told that medium-size countries are, well, too medium-sized to fail. Allan Meltzer, economics professor at Carnegie Mellon University in Pittsburgh, famously said, “Capitalism without failure is like religion without sin.” He was right: There is now every reason for governments and big banks to believe they can spend and take risks, failure no longer being a possible penalty. It’s called moral hazard, a problem so far ignored by a panicked eurocracy and uncorrected in the massive financial reform bill before the U.S. congress.

Adding to uncertainty is the possibility that U.S. banks are more exposed to the trials and tribulations of Europe’s banks than has heretofore been realized. Indeed, our banks are now so nervous about the possible weakness of so called counterparties that they are demanding somewhat higher interest rates on interbank lending.

Of course, investors who value a good night’s sleep above all else can flee to the dollar, as many are doing. But as they nod off they just might have a nightmare or two. They might have heard on the late news that this or that expert says the U.S. recovery remains “fragile,” never mind the cheery economic data. The Federal Deposit Insurance Corporation’s (FDIC) list of “problem” banks now runs to 775 institutions, some 10 percent of the U.S. industry, compared with 252 at the end of 2008. This is in addition to the 72 banks regulators have closed down so far this year, and the 237 that have failed since the beginning of 2008. These mostly smaller banks have taken on property loans that are unlikely to be repaid in full.

More important, there is no end in sight to the deficits the government is piling up. The president is determined to continue spending, despite the ocean of red ink splattered across the nation’s books. Indeed, earlier this week presidential adviser Larry Summers urged Congress to pass a second stimulus package, or risk aborting the recovery. With Democrats determined to continue spending, and Republicans opposed to new taxes, with the bill for health care and other entitlements set to soar as the population ages, only a series of victories by candidates backed by the Tea Party movement has any real prospect of bringing the growth of government, and associated deficits, under control. Meanwhile, the printing presses keep churning out dollars, as the Federal Reserve Board hunts for just the perfect exit strategy and just the right time to implement it.

Which means that inflation is one of the nightmares that those fleeing to the safety of U.S. government bonds will have. Some waken in a sweat and rush to the telephone to buy $1,200 gold, or other commodities. Others give up, and decide that since they can’t really protect themselves against exogenous shocks, events, or unknown unknowns, all they can do is fret. Or forget about it all, dust off the old barbecue, and enjoy the long holiday weekend.



Fed weighs how and when to signal higher rates
YAHOO
By JEANNINE AVERSA, AP Economics Writer
16 March 2010

WASHINGTON – Debate is heating up within the Federal Reserve over how and when to signal that the days of record-low interest rates are numbered.

A rate hike isn't imminent. But at their meeting, which started Tuesday morning, Federal Reserve Chairman Ben Bernanke and his colleagues will likely focus on how to telegraph that higher rates are coming once the economic recovery is more deeply rooted. Eventually, Fed policymakers will need to start bumping up rates to head off inflation.

It will be a challenging maneuver. Fed officials will want to signal a move to higher rates in advance so borrowers and investors aren't jarred. And they will need to send a signal that isn't confusing.

The Fed has held rates at a record low near zero since December 2008. Bernanke and other Fed officials have said low rates are still needed to underpin economic growth.

But they need to decide whether to keep or modify their yearlong pledge to hold rates at record lows for an "extended period." Economists generally think "extended period" means at least six more months.

The Fed could drop that commitment altogether. Or it could pledge to keep rates low only for "some time" or vow to keep "policy accommodative." Or it could change its language in some other way to stress that credit will be tightened when the time is right. Any such step would signal that the days of easy money are fading.

Inside the Fed, debate is intensifying.

Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, has pushed to change the signal. At the Fed's last meeting in late January, Hoenig dissented from the "extended period" pledge. He favored saying rates would stay low for "some time." He thought that would give the Fed more flexibility to start raising rates.

Some economists aren't ruling out a change in language at Tuesday's meeting. An afternoon announcement is expected. Others don't think a change will come until the Fed's next meeting on April 27-28.

"During the Depression, the Fed tightened policy too soon and cut off the recovery before it was self-sufficient," said Joel Naroff, president of Naroff Economic Advisors. "The Fed doesn't want to make that mistake again. I think that they are willing to stay with very easy money longer than they might normally because of all the damage that has been done to the economy."

The recession wiped out 8.4 million jobs. And with companies still wary of ramping up hiring, the unemployment rate — now at 9.7 percent — is likely to stay high.

Even though the jobless rate hasn't budged for two months and companies aren't cutting as many jobs as they did a year ago, hiring is tepid. Consumer and business spending is sufficient to keep the economy growing only modestly. Lending remains tight. And, the housing and commercial real-estate markets are wobbly. A government report out Tuesday showed that housing construction tumbled in February as snowstorms held back activity in some parts of the country.

"Cautiously optimistic is where the Fed is right now," said William Cheney, chief economist at John Hancock. "But it is heavy on the caution and light on the optimism."

That helps explain why the Fed is expected to keep its key rate at a record low Tuesday. It has held its target range for its bank lending rate at zero to 0.25 percent since December 2008. In response, commercial banks' prime lending rate, used to peg rates on certain credit cards and consumer loans, has remained about 3.25 percent — its lowest in decades.

Super-low rates benefit borrowers who qualify for loans and are willing to take on more debt. But they hurt savers. Low rates are especially hard on people living on fixed incomes who are earning measly returns on savings accounts and certificates of deposit.

The Fed could start boosting rates as early as June — if economic growth accelerated. A more likely time is this fall, economists say.

Investors also will be looking to see if the Fed makes any changes to an economic-support program that's lowered mortgage rates and bolstered the housing market. Under that program, the Fed is scheduled to end its mortgage-securities purchases from Fannie Mae and Freddie Mac at the end of this month.

Some analysts fear that once the program ends, mortgage rates could rise. That could weaken the recovery in housing and the overall economy. The Fed has left the door open to extending the program if the economy weakens.

Uncle Sam, credit risk
By MICHAEL BARONE
NYPOST
Last Updated: 5:08 AM, March 27, 2010
Posted: 12:25 AM, March 27, 2010

In recent weeks US Treasury bonds have lost their status as the world's safest invest ment. The numbers are pretty clear. In February, Bloomberg News reports, Berkshire Hathaway sold two-year bonds with an interest rate lower than that on two-year Treasuries. A firm run by a 79-year-old investor is a better credit risk, the markets are telling us, than the US government.

Buffett's firm isn't the only one. Procter & Gamble, Johnson & Johnson and Lowe's have been borrowing money at cheaper rates than Uncle Sam.

Democrats wary of voting for the health-care bill may have been soothed by the Congressional Budget Office's report that it would reduce federal deficits over the next 10 years. But bond buyers know that the Democrats gamed the CBO system to get a good score.

The realities, as former CBO Director Douglas Holtz-Eakin pointed out in The New York Times, are different. The real cost is disguised by the fact that the bill includes 10 years of revenue but only six years of spending. It includes $70 billion in premiums for long-term care that will have to be paid out later. It excludes $114 billion in spending needed to run the program. It includes nearly half a trillion dollars in unrealistic Medicare savings.

Holtz-Eakins' bottom line: The bill won't lower deficits, but raise them by $562 billion over 10 years. Treasury will have to borrow that money -- and probably pay much higher interest than it's paying now.

Moreover, once the bill is fully in effect, the Cato Institute's Alan Reynolds points out, its expenses are likely to grow at least 7 percent a year -- significantly faster than revenues. At that rate, spending doubles every 10 years.

No wonder that Moody's declared last week that the Treasury is "substantially" closer to losing its AAA bond rating.

It's not only the federal government that is heading toward insolvency. State governments will have to spend more under the health-care bill -- $735 million in Tennessee alone, according to Democratic Gov. Phil Bredesen.

And states are already facing a huge problem: pensions. The Pew Charitable Trusts estimates that state-government pensions are underfunded by $450 billion. My American Enterprise Institute colleague Andrew Biggs argues in The Wall Street Journal that the real figure is over $3 trillion.

The reason: States set aside cash to invest in pensions, but typically assume that their investments will rise 8 percent a year. They haven't been getting such high returns and are not likely to do so in the future. But they're under legal obligations to pay the pensions. Retirees get paid off before bondholders, which means that states are going to have to pay more interest when they borrow.

In the '90s, Clinton adviser James Carville said that if he was reincarnated he'd like to come back as the bond market -- "because you can intimidate everybody." Governments, like all organizations, need to borrow routinely. But investors won't lend unless they think they will be paid back. And they'll demand higher interest rates as their loans become riskier.

On Sunday, 219 House Democrats, soothed by their leaders' gaming of the CBO scoring process, voted in reckless disregard of what the bond market has been telling them. Some may share Speaker Nancy Pelosi's optimism that the government's looming fiscal disaster can be avoided by imposing a value-added tax -- in effect, a national sales tax.

But, as we know from the experience of high-tax Western Europe and relatively low-tax America over the last three decades, higher taxes tend to retard economic growth. Lower economic growth means less revenue for government than in CBO projections. Less revenue means more borrowing -- and at some point lenders are going to call a halt.

Barack Obama's project of transforming the United States into something like Western Europe is, according to the CBO, raising the national debt burden on the economy to World War II levels.

I see train wrecks ahead -- as the bond market forces huge spending cuts or tax increases first on states and then on the federal government. It will make what happened in the House on Sunday look pretty.
The dollar's danger
NYPOST
By SCOTT S. POWELL
Last Updated: 4:35 AM, March 25, 2010
Posted: 12:27 AM, March 25, 2010

The ratings agency Fitch just cut Portugal's bond rating to AA- -- a clear sign that the insolvency crisis that began in Greece is far from over. And don't think it's merely a problem for the European Union. In fact, a debt-driven collapse of the dollar may be closer than most Americans realize.

Start by looking at the levels of deficits and debt that can trigger problems. The "tipping point" we see in Greece (and the "contagion countries" on the edges of Europe) occurs when debt exceeds 100 percent of the country's GDP. That's the signal that a nation will be unable to pay its bills -- jeopardizing financial stability.

Now look at the impact of the increases on US spending and borrowing over the last 18 months: The Congressional Budget Office predicts that deficit spending will drive the federal debt to almost $19 trillion by 2015 -- nearly doubling US debt since the TARP bailout was rolled out in late 2008.

Pre-TARP, gross federal debt was 70 percent of GDP. It's now estimated at about 90 percent of GDP. Add in the $1.6 trillion debt liability of Fannie Mae and Freddie Mac, and we're already at that 100 percent debt-to-GDP tipping point.

No, the United States isn't Greece: For a host of reasons, we can probably get away with higher debt. But our problem is about to grow worse.

We've largely been financing our deficit spending with short-term debt -- and the Federal Reserve has been keeping short-term interest rates at or near zero. This makes federal borrowing seem cheaper than it really is -- because those interest rates won't stay at zero.

And when rates head back to normal, Uncle Sam's borrowing costs could easily double. We spend 11 percent of the current budget -- $382 billion -- on debt service; that could rise two- or three-fold to more than $800 billion, warns the CBO.

Worse, a crisis in confidence can lead to a sudden ("shock") increase in interest rates, and a much greater portion of the budget being pinned down with debt service. The sovereign debt crisis in Greece doubled its borrowing rates in just three months and brought riots to its streets.

The Greek crisis was triggered by news that government deficits were exceeding 12 percent of GDP. Here at home, this year's $1.6 trillion budget deficit is nearly 11 percent of projected US GDP.

Consider: To fund that deficit, the US Treasury must borrow another $1.6 trillion -- on top of $2 trillion of debt scheduled to roll over this year. That is, it must place a record $3.5 trillion-plus in debt in 2010.

Where will the money come from when our three largest foreign creditors -- China, Japan and Britain -- have little capacity or willingness to increase their Treasury holdings?

If no one else will bid at the desired rates, the Federal Reserve is likely to step in as the "lender of last resort" -- buying hundreds of billions of dollars of US government debt. But that is effectively printing money to pay our bills -- the classic alarm signal for a coming explosion in inflation.

Creating money out of the thin air of more debt issuance leads investors to demand higher offsetting interest rates in anticipation of the dollar's declining value. This weakens the dollar as the world's reserve currency and (since America imports more than it exports) leads to a broad range of higher domestic prices.

It is inconceivable that America would default on its debt outright. But a "perfect storm" of a spiraling debt and devaluation resulting in a "stealth" default looms on the horizon. A shocking thought for sure -- but inflating the currency has always been the easiest way for debtor nations to pay back creditors on cheaper terms.

What's likely to prevent such a crisis? Not the current leadership in Washington. But the public is already anxious about the skyrocketing of federal spending and debt -- with the Tea Party movement merely the most visible sign of a broader sentiment confirmed by every major poll.

We can at least hope that the voters have had enough of fiscal irresponsibility from Democrats and Republicans, and will elect politicians who realize that we can't borrow, tax and spend our way to prosperity.

We'll find out in November.

Scott S. Powell is a director of RemingtonRand and Alpha Quest LLC and a visiting fellow at Stanford University's Hoover Institution.
Why Democrats Don’t Care about $9.7 Trillion in Debt
It’s because they’re leftists, not liberals.
National Review
Dennis Prager
March 9, 2010 12:00 A.M.

As reported by the Washington Post: “President Obama’s proposed budget would add more than $9.7 trillion to the national debt over the next decade.”

CNN adds, “Of that amount, an estimated $5.6 trillion will be in interest alone.”

The Post continues: “The CBO [Congressional Budget Office] and the White House [are] . . . both predicting a deficit of about $1.5 trillion this year — a post-World War II record at 10.3 percent of the overall economy. But the CBO is considerably less optimistic about future years, predicting that deficits would never fall below 4 percent of the economy under Obama's policies and would begin to grow rapidly after 2015.

“Deficits of that magnitude would force the Treasury to continue borrowing at prodigious rates, sending the national debt soaring to 90 percent of the economy by 2020, the CBO said.”

CNN notes this particularly chilling prediction from the CBO: “By 2020 . . . debt held by the public would reach $20.3 trillion, or 90% of GDP. That’s up from 53% of GDP in 2009.”

I suspect that most Americans, if asked whether these numbers trouble the Democratic leadership and President Obama, would answer in the affirmative.

They would be wrong.

They would be wrong not because the Democratic party and the president are economic illiterates or bad individuals, but because the Democratic party and the president are leftists, and most Americans, including most Democrats, do not understand the Left. They may understand liberalism, but President Obama, Nancy Pelosi, Harry Reid, and most Democratic representatives and senators are not liberals; they are leftists. Few Americans understand the difference.

They do not realize, for example, that there is no major difference between the American Democratic party and the leftist social democratic parties of Western Europe. They do not know that, from Karl Marx to Barack Obama, the Left (as opposed to liberals) has never created wealth because it has never been interested in creating wealth; it is interested in redistributing wealth.

Therefore, unprecedented and unsustainable debt that will negatively affect most Americans’ quality of life, render the dollar increasingly undesirable, and undermine America’s prestige and power in the world — these developments do not particularly disturb the Left. They may trouble the president, the Democratic party, and their allies on some political level, but that pales in comparison to the Left’s zeal for what it really wants: a huge government overseeing a giant welfare state and a country with far fewer rich Americans.

Achieving those goals is far more important than preventing a decline in the American quality of life. The farther left one goes on the spectrum, the more contempt one sees for the present quality of American life; the Left regularly mocks many of the symbols of that life, from the three-bedroom suburban house surrounded by a white picket fence to the SUV, or almost any car, in the driveway (Americans should be traveling on public buses and trains and by riding bicycles, they believe).

As for the dollar, I can bear personal testimony to the decline of its prestige. I am writing this column in Morocco. In Casablanca, my wife and I and another couple hired a Moroccan driver for the day. When it came time to pay, the man refused to accept dollars; he wanted to be paid in either euros or Moroccan dirhams. Yes, dirhams rather than dollars. But the demise of the dollar as the world’s currency disturbs the Left as much as does America’s not getting a gold medal in curling at the Winter Olympics.

And as for America wielding less power in the world, the American Left considers that to be a positive development. They think it is the world community as embodied in the United Nations that should wield power throughout the world, not an “overstretched,” “imperialist,” and “militarist” United States.

I used to believe that the Left and the Right had similar goals for America, that they just differed in the means they wanted to use to get there. I was mistaken. The Left has a very different vision of America than those who hold to America’s founding values, most especially individualism and small government. Their vision is one in which a once-in-a-lifetime chance to establish a giant welfare state dominated by the Left is worth any price — even America’s steep financial decline.

Debt-tastrophe

By THOMAS M. HOENIG
Last Updated: 8:03 AM, February 18, 2010
Posted: 1:14 AM, February 18, 2010

Growing demands on the federal government have invited a massive buildup of government debt now and over the next several years. US fiscal policy must focus on reducing this debt buildup and its consequences.

History holds many examples of severe fiscal strains leading to major inflation. It seems inevitable that a government turns to its central bank to bridge budget shortfalls -- with the result being too-rapid money creation and eventually, not immediately, high inflation.

German hyperinflation is one classic and often-cited example, and with good reason. When I was named president of the Federal Reserve Bank of Kansas City in 1991, my 85-year old neighbor gave me a German 500,000 Mark note.

He'd been in Germany during its hyperinflation and told me that in 1921, the note would have bought a house. In 1923, it wouldn't even buy a loaf of bread. He said, "I want you to have this note as a reminder. Your duty is to protect the value of the currency."

Many say hyperinflation could never happen here in the United States. To them I ask, "Would anyone have believed three years ago that the Federal Reserve would have $1 1/4 trillion in mortgage-backed securities on its books today?" Not likely. So I ask your indulgence in reminding all that the unthinkable becomes possible when the economy is under severe stress.

IN the 1960s, the Federal Re serve's willingness to accom modate fiscal demands and help finance spending on the Great Society and the Vietnam War contributed to a period of accelerating price increases. Inflation rose from roughly 1½ percent in 1965 to almost 6 percent in 1970. It also helped set the stage for the Great Inflation of the 1970s as inflation expectations gradually became unanchored.

Today, the immediate concern is the size of the deficit. The CBO projects the deficit was almost 12 percent of GDP in fiscal year 2009 and will be almost 8 percent in the current fiscal year -- extraordinarily high levels by historical standards.

In the entire history of the United States, the government has run deficits over 10 percent of GDP in only a few instances, and usually only during or immediately following a major war.

EVEN more disconcerting is the longer-term outlook for the federal debt. The Congressional Budget Offices's long-term debt projections clearly show that current fiscal policies are unsustainable. In one scenario, the liftoff point for federal debt -- that is, the time when debt starts rising without any sign of stabilizing -- occurs shortly after 2020. By 2035, federal debt held by the public reaches 80 percent of GDP -- a level only exceeded during and just after World War II.

In another, more pessimistic scenario, the liftoff in debt has already begun -- with federal debt held by the public reaching 181 percent of GDP in 2035, easily exceeding the peak debt-to-GDP ratio of 113 percent at the end of World War II.

I SEE just three ways forward:

Monetize: One option is for the central bank to succumb to political pressure and monetize the debt.

As deficits and debt levels within a country rise relative to national income, interest rates tend to rise as well. The central bank is often pressured to keep rates low and encouraged or required to assist the markets in facilitating the government's funding needs. If the central bank succumbs, its balance sheet will expand, bank reserves will grow -- and inevitably the money supply will increase. If this goes on unchecked, the outcome is almost always higher inflation and ultimately a loss of confidence in the value of the currency and the economy.

Policy Stalemate: The second path forward is a stalemate between the fiscal and monetary authorities -- the fiscal imbalance grows while an independent central bank maintains its focus on long-run price stability.

Although the US government is currently privileged to borrow at favorable rates, the fiscal outlook would inevitably undermine this privilege and its risk premium on debt would increase. Also, as the government competes with private borrowers for funds, the potential exists for the fiscal imbalance to drive up the real cost of borrowing and capital to the private sector as well.

EVENTUALLY, this combina tion weakens economic growth and undermines confidence in the economy's long-run potential. Slowly, but inevitably, the currency weakens, as does access to global financial markets. And the cycle worsens, leading ultimately to a financial and economic crisis.

An interesting example is Canada in the first half of the '90s. In this period, Canadian federal debt rose from about 55 percent of GDP to roughly 70 percent. At the same time, the Bank of Canada targeted a steady downward path for inflation from 3 percent at the end of 1992 to 2 percent at the end of 1995.

With no monetary accommodation from the central bank, unsustainable government deficits and debt caused real interest rates in Canada to climb. Canadians paid a substantial risk premium over US rates to borrow. Moreover, the Canadian dollar came under persistent pressure. Overall economic performance suffered, with unemployment climbing as high as 12 percent.

These economic conditions contributed to the election of a new government, which made a credible commitment to balance the budget. In the following years, the federal budget deficit fell dramatically. Revenue increased, and government expenditures were cut sharply. By 1996, Canadian interest rates had fallen below comparable US rates. Inflation remained subdued, real GDP growth picked up and unemployment fell.

Equitable Fiscal Discipline: The Canadian experience in the second half of the '90s is suggestive of the only responsible way to resolve our growing fiscal imbalance: by addressing its source in an environment of price stability.

All seem to agree this is the way we would prefer to go -- but of course the devil is in the details. At the outset, it requires an institutional framework committed to having an independent central bank. This discourages the fiscal authority from turning to its central bank -- and, should it do so, strengthens the bank's ability to say "no."

KNOWING inflation is not an acceptable alternative to strong fiscal management, a government faced with rising debt levels must provide a credible long-term plan to reestablish fiscal balance. The plan must be clear, have the force of law and its progress measureable so as to reassure markets and the public that the country has the will and ability to repay its debts in a stable currency.

To be broadly accepted, the plan must be seen as fair, in which there is a sense of shared sacrifice across all segments of the economy. These requirements suggest an approach in which we are willing to disappoint a host of special interests.

It means, for example, controlling budget earmarks, trimming subsidies to numerous economic sectors and resolving our banking problems and the perception that Wall Street is favored over Main Street.

There is no way to avoid some short-term pain in fixing the fundamentals in our economy. It is inconvenient for the election cycle, and it is undeniably terrible to have at least 10 percent of the labor force out of work. But shortcuts now mean people out of work again in only a few years because we again try and avoid difficult adjustments.

EVENTUALLY, government budgets that are severely out of balance are inevitably reformed -- either by force of the markets or, preferably, by choice. In time, significant and permanent fiscal reforms must occur in the United States. I much prefer this be done well before anyone feels an irresistible impulse to knock on this central bank's door.

Thomas M. Hoenig is president of the Federal Reserve Bank of Kansas City. Excerpted from his remarks Tuesday at a Peterson- Pew Commission on Budget Re form Policy forum.

Op-Ed Contributor
How to Watch the Banks
NYTIMES
By HENRY M. PAULSON Jr.
February 16, 2010

Washington

SIXTEEN months ago, our financial system teetered on the brink of collapse. The Treasury, the Federal Reserve and the Federal Deposit Insurance Corporation took actions that were unpopular and previously unthinkable — but absolutely necessary to stave off an economic catastrophe in which unemployment could have exceeded the 25 percent level of the Great Depression.

These temporary actions have ended or will end. And our financial system is much more stable. But it is critical that we learn from the financial crisis and put in place reforms to avert a repeat of 2008 or something even worse.

Congress must pass financial regulatory reform. Delays are creating uncertainty, undermining the ability of financial institutions to increase lending to the businesses of all sizes that want to invest and fuel our recovery. Our overriding goal in restructuring our financial architecture should be that taxpayers never again have to save a failing financial institution.

The debate recently has centered on big banks and trading risks. I agree that big banks do pose a dangerously large risk to our financial system, and I am troubled that concentration in the industry has only increased since the crisis. But if we are to protect our system from falling into trouble again, we need broad-based reform that covers all types of financial institutions and all forms of potentially risky activities.

For example, the most recent proposal by the Obama administration — to bar big banks from trading driven by other than customer-related activity — would not have prevented the collapse of Fannie Mae, Freddie Mac, Lehman Brothers, American International Group, Washington Mutual, Wachovia or other institutions whose failure contributed to the crisis. Rather than dictating a set of rules that will become out of date as the markets evolve, policy makers should devise legislation that ensures that regulators have the authority to tackle the issue of size and all potential systemic risks.

This calls for two vital changes. First, we must create a systemic risk regulator to monitor the stability of the markets and to restrain or end any activity at any financial firm that threatens the broader market. Second, the government must have resolution authority to impose an orderly liquidation on any failing financial institution to minimize its impact on the rest of the system.

Together, these two reforms will enable the regulatory system to better prevent the kinds of excesses that fueled our recent crisis, restore market discipline and keep the failure of a large institution from bringing down the rest of the system.

A single agency responsible for systemic risk would be accountable in a way that no regulator was in the run-up to the 2008 crisis. With access to all necessary information to monitor the markets, this regulator would have a better chance of identifying and limiting the impact of future speculative bubbles.

Given our global markets, we have to address the issue of size on a multinational level. We should work through the Financial Stability Board, a global regulatory agency with headquarters in Switzerland, to establish an international agreement calling for stronger capital and liquidity requirements for large, complex institutions. The need for adequate liquidity cushions is not as well understood, but in my judgment it is even more important than the need for banks to maintain higher capital levels.

As for our domestic approach, we now have different government regulators focusing on the individual trees, and we need one regulator accountable for looking at the entire forest. My preference is for the Federal Reserve to be the systemic risk regulator, because the responsibility for identifying and limiting potential problems is a natural complement to its role in monetary policy.

Congress, however, seems to be moving toward having a council of regulators perform this function. While that is not my preference, I believe a council can be workable if it is led by either the Treasury secretary or the Fed chairman, and is structured to ensure that strong decisions are reached quickly in a crisis. Too many such panels in government act by consensus, allowing a single member to render the council immobile.

No systemic risk regulator, no matter how powerful, can be relied on to see everything and prevent future problems. That’s why our regulatory system must reinforce the responsibility of lenders, investors, borrowers and all market participants to analyze risk and make informed decisions. This is possible only if everyone understands that no financial institution is too big to fail, and that its investors and creditors will have to bear the consequences if it does.

To address the moral hazard issue, the government needs broad-based authority to liquidate any failing financial institution without going through the bankruptcy process, which is not well-suited for such complex firms in the midst of a financial crisis. We must send a clear signal to market participants that whenever this process is put in motion, the outcome is liquidation; we cannot leave any hope that we would inject taxpayer dollars to preserve the failing firm in its present form.

Winding down a large institution is difficult and time-consuming. The regulators with this responsibility will need to be trained to do the job. And we must also require all large firms to develop a road map for their liquidation well ahead of any failure.These are not the only necessary reforms — we must also address regulation of derivatives and our over-reliance on credit ratings agencies. Over time, we have to simplify the patchwork quilt of regulatory agencies and improve transparency so that consumers and investors can punish excesses through their own informed investing decisions. We have to examine the many policies that favor homeownership, and recalibrate our support for them. We must also tackle what is by far our greatest economic challenge — the reduction of budget deficits — a big part of which will involve reforming our major entitlement programs: Medicare, Medicaid and Social Security.

It has been a difficult, and humbling, two years for our nation. But every other major country has more significant economic problems than we do and, with the resilience of our economy and the ingenuity of our people, we can meet our challenges. Nonetheless, we must not lose our sense of urgency, or the political courage to make the necessary reforms to ensure our long-term prosperity.

Henry M. Paulson Jr., the secretary of the Treasury from 2006 to 2009, is the author of “On the Brink: Inside the Race to Stop the Collapse of the Global Financial System.”

Geithner Says US Credit Rating Safe Despite Debt
NYTIMES
By THE ASSOCIATED PRESS
February 7, 2010
Filed at 8:01 a.m. ET

WASHINGTON (AP) -- Treasury Secretary Timothy Geithner (GYT'-nur) says the U.S. government ''will never'' lose its sterling credit rating despite big budget deficits and a newly increased debt limit that now tops $14 trillion.

Geithner says in an interview broadcast Sunday that in times of economic crisis, international investors will continue to buy U.S. Treasury bonds because the bonds are a safe investment.

Moody's Investors Service recently issued a warning that the government's credit rating could eventually be in jeopardy if nation's finances don't improve. The cost of borrowing would increase significantly if the ratings service lowered the credit rating, also known as a bond rating, for U.S. Treasuries.

Geithner tells ABC's ''This Week'' that will never happen.

News Analysis
Huge Deficits May Alter U.S. Politics and Global Power
NYTIMES
By DAVID E. SANGER
February 2, 2010

WASHINGTON — In a federal budget filled with mind-boggling statistics, two numbers stand out as particularly stunning, for the way they may change American politics and American power.

The first is the projected deficit in the coming year, nearly 11 percent of the country’s entire economic output. That is not unprecedented: During the Civil War, World War I and World War II, the United States ran soaring deficits, but usually with the expectation that they would come back down once peace was restored and war spending abated.

But the second number, buried deeper in the budget’s projections, is the one that really commands attention: By President Obama’s own optimistic projections, American deficits will not return to what are widely considered sustainable levels over the next 10 years. In fact, in 2019 and 2020 — years after Mr. Obama has left the political scene, even if he serves two terms — they start rising again sharply, to more than 5 percent of gross domestic product. His budget draws a picture of a nation that like many American homeowners simply cannot get above water.

For Mr. Obama and his successors, the effect of those projections is clear: Unless miraculous growth, or miraculous political compromises, creates some unforeseen change over the next decade, there is virtually no room for new domestic initiatives for Mr. Obama or his successors. Beyond that lies the possibility that the United States could begin to suffer the same disease that has afflicted Japan over the past decade. As debt grew more rapidly than income, that country’s influence around the world eroded.

Or, as Mr. Obama’s chief economic adviser, Lawrence H. Summers, used to ask before he entered government a year ago, “How long can the world’s biggest borrower remain the world’s biggest power?”

The Chinese leadership, which is lending much of the money to finance the American government’s spending, and which asked pointed questions about Mr. Obama’s budget when members visited Washington last summer, says it thinks the long-term answer to Mr. Summers’s question is self-evident. The Europeans will also tell you that this is a big worry about the next decade.

Mr. Obama himself hinted at his own concern when he announced in early December that he planned to send 30,000 American troops to Afghanistan, but insisted that the United States could not afford to stay for long.

“Our prosperity provides a foundation for our power,” he told cadets at West Point. “It pays for our military. It underwrites our diplomacy. It taps the potential of our people, and allows investment in new industry.”

And then he explained why even a “war of necessity,” as he called Afghanistan last summer, could not last for long.

“That’s why our troop commitment in Afghanistan cannot be open-ended,” he said then, “because the nation that I’m most interested in building is our own.”

Mr. Obama’s budget deserves credit for its candor. It does not sugarcoat, at least excessively, the potential magnitude of the problem. President George W. Bush kept claiming, until near the end of his presidency, that he would leave office with a balanced budget. He never got close; in fact, the deficits soared in his last years.

Mr. Obama has published the 10-year numbers in part, it seems, to make the point that the political gridlock of the past few years, in which most Republicans refuse to talk about tax increases and Democrats refuse to talk about cutting entitlement programs, is unsustainable. His prescription is that the problem has to be made worse, with intense deficit spending to lower the unemployment rate, before the deficits can come down.

Mr. Summers, in an interview on Monday afternoon, said, “The budget recognizes the imperatives of job creation and growth in the short run, and takes significant measures to increase confidence in the medium term.”

He was referring to the freeze on domestic, non-national-security-related spending, the troubled effort to cut health care costs, and the decision to let expire Bush-era tax cuts for corporations and families earning more than $250,000.

But Mr. Summers said that “through the budget and fiscal commission, the president has sought to provide maximum room for making further adjustments as necessary before any kind of crisis arrives.”

Turning that thought into political action, however, has proved harder and harder for the Washington establishment. Republicans stayed largely silent about the debt during the Bush years. Democrats have described it as a necessary evil during the economic crisis that defined Mr. Obama’s first year. Interest in a long-term solution seems limited. Or, as Isabel V. Sawhill of the Brookings Institution put it Monday on MSNBC, “The problem here is not honesty, but political will.”

One source of that absence of will is that the political warnings are contradicted by the market signals. The Treasury has borrowed money to finance the government’s deficits at remarkably low rates, the strongest indicator that the markets believe they will be paid back on time and in full.

The absence of political will is also facilitated by the fact that, as Prof. James K. Galbraith of the University of Texas puts it, “Forecasts 10 years out have no credibility.”

He is right. In the early years of the Clinton administration, government projections indicated huge deficits — over the “sustainable” level of 3 percent — by 2000. But by then, Mr. Clinton was running a modest surplus of about $200 billion, a point Mr. Obama made Monday as he tried anew to remind the country that the moment was squandered when “the previous administration and previous Congresses created an expensive new drug program, passed massive tax cuts for the wealthy, and funded two wars without paying for any of it.”

But with this budget, Mr. Obama now owns this deficit. And as Mr. Galbraith pointed out, it is possible that the gloomy projections for 2020 are equally flawed.

Simply projecting that health care costs will rise unabated is dangerous business.

“Much may depend on whether we put in place the financial reforms that can rebuild a functional financial system,” Mr. Galbraith said, to finance growth in the private sector — the kind of growth that ultimately saved Mr. Clinton from his own deficit projections.  His greatest hope, Mr. Galbraith said, was Stein’s law, named for Herbert Stein, chairman of the Council of Economic Advisers under Presidents Richard M. Nixon and Gerald R. Ford.

Stein’s law has been recited in many different versions. But all have a common theme: If a trend cannot continue, it will stop.

Wall Street pares gains after bond auction
YAHOO
December 10, 2009

NEW YORK (Reuters) – Stocks slightly pared gains after an auction of 30-year Treasuries attracted weak demand on Thursday.

U.S. Treasury debt prices extended losses, sending long-bond yields to a four-month high after the weak bond auction.

The Dow Jones industrial average (.DJI) was up 52.68 points, or 0.51 percent, at 10,389.73. The Standard & Poor's 500 Index (.SPX) was up 5.57 points, or 0.51 percent, at 1,101.52. The Nasdaq Composite Index (.IXIC) was up 9.38 points, or 0.43 percent, at 2,193.11.

Dollar hits 14-year low against yen
YAHOO
November 27, 2009

LONDON (AFP) – The dollar struck a 14-year low against the yen on Friday amid jitters Dubai may default on its debt, which sent global stock markets reeling and prompted investors to exit risky trades.

During Asian trading, the dollar tumbled to 84.82 yen, which was the lowest level since July 1995, but has since strengthened somewhat.  In later European deals, the dollar stood at 86.53 yen compared with 86.59 yen late on Thursday in New York. The euro fell to 1.4893 dollars from 1.5019 dollars late on Thursday.  Analyst Jane Foley at online trading group Forex.com said dealers exited assets that are deemed as risky -- such as the euro -- and sought safety in the safe-haven yen.

"The market is taking a breather. Volatility had soared in early hours after the risk trade headed for the exits in thinned liquidity," Foley said.

She added: "It is likely to take at least a few days before the implications of the impact of a possible default from Dubai are properly digested."

"For the present it seems that the market is seeing this negative news as a blow to the global recovery but not one that will push it off course."

Gold meanwhile dipped on profit-taking after hitting a record high of 1,195.13 dollars an ounce on Thursday on the back of the weak dollar.  The greenback also remained under pressure as investors continued to price in expectations that the United States is in no hurry to raise its near-zero interest rates.

US financial markets will reopen later on Friday after the Thanksgiving holiday on Thursday.

World share prices tumbled for a second day on Friday on fears over global banks' exposure to a potential debt crisis in Dubai, after its government issued a shock call to suspend the debt of a key state company.

Meanwhile the yen's surge against the dollar added pressure on Japanese authorities to intervene in markets, something they have not done since 2004, because the stronger yen hurts exports of Japanese companies.

Breaking from his recent cautious remarks on currency movements, Finance Minister Hirohisa Fujii acknowledged that the yen's rapid rise was "harmful" to the economy.

"We will take appropriate action toward disorderly movements," he told reporters on Friday, adding that he would discuss foreign exchange with Europe and the US "when needed."

In London on Friday, the euro was changing hands at 1.4893 dollars against 1.5019 dollars late on Thursday, at 128.87 yen (129.84), 0.9083 pounds (0.9090) and 1.5081 Swiss francs (1.5059).  The dollar stood at 86.53 yen (86.59) and 1.0127 Swiss francs (1.0028).  The pound was at 1.6394 dollars (1.6532).

On the London Bullion Market, the price of gold sank to 1,156.28 dollars an ounce from 1,182.75 dollars an ounce late on Thursday.

Stocks slide as rising dollar hits oil prices
YAHOO
By TIM PARADIS, AP Business Writer
October 26, 2009

NEW YORK – A strengthening dollar and worries about an overheated market pounded stocks.

Stock indexes started higher Monday but turned sharply lower at midmorning as a rebound in the value of the dollar stalled a rally in commodities. Early gains in prices for oil and other commodities had pushed up shares of energy and materials companies.

The sharp swings in currency and commodities markets sent the Dow Jones industrial average whipsawing in a 200-point range, surrendering an early advance for a loss of 104 points. Stocks have fallen in four of the last five days.

"This is the tug-of-war that's been going on for a while now," said Samuel Dedio, portfolio manager of the Artio U.S. Smallcap Fund in New York, referring to sparring between the dollar and stocks.

Oil gave up early gains to settle down $1.82 at $78.68 per barrel on the New York Mercantile Exchange. That hurt the shares of major oil companies such as ConocoPhillips.

Changes in the dollar's value against other currencies frequently send commodities prices up or down. Since most commodities are priced in dollars they become more attractive to investors outside the U.S. when the dollar is weak, and more expensive when the dollar is strong.

Analysts also said some investors are looking to pocket gains after a stock market run that has stretched nearly eight months and brought share prices to their highest levels in a year.

"I'm not sure that you need to have a good reason to see a reversal like this other than too much too fast," said Harry Rady, chief executive of Rady Asset Management in San Diego, referring to the market's rise from 12-year lows in early March.

Technology shares fared better than other parts of the market Monday after Marvell Technology Group Ltd., which makes chips used in phone networks, raised its fiscal third-quarter revenue forecast. That helped the technology-focused Nasdaq composite index limit its losses. RadioShack Corp.'s third-quarter sales topped expectations, helping some retailers.

Richard Ross, global technical strategist at Auerbach Grayson in New York, said the direction of the dollar as well as volatility continues to drive stock trading. "You're seeing this sort of waltz between the dollar and volatility and stocks," Ross said.

The Dow fell 104.22, or 1.1 percent, to 9,867.96. The index fell 109 Friday. The slide is the first consecutive triple-digit loss for the Dow since June 15-16.

The broader Standard & Poor's 500 index fell 12.65, or 1.2 percent, to 1,066.95. The index, which is the basis for many mutual funds, is down 2.8 percent from its recent peak a week ago.

The Nasdaq fell 12.62, or 0.6 percent, to 2,141.85.

About three stocks fell for every one that rose on the New York Stock Exchange, where consolidated volume came to 5.7 billion shares compared with 4.8 billion Friday.

Stocks fell Friday after a rise in the dollar hurt commodity prices. The Dow lost 0.2 percent last week, while the S&P 500 index fell 0.7 percent.

Bond prices fell. The yield on the benchmark 10-year Treasury note, which moves opposite its price, rose to 3.56 percent from 3.49 percent late Friday. It was the first time since late August that the yield topped 3.50 percent.

The dollar rose against most other major currencies, while gold fell.

Financial stocks posted some of the biggest losses as an analyst lowered his ratings on some regional banks and as traders worried about what might happen if regulators try to impose rules on the size of financial institutions.

"We're seeing legislation in Washington drive trading," said John Brady, senior vice president of global interest rate products at MF Global in Chicago.

Meanwhile, Rochdale Securities bank analyst Richard Bove lowered his ratings on Fifth Third Bancorp, SunTrust Banks Inc. and US Bancorp. Fifth Third fell 82 cents, or 7.9 percent, to $9.52 and SunTrust slid $1.14, or 5.4 percent, to $19.85. US Bancorp fell 80 cents, or 3.2 percent, to $24.15.

Homebuilder stocks fell as investors tried to determine whether Congress will extend a tax credit for first-time homebuyers. Top Democrats in the Senate pushed for a plan that would continue the credit but phase it out over the next year.

An analyst also cut his estimates on several companies in the industry while warning that most companies won't eke out a small profit until late 2011.

Pulte Homes Inc. fell 38 cents, or 3.8 percent, to $9.70, while Hovnanian Enterprises Inc. slid 23 cents, or 5.4 percent, to $4.07.

Among oil companies, ConocoPhillips sank $1.23, or 2.4 percent, to $50.74.

In other trading, Marvell rose 41 cents, or 2.8 percent, to $14.99, while RadioShack rose $2.49, or 15.9 percent, to $18.15.

The Russell 2000 index of smaller companies fell 7.18, or 1.2 percent, to 593.68.

Overseas markets fell after U.S. stocks dropped. Britain's FTSE 100 fell 1 percent, Germany's DAX index and France's CAC-40 each fell 1.7 percent. Japan's Nikkei stock average rose 0.8 percent.

The Dethroning of King Dollar?  What the currency turmoil means.
Weekly Standard
by Irwin M. Stelzer
10/24/2009 12:02:00 AM

"Dollar murdered. Drowned in red ink. Clues point to the White House." So might a tabloid headline read as the angry mourners gathered to affix blame for the end of the era in which the dollar served as the currency in which the world does business -- its reserve currency, to use the economists' jargon. But if such a funeral ever takes place, the mourners should remember that right now they aren't too happy with the existing system.

The Chinese are cross because the falling dollar means the stacks of US IOUs they have in their vaults will be paid back in a devalued currency. The Americans are cross because the Chinese refusal to allow the renminbi to rise in value meant goods made in Chinese factories will continue to displace made-in-America products, and provide jobs for Chinese rather than American workers. The Europeans are cross because the strong euro threatens to abort the export growth on which they are depending to fuel their economic recovery. The British are cross because the weak pound is causing sticker shock when they travel abroad, and suggests that a spurt of inflation is just around the corner. In short, everyone seems to be terribly unhappy with developments in the currency markets when the dollar was king. Well, not terribly.

The Chinese might be unhappy that the dollar is declining in value, but are delighted that their policy of pegging the renminbi to the dollar is keeping their export machine humming -- they need millions of new jobs to prevent their still-poor masses from wondering whether some other form of political organization might provide a better life. The Americans might be fearful that further declines in the dollar will dethrone it as the world's reserve currency, but the Obama administration, talking the talk of dollar strength but walking the walk of dollar weakness, is hoping that a cheap dollar will make imports more expensive and exports more competitive, creating jobs by the time the 2012 presidential election rolls around. European exporters might be groaning about the growth-stifling effect of their high-flying currency (although German manufacturers seem to be doing just fine), but eurocrats are secretly delighted that the euro is proving a source of strength in these difficult times for members of euroland, and preventing inflation from taking hold.

Other players are also trying to cope with the falling dollar. Brazil has tried to stem the rise of its currency, which has appreciated over 40% against the dollar since March. To no avail. Oil and other commodity producers are raising prices to make up for the declining value of each dollar they receive by earning more of them. But these are minor players compared with the geopolitical players who see an opportunity to replace the dollar as the currency in which the world does business, to cut the US down to size -- think China, Russia, Venezuela, Iran.

It is one thing to want to replace the dollar, quite another to find a suitable substitute. The renminbi can't be the chosen currency so long as it is pegged to the dollar, for its value will move with the dollar. The ruble is not a candidate, since there is not enough of the currency around to handle the volume of world trade and, besides, it is not the sort of money on which you can rely to hold its value, especially if oil prices collapse. Which brings us to the euro.

As Jean Pisani-Ferry and Adam Posen, director of Brussels think tank Bruegel and fellow at the Peterson Institute for International Economics in Washington, respectively, have pointed out, "There is no sign of a move to the euro as a global currency. The share of dollars in global reserves remains almost three times that of the euro." The reasons for this failure of the euro to advance further as a global currency are not clear, but seem to be rooted in the failure of the EU to encourage economic growth, to develop better systems of economic governance, and to broaden the euro area by taking on new members. Talk about pricing oil in euros instead of dollars remains just that -- talk. And in the recent crisis it was the Federal Reserve Board that was called upon to provide currency to meet emergency needs for liquidity -- that means dollars.

Still, doubts about the dollar's future persist. Its recent decline may be consistent with its performance in previous currency cycles. And the drop might be due to a willingness by investors to take on more risk, now that the recession seems to be ending, rather than to a lack of faith in the safety of the dollar, to which they will scamper back at the first sign of international trouble. But investors do remain worried that the dollar's decline, so far acceptably gradual, will turn into a rout, perhaps not next year, but by 2011.

Federal Reserve Board chairman Ben Bernanke says that can be avoided if two policy steps are taken. First, the US government must make "a clear commitment to substantially reduce federal deficits over time." Second, Asian countries must boost domestic demand so that they don't have to rely so heavily on exports to the US, and allow their currencies to appreciate against the dollar so that the US trade deficit continues to fall as a percent of the American GDP.

What Bernanke did not say, either because he was playing the discrete central banker or because he doesn't believe it, is that neither of these things is likely. The Obama administration has already penciled in huge deficits for a decade and more, and is in the process of adding perhaps another trillion to the US deficit by "reforming" health care -- claims of savings are somewhere between delusions and lies. It will then turn its attention to the energy sector, and the subsidies required to fund its green revolution. Only Obama knows what spending comes next as he seeks to go down in history as the president who "transformed" the American economy.

Meanwhile, the Chinese are unlikely to allow their currency to appreciate in value, and other Asian nations will continue to intervene to prevent their currencies from rising against both the dollar and renminbi. Trade imbalances therefore will persist.

Which puts the ball right back in the Fed's court. Unless Bernanke drains liquidity from the financial system, and shrinks the Fed's balance sheet by winding down $2 trillion in support programs -- and does so precisely when the recovery takes hold so as not to cause a relapse by moving too early -- the dollar's decline will accelerate, shattering confidence in its long-term value. One well-respected expert tells me that in two-to-five years the dollar will no longer be considered safe enough to be the currency in which the world does business. Its replacement: separate deals in local currencies -- the Chinese paying for Brazil's oil in renminbi, which the Brazilians use to purchase stuff made in China -- and the International Monetary Fund's drawing rights, bits of paper backed by a basket of currencies, including but not limited to the dollar. That would mark the end of an era that has seen world trade flourish and millions emerge from poverty. Sad.

Irwin M. Stelzer is a contributing editor to THE WEEKLY STANDARD, director of economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London).

Debtor Nation: The U.S. could learn some lessons from 1946 Great Britain.
Weekly Standard
by Irwin M. Stelzer
10/17/2009 12:01:00 AM

Americans should be hoping that the Chinese will be kinder to us than we were to the Brits after World War II. Readers of a certain age will remember, and the few younger ones who study history will have learned what creditor Uncle Sam did to debtor John Bull when Britain sent John Maynard Keynes to Washington to negotiate borrow the odd billion from us. Britain had spent blood and treasure to beat the Nazis, and was hoping or a gift of $3 billion, a credit line of $5 billion, and other generosities.

As Robert Skidelsky points out in his magnificent biography of Keynes, "The Americans had never accepted that they owed Britain a moral debt" for its disproportionately large sacrifices. Instead, President Truman, advised by communist spies such as Harry Dexter White, insisted on terms so onerous that the Britain was, in some views, permanently expelled from the first rank of economic powers for decades, until Margaret Thatcher decided that her government's job was definitely not merely to manage decline.

Fast forward to today, and the plunging dollar. The Obama administration may mouth support for a strong dollar, but markets aren't easily fooled, or if fooled, are not fooled for long. They know that administration policy is relying heavily on a depreciating currency. In the short run, the White House hopes that a combination of protectionism and a cheap dollar will reduce the flow of imports and increase the volume of exports. That, the theory is, will create jobs "right here in America" as the Wal-Marts of the country switch to domestic suppliers.

In the longer run, the administration knows that it will somehow have to repay the massive debts it is incurring as it attempts to stimulate the economy, throws another trillion at what it sees as an underperforming health care system, and prepares to burden the energy economy with billions, or even trillions, in new costs in the interests of satisfying the green lobby that it is doing something about greenhouse gas emissions.

Of course, the Obama team could take a lesson from Argentina, which defaulted on its debts eight years ago and nevertheless is headed back into the market, to borrow money from lenders eager to increase their returns and afflicted with memory loss. P.T. Barnum, the great circus impresario, said, "There's a sucker born every minute," although it is not certain that he had international bankers in mind, since an annual sucker-birth rate of 525,600 might have to include more than leading bankers. Some regulators, perhaps.

But debt repudiation would be unbecoming a great power, much less one that hopes to maintain the dollar as a reserve currency. If indeed American any longer does. The administration's critics, among them Pulitzer Prize winning commentator Charles Krauthammer, believe the President wants to make America less of a hegemon and more of an ordinary nation, much like others in the international organizations of which Obama is so fond. That effort includes an increase in the U.S. contribution to the International Monetary Fund's ability to issue drawing rights, which the Russian, Chinese, and other regimes hostile to America want to see replace the dollar as the currency in which the world does business -- unless, of course, they find some way to have their own currencies become more acceptable in international trade.

But even the Chinese do not see the dollar's role being so diminished in the near- or medium-term future. Instead, they see themselves in the position that America was in vis-à-vis Britain in 1946. America is deeply in debt, and with the red ink cascading across the nation's books, digging itself deeper into debt every day. The Chinese, America's principal creditor, are worried that Obama and his successors will attempt to pay back the more-than-trillion dollars it owes China in wildly depreciated dollars. So it is making it known that it wants to see some plan coming out of the White House that will begin to reduce the deficit and, eventually the national debt.

No such plan exists. Obama, who styles himself a "transformational president", intends to keep the spending taps wide open. The old adage that if you owe your banker a few dollars he has you under his thumb, but if you owe him a huge sum you have him where you want him, is not true. Not if the Chinese are your creditor. So it should be no surprise that Obama is the first president to refuse to receive the Dalai Lama, despite the urgings of the louche celebrities who helped fund the President's election campaign. Or that America no longer presses the Chinese regime on human rights issues.

Which brings us back to Keynes, Truman, and the post-war world. Unless there is a major change in US economic policy, and soon, our version of the great British economist, White House adviser Larry Summers, Treasury Secretary Tim Geithner, or Federal Reserve Board chairman Ben Bernanke, or all three, will head to Beijing to plead for the Chinese to continue lending us money. The terms we will be offered are unlikely to be easy, and will include IMF-style controls on our fiscal policy.

Exaggeration? Perhaps, but less so if, as has been true in the past, the great, resilient American economy offsets the mistakes of its political masters by growing our way out of the problem. "The good news is that this deep and long recession appears to be over, and with improving credit markets, the U.S. can return to solid growth next year without worry about inflation," Lynn Raeser, president of the National Association of Business Economists told the group's annual gathering last week. Set aside the predictable drop in auto sales after the demise of the cash-for-clunkers program removed a $4,500 per-car subsidy, and retail sales are looking rather good -- up somewhere between 2% and 3% at an annual rate in the third quarter. Banks are coming to the end of a period of massive write-downs, even though billions in consumer and commercial property loans remain to be written off. Corporations are sitting on piles of cash, waiting to be spent if the uptick in consumer spending proves durable. Banks are again lending to developers of commercial properties, and house prices seem to be somewhere between stable and rising, although the risk that the patient will have a relapse is not trivial.

Add to renewed growth the apparent willingness of the Fed to head off inflation -- Bernanke's statement to that effect stemmed the dollar's decline, whereas statements favoring a strong dollar by Summers and Geithner did not -- and we might not find ourselves in the position Britain was in after the second World War. Indeed, the Chinese might be so dependent on access to our markets to keep their economy growing that power will lie on our side of the bargaining table.

Irwin M. Stelzer is a contributing editor to THE WEEKLY STANDARD, director of economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London).


The Dollar's New Best Friend
Beijing warms up to the greenback--because it has to.
Weekly Standard
by Gordon G. Chang
06/29/2009, Volume 014, Issue 39

Last Tuesday, Brazil, Russia, India, and China--the so-called BRIC nations--met in Yekaterinburg, Russia, for what was supposed to be an anti-American gabfest. The main agenda item for the first formal meeting of the four largest developing economies was the future of the dollar. In recent months, Beijing and Moscow have led a global charge against the greenback, and Brasilia has been a willing co-conspirator in the effort. The BRIC post-summit communiqué referred to the world's currency problems but, to the surprise of observers, did not attack the dollar head on.

What happened? Beijing, apparently, stopped the other nations cold. The Chinese called the tune at the Moscow meeting--their economy is almost as large as the other three combined--and so the surprisingly nonconfrontational tone of the BRIC official statement mirrored Beijing's recent climbdown on the currency issue.

The Chinese government in the last few weeks seems to have radically changed its tune on this issue. In March, Zhou Xiaochuan, the head of China's central bank, called for the replacement of the dollar as the world's reserve currency in a widely reported text released to the public. In May, however, Beijing officials took a different tack, going out of their way to talk about the dollar's unique status.

Why is Beijing acting like the greenback's new best friend? The Chinese of course realize they would sustain massive losses if they triggered a global flight from the dollar, and they do not appear to have any good ideas as to what should replace the world's financial architecture, now built on the American currency. Yet there is more to their newfound sense of responsibility. They are starting to understand that they have little ability to change the dollar-based international system.

Their fundamental problem is that the Chinese economy, for all the talk of "delinkage," is still tightly bound to America. China has an export-dominated economy--perhaps as much as 38 percent of its gross domestic product is attributable to the sale of goods to foreign markets. The country exports to many nations, but there is one market on which it is particularly dependent. In 2007, 97.7 percent of China's overall trade surplus related to sales to the United States, and in 2008 the figure was 90 percent. In short, China runs a trade deficit with the rest of the world, buying raw materials and components, and a surplus against the United States, selling finished goods. Beijing, therefore, is locked into buying Treasuries and will remain so until Chinese manufacturers either find new foreign markets--something they are only having moderate success in doing--or they can sell to Chinese consumers. And consumption growth, despite rosy government statistics, appears to be anemic.

This extraordinary reliance on the American market means that China had--and still has--no real choice but to continue to purchase dollar-denominated obligations with its export earnings. It is, of course, theoretically possible for Chinese technocrats to convert dollar earnings into pounds, euros, or yen, but the markets for those currencies are not big enough to handle the country's outsized purchases.

Beijing has, moreover, a more fundamental problem: Chinese officials cannot at this stage afford to turn their back on the dollar and thereby constrain the American economy. If they constrain the American economy, Americans will not be able to continue to buy Chinese goods. If Americans cannot buy Chinese goods, the Chinese economy will precipitously decline, and if the Chinese economy precipitously declines, the country's political system, dependent on the ongoing delivery of prosperity, will be destabilized. So Beijing, despite its incessant carping, continues to buy dollar-denominated debt. As Dai Xianglong, former central bank chief and now head of the national social security fund, says, China has no choice but to purchase U.S. Treasury obligations. In Beijing, it is known as the "dollar trap."

The central government does occasionally sell Treasuries, but such dispositions are small and always followed by more purchases. Americans are concerned that the Chinese will one day change their mind and dump our debt, thereby throwing our economy--and the global financial system--into turmoil. Beijing, from time to time, hints that is what it could do. For instance, in the middle of 2007, two Chinese officials threatened to employ the "nuclear option" against the United States: sell dollars and U.S. Treasury obligations. "I personally believe we have so many foreign exchange reserves that we should be smarter in setting the issues," said Xia Bin, one of the pair. "It should at least be a bargaining chip in talks." This is the first time that a senior economic adviser in Beijing publicly suggested using China's reserves for political leverage. He Fan, the other official, wrote in the official China Daily about Beijing causing "a mass depreciation" of the greenback.

We should thank Xia and He for revealing the thinking in the inner circles in Beijing and for providing a reminder that we need to pay down our debt and rebalance our economic relations with China. But their remarks, in reality, were not much of a threat. What would happen in the worst case scenario if the Chinese central government decided to dump U.S. Treasuries? Beijing would have to buy something with the proceeds of its sales. As a practical matter, it would have to buy debt denominated in pounds, euros, and yen. The values of those currencies would then skyrocket. London, Brussels, and Tokyo would then have to try to depress the values of their currencies, which means they would have to buy .  .  . dollars. In short, there would be a great circular flow of cash in the world's currency and debt markets.

There would be turmoil in those markets, but it would not last long beyond the time the Chinese ended their dollar dump. And we would end up in just the same place that we are now, except that our friends, instead of a potential adversary, would be holding our debt. Global markets are still deep and flexible and can handle just about anything. The fact that Beijing has not employed its so-called nuclear weapon is an indication that the Chinese know it is not, as a practical matter, usable.

And the Chinese realize something else. They have been, over the last two decades, the biggest beneficiary of the dollar-based international financial system that Washington maintains. If the dollar were dethroned, there would be turmoil in global markets. That would, in all probability, lead to a reduction in global commerce. And should Beijing get its wish and the renminbi become the world's reserve currency, its value would surely appreciate, thereby choking off China's export economy. A recent estimate says the renminbi is undervalued by about 40 percent against the dollar.

Hillary Clinton once said we can't "get tough" with our Chinese bankers. She's wrong. We can.

Gordon G. Chang is the author of The Coming Collapse of China.

MORE CHINA INSIGHT HERE

Page last updated at 11:31 GMT, Friday, 26 June 2009 12:31 UK
Detail from a dollar bill
The dollar has been the world's reserve currency for decades

China argues to replace US dollar
China's central bank has reiterated its call for a new reserve currency to replace the US dollar.

The report from the People's Bank of China (PBOC) said a "super-sovereign" currency should take its place.

Central bank chief Zhou Xiaochuan has loudly led calls for the dollar to be replaced during the financial crisis.

The bank report called for more regulation of the countries that issue currencies that underpin the global financial system.

"An international monetary system dominated by a single sovereign currency has intensified the concentration of risk and the spread of the crisis," the Chinese central bank said.

The dollar fell after the report was released. The US currency dropped 1% against the euro to $1.4088, and declined 0.8% versus the British pound to $1.6848.

SDRs

Mr Zhou caused a stir earlier this year when he said the dollar could eventually be replaced as the world's main reserve currency by the Special Drawing Right (SDR), which was created as a unit of account by the IMF in 1969.

CURRENCY RESERVES
Foreign currency held by a government or a central bank
Used to pay foreign debt obligations or influence exchange rates
The dollar is viewed as the world's reserve currency as the vast majority of reserves are held in the US currency
Smaller amounts are held in euros, pounds and yen

The PBOC said in the report that not only should the world adopt the SDR, but that the IMF should be entrusted with managing a portion of its member countries' foreign currency reserves.

"To avoid intrinsic shortcomings in using a sovereign currency as a reserve currency, we need to create an international reserve currency that is divorced from sovereign states and can maintain a stable value over the long term," the PBOC report said.

It also issued some veiled criticism of the US policies, saying that one of the major issues was that it was difficult to balance the needs of domestic politics with the requirements of being the world's reserve currency.

"The economic development model of debt-based consumption is most difficult to sustain," the PBOC said.

Russian President Dmitry Medvedev recently joined Mr Zhou in saying it was time to consider an alternative benchmark currency for international debt.

But Russian finance minister Alexei Kudrin then said "it's too early to speak of an alternative".




Page last updated at 07:05 GMT, Monday, 15 June 2009 08:05 UK
Alexei Kudrin
Mr Kudrin said the US dollar's reserve status was safe

Dollar's reserve status 'is safe'
The dollar has risen after Russian finance minister Alexei Kudrin said it would not be replaced as the world's reserve currency in the near future.

Earlier in the week, Russian President Dmitry Medvedev and Chinese central bank governor Zhou Xiaochuan had both questioned the dollar's status.

They had said it was time to consider an alternative benchmark currency for international debt.

But Mr Kudrin said "it's too early to speak of an alternative".

His remarks came ahead of a summit of leaders of Russia, China, India and Brazil on Tuesday in the Russian city of Yekaterinburg.

A Kremlin spokesman said on Sunday that the summit would not be discussing the possibility of a new global reserve currency.

"We will speak more about the possible ways to reform international financial institutions," he said.

The dollar was up 0.61 of a euro cent at 0.7197 euros and up 0.38 pence at £0.6119 (making one pound worth $1.63438).






Page last updated at 23:41 GMT, Monday, 15 June 2009 00:41 UK
By Katie Hunt
Business reporter, BBC News

Roubles being printed
China and Russia fear the value of their dollar holdings may fall

Dollar poses dilemma for Bric countries
Brazil, Russia, India and China, collectively known as the Bric countries, are holding their first formal summit in the Russian city of Yekaterinburg.

On the agenda is the role of the dollar and its status as the world's dominant currency.

China, Russia and, to a lesser extent, Brazil have expressed a desire to see the dollar one day replaced as the world's main trading currency.

And fears that these big holders of dollar assets may be looking to switch from the US currency have unsettled financial markets and US politicians.

"Although China's call for a new reserve currency is premature, it is legitimate," says Shujie Yao, a professor of economics at the School of Contemporary Chinese Studies at the University of Nottingham.

Stir

Chinese and Russian officials have questioned the dollar's status as the dominant currency on several occasions in recent months.

Brazil has also expressed concern although India remains less active on this front.

CURRENCY RESERVES
Foreign currency held by a government or a central bank
Used to pay foreign debt obligations or influence exchange rates
The dollar is viewed as the world's reserve currency as the vast majority of reserves are held in the US currency
About 90% of all foreign exchange transactions involve the dollar

China's central bank governor caused a stir in March when he said the US dollar should be replaced as the world's largest reserve currency by the Special Drawing Right (SDR) - a unit of account issued by the International Monetary Fund.

And Russian President Dmitry Medvedev said at the beginning of this month that the idea of a "supranational currency" should be discussed at the Bric summit.

These concerns have in part led to a decline in the dollar against other major currencies in recent months and sent jitters through the market for US government debt.

'Substantial impact'

As two of the world's biggest holders of US dollar assets, China and Russia fear that the steps that the US is taking to boost its economy and help it recover from the financial crisis could undermine the value of the US currency.

BRIC COUNTRIES
Brazil, Russia, India, China
Account for more than 13% of world economy
Account for 40% of world population
Term 'Bric' coined by investment bank Goldman Sachs

"If you own trillions of dollar assets, the last thing you want is any more dollars being printed," says Simon Derrick, currency strategist at Bank of New York Mellon.

"A 10% fall in the dollar has, in theory, a substantial impact on China's spending power," he adds.

China and Russia have already taken some small steps to diversify their currency reserves away from the dollar:

  • China has made arrangements with six countries worth 650bn yuan ($95bn) that allow trade to be conducted in renminbi rather than dollars
  • China and Russia have said they will buy bonds to be issued by the IMF
  • Data released on Monday showed that both China and Russia had trimmed their holdings of US government bonds in April.

But analysts say the Bric countries are unlikely to mount a real challenge to the dollar's supremacy.

Any concrete suggestion of a wholesale switch away from the dollar would dramatically undermine the value of their own reserves.

"They are expressing their frustration but there's little they can really do about it. They can only take steps on the margin," says Jan Randolph, head of sovereign risk analysis at IHS Global Insight.

Charm offensive

These developments have not gone unnoticed in the US.

President Hu Jintao arrives in the Ural Mountains city of Yekaterinburg, Russia
China is uneasy over its vast holdings of dollars

A weaker dollar and rising government bond yields can make it more expensive for the US government to borrow money.

This ultimately could lead to problems in financing the measures taken to help the US economy recover.

To address these concerns, US Treasury Secretary Timothy Geithner visited China at the end of May to give assurance over the safety of dollar assets, and met with his Russian counterpart over the weekend at the sidelines of the G8 finance ministers meeting.

His charm offensive appears to be working, at least for now.

The dollar rose on Monday after Russian Finance Minister Alexei Kudrin said it would not be replaced as the world's reserve currency in the near future and China's vice foreign minister Ha Yafei has assured the US that "nobody is talking about dumping the US dollar".

China and Russia may now have decided that it is self-defeating to make comments that undermine the value of the dollar and thus the value of their own reserves, says Mr Derrick at Bank of New York Mellon.

But this does little to alter the basic unease Russia and China feel over their vast holdings of dollars.

"While officials may feel that it is appropriate to provide verbal support for the dollar, it will ultimately be their actions that matter," says Mr Derrick.



Page last updated at 09:49 GMT, Tuesday, 24 March 2009
Yuan and dollar notes
Reform of the financial system is on top of the agenda at the G20 summit

China suggests switch from dollar
China's central bank has called for a new global reserve currency run by the International Monetary Fund to replace the US dollar.

Central bank governor Zhou Xiaochuan did not explicitly mention the dollar, but said the crisis showed the dangers of relying on one currency.

With the world's largest currency reserves of $2tn, China is the biggest holder of dollar assets.

Its leaders have often complained about the dollar's volatility.

China has long been uneasy about relying on the dollar for trade and to store its reserves and recently expressed concerns that Washington's efforts to rescue the US economy could erode the value of the currency.

His speech was, unusually, published in both Chinese and English, signalling it was intended for an international audience.

CURRENCY RESERVES
Foreign currency held by a government or a central bank
Used to pay foreign debt obligations or influence exchange rates
The dollar is viewed as the world's reserve currency as the vast majority of reserves are held in the US currency
Smaller amounts are held in euros, pounds and yen

"The outbreak of the crisis and its spillover to the entire world reflected the inherent vulnerabilities and systemic risks in the existing international monetary system," said Mr Zhou in an essay on the People's Bank of China website.

Mr Zhou said the primacy of the US currency in the financial system had led to increasingly frequent crises since the collapse in the early 1970s of the system of fixed exchange rates.

On Tuesday, the dollar weakened against most major currencies following the announcement of a US plan to buy up toxic debt.

'Light in tunnel'

Mr Zhou said the dollar could eventually be replaced as the world's main reserve currency by the Special Drawing Right (SDR), which was created as a unit of account by the IMF in 1969.

"The role of the SDR has not been put into full play, due to limitations on its allocation and the scope of its uses," he said.

"However, it serves as the light in the tunnel for the reform of the international monetary system."

The essay comes before the G20 summit in London on 2 April, at which reform of the international financial system is top of the agenda.

"This confirms that China intends to play fully its role of global economic and political power at the next G20 summit," said Sebastien Barbe, an analyst at French financial service firm Calyon in Hong Kong.


The Reckoning: Dollar Shift: Chinese Pockets Filled as Americans’ Emptied
NYTIMES
By MARK LANDLER
December 26, 2008
“Usually it’s the rich country lending to the poor. This time, it’s the poor country lending to the rich.”

— Niall Ferguson


WASHINGTON — In March 2005, a low-key Princeton economist who had become a Federal Reserve governor coined a novel theory to explain the growing tendency of Americans to borrow from foreigners, particularly the Chinese, to finance their heavy spending.

The problem, he said, was not that Americans spend too much, but that foreigners save too much. The Chinese have piled up so much excess savings that they lend money to the United States at low rates, underwriting American consumption.

This colossal credit cycle could not last forever, he said. But in a global economy, the transfer of Chinese money to America was a market phenomenon that would take years, even a decade, to work itself out. For now, he said, “we probably have little choice except to be patient.”

Today, the dependence of the United States on Chinese money looks less benign. And the economist who proposed the theory, Ben S. Bernanke, is dealing with the consequences, having been promoted to chairman of the Fed in 2006, as these cross-border money flows were reaching stratospheric levels.

In the past decade, China has invested upward of $1 trillion, mostly earnings from manufacturing exports, into American government bonds and government-backed mortgage debt. That has lowered interest rates and helped fuel a historic consumption binge and housing bubble in the United States.  China, some economists say, lulled American consumers, and their leaders, into complacency about their spendthrift ways.

“This was a blinking red light,” said Kenneth S. Rogoff, a professor of economics at Harvard and a former chief economist at the International Monetary Fund. “We should have reacted to it.”

In hindsight, many economists say, the United States should have recognized that borrowing from abroad for consumption and deficit spending at home was not a formula for economic success. Even as that weakness is becoming more widely recognized, however, the United States is likely to be more addicted than ever to foreign creditors to finance record government spending to revive the broken economy.

To be sure, there were few ready remedies. Some critics argue that the United States could have pushed Beijing harder to abandon its policy of keeping the value of its currency weak — a policy that made its exports less expensive and helped turn it into the world’s leading manufacturing power. If China had allowed its currency to float according to market demand in the past decade, its export growth probably would have moderated. And it would not have acquired the same vast hoard of dollars to invest abroad.

Others say the Federal Reserve and the Treasury Department should have seen the Chinese lending for what it was: a giant stimulus to the American economy, not unlike interest rate cuts by the Fed. These critics say the Fed under Alan Greenspan contributed to the creation of the housing bubble by leaving interest rates too low for too long, even as Chinese investment further stoked an easy-money economy. The Fed should have cut interest rates less in the middle of this decade, they say, and started raising them sooner, to help reduce speculation in real estate.

Today, with the wreckage around him, Mr. Bernanke said he regretted that more was not done to regulate financial institutions and mortgage providers, which might have prevented the flood of investment, including that from China, from being so badly used. But the Fed’s role in regulation is limited to banks. And stricter regulation by itself would not have been enough, he insisted.

“Achieving a better balance of international capital flows early on could have significantly reduced the risks to the financial system,” Mr. Bernanke said in an interview in his office overlooking the Washington Mall.

“However,” he continued, “this could only have been done through international cooperation, not by the United States alone. The problem was recognized, but sufficient international cooperation was not forthcoming.”

The inaction was because of a range of factors, political and economic. By the yardsticks that appeared to matter most — prosperity and growth — the relationship between China and the United States also seemed to be paying off for both countries. Neither had a strong incentive to break an addiction: China to strong export growth and financial stability; the United States to cheap imports and low-cost foreign loans.

In Washington, China was treated as a threat by some people, but mostly because it lured away manufacturing jobs. Others argued that China’s heavy lending to this country was risky because Chinese leaders could decide to withdraw money at a moment’s notice, creating a panicky run on the dollar.  Mr. Bernanke viewed such international investment flows through a different lens. He argued that Chinese invested savings abroad because consumers in China did not have enough confidence to spend. Changing that situation would take years, and did not amount to a pressing problem for the Americans.

“The global savings glut story did us a collective disservice,” said Edwin M. Truman, a former Fed and Treasury official. “It created the idea that the world was doing it to us and we couldn’t do anything about it.”

But Mr. Bernanke’s theory fit the prevailing hands-off, pro-market ideology of recent years. Mr. Greenspan and the Bush administration treated the record American trade deficit and heavy foreign borrowing as an abstract threat, not an urgent problem.  Mr. Bernanke, after he took charge of the Fed, warned that the imbalances between the countries were growing more serious. By then, however, it was too late to do much about them. And the White House still regarded imbalances as an arcane subject best left to economists.

By itself, money from China is not a bad thing. As American officials like to note, it speaks to the attractiveness of the United States as a destination for foreign investment. In the 19th century, the United States built its railroads with capital borrowed from the British.  In the past decade, China arguably enabled an American boom. Low-cost Chinese goods helped keep a lid on inflation, while the flood of Chinese investment helped the government finance mortgages and a public debt of close to $11 trillion.

But Americans did not use the lower-cost money afforded by Chinese investment to build a 21st-century equivalent of the railroads. Instead, the government engaged in a costly war in Iraq, and consumers used loose credit to buy sport utility vehicles and larger homes. Banks and investors, eagerly seeking higher interest rates in this easy-money environment, created risky new securities like collateralized debt obligations.

“Nobody wanted to get off this drug,” said Senator Lindsey Graham, the South Carolina Republican who pushed legislation to punish China by imposing stiff tariffs. “Their drug was an endless line of customers for made-in-China products. Our drug was the Chinese products and cash.”

A New Economic Dance

The United States has been here before. In the 1980s, it ran heavy trade deficits with Japan, which recycled some of its trading profits into American government bonds.

At that time, the deficits were viewed as a grave threat to America’s economic might. Action took the form of a 1985 agreement known as the Plaza Accord. The world’s major economies intervened in currency markets to drive down the value of the dollar and drive up the Japanese yen.

The arrangement did slow the growth of the trade deficit for a time. But economists blamed the sharp revaluation of the Japanese yen for halting Japan’s rapid growth. The lesson of the Plaza Accord was not lost on China, which at that time was just emerging as an export power.

China tied itself even more tightly to the United States than did Japan. In 1995, it devalued its currency and set a firm exchange rate of roughly 8.3 to the dollar, a level that remained fixed for a decade.

During the Asian financial crisis of 1997-98, China clung firmly to its currency policy, earning praise from the Clinton administration for helping check the spiral of devaluation sweeping Asia. Its low wages attracted hundreds of billions of dollars in foreign investment.

By the early part of this decade, the United States was importing huge amounts of Chinese-made goods — toys, shoes, flat-screen televisions and auto parts — while selling much less to China in return.

“For consumers, this was a net benefit because of the availability of cheaper goods,” said Lawrence Meyer, a former Fed governor. “There’s no question that China put downward pressure on inflation rates.”

But in classical economics, that trade gap could not have persisted for long without bankrupting the American economy. Except that China recycled its trade profits right back into the United States.

It did so to protect its own interests. China kept its banks under tight state control and its currency on a short leash to ensure financial stability. It required companies and individuals to save in the state-run banking system most foreign currency — primarily dollars — that they earned from foreign trade and investment.

As foreign trade surged, this hoard of dollars became enormous. In 2000, the reserves were less than $200 billion; today they are about $2 trillion.

Chinese leaders chose to park the bulk of that in safe securities backed by the American government, including Treasury bonds and the debt of Fannie Mae and Freddie Mac, which had implicit government backing.

This not only allowed the United States to continue to finance its trade deficit, but, by creating greater demand for United States securities, it also helped push interest rates below where they would otherwise have been. For years, China’s government was eager to buy American debt at yields many in the private sector felt were too low.

This financial and trade embrace between the United States and China grew so tight that Niall Ferguson, a financial historian, has dubbed the two countries Chimerica.

‘Tiptoeing’ Around a Partner

Being attached at the hip was not entirely comfortable for either side, though for widely differing reasons.

In the United States, more people worried about cheap Chinese goods than cheap Chinese loans. By 2003, China’s trade surplus with the United States was ballooning, and lawmakers in Congress were restive. Senator Graham and Senator Charles E. Schumer, Democrat of New York, introduced a bill threatening to impose a 27 percent duty on Chinese goods.

“We had a moment where we caught everyone’s attention: the White House and China,” Mr. Graham recalled.

At the People’s Bank of China, the central bank, a consensus was also emerging in late 2004: China should break its tight link to the dollar, which would make Chinese exports more expensive.

Yu Yongding, a leading economic adviser, pressed the case. The American trade and budget deficits were not sustainable, he warned. China was wrong to keep its currency artificially depressed and depend too much on selling cheap goods.

Proponents of revaluation in China argued that the country’s currency policies denied the fruits of prosperity to Chinese consumers. Beijing was investing their savings in low-yielding American government securities. And with a weak currency, they said, Chinese could not afford many imported goods.

The central bank’s English-speaking governor, Zhou Xiaochuan, was among those who favored a sizable revaluation.

But when Beijing finally acted to amend its currency policy in 2005, under heavy pressure from Congress and the White House, it moved cautiously. The renminbi, the Chinese currency, was allowed to climb only 2 percent. The Communist Party opted for only incremental adjustments to its economic model after a decade of fast growth.

Little changed: China’s exports kept soaring and investment poured into steel mills and garment factories.

But American officials eased the pressure. They decided to put more emphasis on encouraging Chinese consumers to spend more of their savings, which they hoped would eventually bring the two economies into better balance. On a tour of China, John W. Snow, the Treasury secretary at the time, even urged the Chinese to start using credit cards.

China kicked off its own campaign to encourage domestic consumption, which it hoped would provide a new source. But Chinese save with the same zeal that, until recently, Americans spent.

Shorn of the social safety net of the old Communist state, they squirrel away money to pay for hospital visits, housing or retirement. This accounts for the savings glut identified by Mr. Bernanke.

Privately, Chinese officials confided to visiting Americans that the effort was not achieving much.

“It is sometimes hard to change successful models,” said Robert B. Zoellick, who negotiated with the Chinese as a deputy secretary of state. “It is prototypically American to say, ‘This worked well, but now you’ve got to change it.’ ”

In Washington, some critics say too little was done. A former Treasury official, Timothy D. Adams, tried to get the I.M.F. to act as a watchdog for currency manipulation by China, which would have subjected Beijing to more global pressure.

Yet when Mr. Snow was succeeded as Treasury secretary by Henry M. Paulson Jr. in 2006, the I.M.F. was sidelined, according to several officials, and Mr. Paulson took command of China policy.

He was not shy about his credentials. As an investment banker with Goldman Sachs, Mr. Paulson made 70 trips to China. In his office hangs a watercolor depicting the hometown of Zhu Rongji, a forceful former prime minister.

“I pushed very hard on currency because I believed it was important for China to get to a market-determined currency,” Mr. Paulson said in an interview. But he conceded he did not get what he wanted.

In late 2006, Mr. Paulson invited Mr. Bernanke to accompany him to Beijing. Mr. Bernanke used the occasion to deliver a blunt speech to the Chinese Academy of Social Sciences, in which he advised the Chinese to reorient their economy and revalue their currency.

At the last minute, however, Mr. Bernanke deleted a reference to the exchange rate being an “effective subsidy” for Chinese exports, out of fear that it could be used as a pretext for a trade lawsuit against China.

Critics detected a pattern. They noted that in its twice-yearly reports to Congress about trading partners, the Treasury Department had never branded China a currency manipulator.

“We’re tiptoeing around, desperately trying not to irritate or offend the Chinese,” said Thea M. Lee, public policy director of the A.F.L.-C.I.O. “But to get concrete results, you have to be confrontational.”

An Embrace That Won’t Let Go

For China, too, this crisis has been a time of reckoning. Americans are buying fewer Chinese DVD players and microwave ovens. Trade is collapsing, and thousands of workers are losing their jobs. Chinese leaders are terrified of social unrest.

Having allowed the renminbi to rise a little after 2005, the Chinese government is now under intense pressure domestically to reverse course and depreciate it. China’s fortunes remain tethered to those of the United States. And the reverse is equally true.

In a glassed-in room in a nondescript office building in Washington, the Treasury conducts nearly daily auctions of billions of dollars’ worth of government bonds. An old Army helmet sits on a shelf: as a lark, Treasury officials have been known to strap it on while they monitor incoming bids.

For the past five years, China has been one of the most prolific bidders. It holds $652 billion in Treasury debt, up from $459 billion a year ago. Add in its Fannie Mae bonds and other holdings, and analysts figure China owns $1 of every $10 of America’s public debt.

The Treasury is conducting more auctions than ever to finance its $700 billion bailout of the banks. Still more will be needed to pay for the incoming Obama administration’s stimulus package. The United States, economists say, will depend on the Chinese to keep buying that debt, perpetuating the American habit.

Even so, Mr. Paulson said he viewed the debate over global imbalances as hopelessly academic. He expressed doubt that Mr. Bernanke or anyone else could have solved the problem as it was germinating.

“One lesson that I have clearly learned,” said Mr. Paulson, sitting beneath his Chinese watercolor. “You don’t get dramatic change, or reform, or action unless there is a crisis.”

David Barboza contributed reporting from Shanghai, and Keith Bradsher from Hong Kong.

Just a thought about one of the underpinnings of a free society...and another.
MediaNews Sees Bad Timing on Newspapers, Not Bad Bets
NYTIMES
By RICHARD PÉREZ-PEÑA
December 15, 2008

SAN JOSE — Dean Singleton expanded his newspaper empire at the worst possible time, in the worst part of the country he could have chosen, and he has been paying the price ever since in plummeting advertising and shrinking papers. Yet somehow, even in today’s adverse climate, he professes optimism.

In 2006 and 2007, as prices for newspapers were peaking, Mr. Singleton’s company, the MediaNews Group, bought this city’s daily, The Mercury News, and more than 30 smaller San Francisco Bay Area papers. He gambled his company on California just as the bottom was about to fall out for newspapers, especially here.

“In retrospect, the timing was not good,” said Mr. Singleton, the head of and a major shareholder in the company, which is privately held. “But in our business, you buy newspapers when they’re for sale. If we could have foreseen the current economic downturn in the state, it might have changed our views, but we couldn’t foresee that.”

The news about his industry seems to get worse by the day. Last week, the Tribune Company filed for bankruptcy protection. And Moody’s Investors Service said that MediaNews was approaching the point where its debt, almost $1 billion, would be nine times its annual earnings before interest, taxes, depreciation and amortization — technically putting the company in default.

MediaNews’s credit rating is far below investment grade, indicating a high risk of actual default, but Mr. Singleton insisted that the debt was manageable. He said that MediaNews’s primary lender, the Hearst Corporation, was also a major shareholder, with a significant interest in keeping MediaNews afloat.

“I don’t see any other large newspaper company in danger of following Tribune,” which was much more leveraged than its peers, Mr. Singleton said.

In a rare burst of good news for him, new industry miseries could work to his benefit — outside of California — by weakening or eliminating competitors to his Denver Post and Pioneer Press in St. Paul.

The E. W. Scripps Company recently put The Rocky Mountain News up for sale and said the paper might close; and The Star Tribune of Minneapolis, which has defaulted on its debts, said it needed to cut $30 million in costs and win concessions from its unions.

MediaNews had a lot of company in buying newspapers just as revenue began to collapse, for prices that, even then, analysts warned were inflated. The McClatchy Company bought Knight Ridder, the Tribune Company bought all its stock to go private, private investors bought the newspapers in Philadelphia and Minneapolis, and there were many smaller deals. All those buyers are suffering now, and newspapers cannot find buyers even at a fraction of the prices offered two years ago.

Despite the risks, Mr. Singleton contends that in the long run, California — particularly the Bay Area — is the place to be. “I have no doubt that The Mercury News’s revenue base will perform better when things turn around than almost any newspaper in the country,” he said.

Others are not so sure. “The Bay Area has been the canary in the newspaper coal mine, and that was recognized a long time ago by a lot of people,” said Ken Doctor, a newspaper analyst at the firm Outsell. “The impact of the Internet has been heavier here and earlier here than anywhere else in the country.”

Sites like Craigslist and eBay, which have long fueled the migration of advertising to the Internet, began in the Bay Area, and are more entrenched there than in any other part of the country.

Already known for squeezing costs as hard as anyone in the industry, Mr. Singleton and his team have cut spending at a furious pace, trying to keep pace with tumbling revenue. His detractors among analysts and journalists concede that in this market, any owner would have to make deep cuts. But they say that he was already inclined to a slash-and-burn approach that is little more than a prescription for having the papers do steadily less, and do it less well.

“There’s no newspaper in the country that I know of that’s not suffering,” said John McManus, a journalism professor at San Jose State University. “But Dean Singleton has hollowed out The Mercury News.”

The Mercury News, the Silicon Valley paper that was long considered one of the nation’s best, began shrinking years before MediaNews took over, under the now-dissolved Knight Ridder chain. The news staff, from a high of more than 400 people early in this decade, has fallen below 150, producing a much slimmer, more locally focused paper.

It no longer has a movie reviewer. The science and book sections are gone. Most national and international news comes from wire services.

A business section that was one of the nation’s biggest has shrunk by about two-thirds in the face of competition in its bread-and-butter field — technology — from Web sites like CNet and TechCrunch. Matt Marshall, a reporter covering Silicon Valley’s venture capital scene, left The Mercury News and has his own Web site, VentureBeat, covering much the same ground.

“My philosophy on pretty much everything these days is born of pure necessity,” said Bud Geracie, the acting sports editor. “There’s no grand plan; it’s how we get through today.”

Dave Butler, the executive editor, acknowledged that the paper no longer had the ambitions it once did. Now, he said, “we’re protecting the core mission, which is good, hard local news and information.”

Ownership changes and disputes over the direction of the paper have contributed to rapid turnover in the top ranks. The Mercury News has had six publishers and four executive editors in this decade.

Early this year, Mr. Butler’s predecessor, Carole Leigh Hutton, was forced out after proposing design changes in an attempt to attract readers. Just after her ouster, a former publisher, George Riggs, who had come to head MediaNews’s California operations, resigned.

MediaNews, a national chain based in Denver, has been concentrating on California since the 1990s. It built two extensive networks, in the Bay Area and in Southern California, with dozens of small suburban papers and a few larger ones like The Oakland Tribune and The Los Angeles Daily News.

But a complex set of deals in 2006 and 2007 greatly increased the company’s California presence. They gave Mr. Singleton control of his two largest California papers, The Mercury News and the nearby Contra Costa Times; a string of small daily and weekly Bay Area papers; and The Daily Breeze, near Los Angeles.

Mr. Singleton, 57, has assembled what was intended as his greatest achievement, an arc of papers around the Bay, dominating most of the region, with the Hearst Corporation’s troubled San Francisco Chronicle in the middle.

“We do make money, but I couldn’t get into how much,” said Mac Tully, publisher of The Mercury News. “We’re revenue-challenged, no question.” Mr. Singleton said much the same about the company as a whole.

The company does not publicly report financial data, but MediaNews executives acknowledge that its revenues, like the entire industry’s, have fallen sharply. Last summer, the company negotiated new terms with its creditors, and paid down some debts.

“We still have more leverage than we wish we had,” Mr. Singleton said. I don’t know if we bought enough room for the long term or not, but we certainly believe we did.”

At the peak of the dot-com boom, The Mercury News had more than $100 million a year in help-wanted classified ads; this year, executives say, the figure will be around $10 million.

The paper’s weekday circulation, 224,000, is 20 percent below its 1990s high — a fairly typical decline for the industry.

It serves a fast-growing region, Santa Clara County, but immigration has driven that growth, making a tough market for an English-language paper. Half the adults in the county speak a language other than English at home, the Census Bureau reports, one of the highest levels of that phenomenon in the country.

Many current and former Mercury News executives say that a lack of investment by Knight Ridder and MediaNews have given the paper a fairly ordinary Web site that has been slow to adopt practices that keep readers coming back many times a day, like publishing articles online well before they appear in print, updating them frequently, blogging and posting videos.

“The answer for newspapers has to lie in building their Web sites better and better, and promote, promote, promote,” said Mr. Riggs, who was the Mercury News publisher under both companies. “We haven’t seen that.”

Mr. Butler, the editor, said that with money tight, Web improvements have to wait. “Until or unless we see that those things pay for themselves, we make a serious mistake in focusing too much on that,” he said.

He said that even in the heart of Silicon Valley, until recently his newsroom used a 14-year-old computer system that was incompatible with those at nearby MediaNews papers.

“And this building is pretty rundown,” he said, waving his arm across a sprawling newsroom where some employees are surrounded by empty desks. The dinginess is made plain on his unadorned office walls, where lighter-colored rectangles show where pictures used to hang.

In October, the company announced that it planned to sell the building and move to smaller quarters. This is a terrible time to be selling real estate — or much of anything — in the Bay Area, but executives say no deal would be complete until 2010, and by then everything might have changed.

“California has always been bigger than life, in the upturns and the downturns,” Mr. Singleton said. “This thing will turn around.”

Ilinois Threatens Bank Over Sit-In

NYTIMES
By MONICA DAVEY
December 9, 2008

CHICAGO — Illinois will no longer do business with Bank of America until the bank restores credit to the shuttered factory here where workers are continuing their sit-in, Gov. Rod R. Blagojevich announced Monday.

Executives at the plant, Republic Windows and Doors, which is on the city’s North Side, have said they need the restoration of their line of credit, which the bank canceled last week, to enable them to pay workers severance and vacation time owed to them.

“During these times of economic turmoil, we must ensure that workers’ rights are protected,” Governor Blagojevich said. He said the Illinois Department of Labor will file a complaint if negotiations between the factory’s owners, the workers’ union and Bank of America officials, expected later this afternoon, are not resolved rapidly.

“Families are already struggling to keep afloat,” the governor said, in a release issued by his office. “I hope that the company will be motivated to exhaust all resources to stay open. We should be putting people to work during this difficult economic time — not sending them to the unemployment line.”

Governor Blagojevich’s announcement came after President-Elect Barack Obama’s defense of the workers Sunday, in which Mr. Obama said the company should “follow through on its commitment” to pay them.

The workers, who were laid off last Friday, continued their sit-in for the fourth day Monday, as they awaited the meeting, which was to be held downtown. The meeting was the first sign of progress in the peaceful, yet dramatic labor situation that has captured the attention of a nation reeling from the recession and the loss of more than 600,000 manufacturing jobs.

For years the workers had assembled vinyl windows and sliding doors for Republic; they said they would not leave, even after company officials announced the factory was closing.

The workers, members of Local 1110 of the United Electrical, Radio and Machine Workers of America, said they were owed vacation and severance pay and were not given the 60 days of notice generally required by federal law when companies make layoffs. Lisa Madigan, the attorney general of Illinois, said her office was investigating, and representatives from her office interviewed workers at the plant on Sunday.

Some of the plant’s 250 workers stayed all night, all weekend, in what they were calling an occupation of the factory. Their sharpest criticisms were aimed at their former bosses, who they said gave them only three days’ notice of the closing, and the company’s creditors. But their anger stretched broadly to the government’s costly corporate bailout plans, which, they argued, had forgotten about regular workers.

“They want the poor person to stay down,” said Silvia Mazon, 47, a mother of two who worked as an assembler here for 13 years and said she had never before been the sort to march in protests or make a fuss. “We’re here, and we’re not going anywhere until we get what’s fair and what’s ours. They thought they would get rid of us easily, but if we have to be here for Christmas, it doesn’t matter.”

Company officials, who were no longer at the factory, did not return telephone or e-mail messages. A meeting between the owners and workers is scheduled for Monday. The company, which was founded in 1965 and once employed more than 700 people, had struggled in recent months as home construction dipped, workers said.

Still, as they milled around the factory’s entrance this weekend, some workers said they doubted that the company was really in financial straits, and they suggested that it would reopen elsewhere with cheaper costs and lower pay. Others said managers had kept their struggles secret, at one point before Thanksgiving removing heavy equipment in the middle of the night but claiming, when asked about it, that all was well.

Workers also pointedly blamed Bank of America, a lender to Republic Windows, saying the bank had prevented the company from paying them what they were owed, particularly for vacation time accrued.

“Here the banks like Bank of America get a bailout, but workers cannot be paid?” said Leah Fried, an organizer with the union workers. “The taxpayers would like to see that bailout go toward saving jobs, not saving C.E.O.’s.”

In a statement issued Saturday, Bank of America officials said they could not comment on an individual client’s situation because of confidentiality obligations. Still, a spokeswoman also said, “Neither Bank of America nor any other third party lender to the company has the right to control whether the company complies with applicable laws or honors its commitments to its employees.”

Inside the factory, the “occupation” was relatively quiet. The Chicago police said that they were monitoring the situation but that they had had no reports of a criminal matter to investigate.

About 30 workers sat in folding chairs on the factory floor. (Reporters and supporters were not allowed to enter, but the workers could be observed through an open door.) They came in shifts around the clock. They tidied things. They shoveled snow. They met with visiting leaders, including Representatives Luis V. Gutierrez and Jan Schakowsky, both Democrats from Illinois, and the Rev. Jesse Jackson.

Throughout the weekend, people came by with donations of food, water and other supplies.

The workers said they were determined to keep their action — reminiscent, union leaders said, of autoworkers’ efforts in Michigan in the 1930s — peaceful and to preserve the factory.

“The fact is that workers really feel like they have nothing to lose at this point,” Ms. Fried said. “It shows something about our economic times, and it says something about how people feel about the bailout.”

Until last Tuesday, many workers here said, they had no sense that there was any problem. Shortly before 1 p.m. that day, workers were told in a meeting that the plant would close Friday, they said. Some people wept, others expressed fury.

Many employees said they had worked in the factory for decades. Lalo Muñoz, who was among those sleeping over in the building, said he arrived 34 years ago. The workers — about 80 percent of them Hispanic, with the rest black or of other ethnic and national backgrounds — made $14 an hour on average and received health care and retirement benefits, Ms. Fried said.

“This never happens — to take a company from the inside,” Ms. Mazon said. “But I’m fighting for my family, and we’re not going anywhere.”

I took economics with Raymond Saulnier...any relation?
Economy Is Only Issue for Michigan Governor
NYTIMES
By MONICA DAVEY and SUSAN SAULNY
November 15, 2008

LANSING, Mich. — This is what a day looks like for Jennifer M. Granholm, the governor of Michigan, the state that sits, miserably, at the leading edge of the nation’s economic crisis.

Morning: Rev up government workers and ministers at a huge conference in Detroit to cope with expanding signs of poverty. Afternoon: Tell a room crushed with reporters here, in the state capital, why a federal bailout is essential for the Big Three automakers, who are also, of course, residents of her state. Evening: Pack for Israel and Jordan, where Ms. Granholm hopes to persuade companies that work with wireless electricity, solar energy and electric cars to bring their jobs to Michigan.

Whatever else Ms. Granholm, a Democrat in her second term, might once have dreamed of tackling as a governor (she barely seems to recall other realms of aspiration now), the economy is nearly all she has found herself thinking about, talking about, fighting about over the last six years. And Michigan, which has been hemorrhaging jobs since before 2001 and was once mainly derided in the rest of the nation as a “single-state recession,” now looks like an ominous sketch of just how bad things may get.

“This has been six straight years of jobs, jobs, jobs,” Ms. Granholm said, punctuating the word with three somber claps at her office table. Despite scathing critiques from some here who say she has failed to turn around Michigan’s woes, Ms. Granholm said in an interview that she still believed that her efforts to remake the state’s economy — in part by luring jobs that make something other than cars — would eventually overcome the steady stream of vanishing jobs.

“We were hoping it was going to be in 2009 where we’d see the balance tip, but with this financial meltdown and the challenges now in the auto industry obviously, I’m not sure whether that’s going to happen,” she said. “Probably not. But we’re going to still hammer away at it.”

She finds herself in the national spotlight more than ever. She is loudly pushing for the auto industry rescue while Michigan’s Congressional delegation works votes on Capitol Hill. President-elect Barack Obama has put her on his transition economic advisory board (an appointment her strongest critics here deride as ludicrous, akin to putting a tobacco executive on a health board).

Ms. Granholm, who played Sarah Palin in Senator Joseph R. Biden Jr.’s warm-ups for the vice-presidential debate and who is barred by term limits from seeking re-election in 2010, has been mentioned as someone Mr. Obama may appoint to his cabinet. It is a notion Ms. Granholm — long a Bush administration critic for what she describes as inconsistent enforcement of trade pacts and a lack of manufacturing policy — gently dismisses: “I really want to be governor when I have a partner in the White House.”

Her critics seem dismayed by the speculation. They blame her and the state’s business regulations and taxes, at least partly, for Michigan’s long list of dismal rankings among the states (No. 2 in unemployment; No. 5 in foreclosure starts; No. 51, including the District of Columbia, in attracting new residents). The governor’s approval ratings dropped to slightly less than 50 percent favorable last month from a high of near 70 percent in 2003.

“I fear if she has the president’s ear,” said Michael D. LaFaive, director of fiscal policy at the Mackinac Center for Public Policy, a research group in Midland, Mich., that advocates a free market. “There’s a reason people are fleeing the state, and it has much to do with the bad public policies this state has embraced over the last 6 to 12 years.”

But Ms. Granholm’s supporters say she has done all she could, given gloomy times brought on long before she arrived by monumental changes in the nation’s manufacturing, and, most of all, in the auto industry. As Ms. Granholm sees it, the state has responded by revamping just about everything — taxes, education, even the sorts of businesses it is seeking.

In her constant courting of companies in the United States and overseas, Ms. Granholm said she had focused on bringing home businesses that work with alternative energy (like wind turbines), domestic security (a field auto suppliers might easily move into), advanced manufacturing (like robotics) and life sciences.

The state has recently enacted a tougher, college-preparatory-style curriculum in its high schools. Its “No Worker Left Behind” retraining program depends on what jobs local employers say they actually need to fill. And this year, it began offering incentives to moviemakers in the hopes of building a “creative economy,” a concept, Ms. Granholm says, “we haven’t necessarily had since Motown days.”

In all of this, her efforts have brought more than 120,800 new jobs to the state since she took office in 2003, her office says. (Her staff noted those “direct” jobs were estimated to have brought two to three times as many new “indirect” jobs that cropped up around the others, and said state efforts had helped “retain” 233,000 jobs from companies that had hinted of leaving Michigan.)

Still, net losses since mid-2000 (and just for manufacturing jobs, since 1999) swamp the picture. Since June 2000, the state’s net job loss was more than 500,000; since Ms. Granholm took office, the net loss was 281,500.

“Sometimes leadership is planting trees under whose shade you’ll never sit,” she said. “It may not happen fully till after I’m gone. But I know that the steps we’re taking are the right steps.”

Jennifer Mulhern Granholm (she took the last name of her husband, Daniel, as her middle name and he did the same with her last name), 49, was born in Vancouver, British Columbia. She briefly considered an acting career and was once a contestant on “The Dating Game,” and graduated from University of California, Berkeley, and Harvard Law School. Eventually, she moved to Michigan. A former prosecutor, she was elected Michigan’s attorney general in 1998, then became the state’s first woman to be elected governor four years later. She has three children.

Even her critics praise Ms. Granholm’s political skills, her engaging speaking style, her ability to make even her most vocal opponents in the Legislature admit that they like her. But they say she started off as a nearly untested policy maker trying to solve an economic problem that would have challenged someone with far more experience.

“I think she’s a good politician, but at the same time, she’s not necessarily a great decision maker,” said Saul Anuzis, the state Republican Party chairman.

But Mark Schauer, the State Senate’s Democratic leader who was elected this month to Congress, pointed to a “hostile” Legislature — both chambers were controlled by Republicans until 2006 (and the Senate still is) — for a “lack of urgency” despite Ms. Granholm’s “focus and tenacity” on the economy.

In 2007, a contentious standoff over how to solve a more than $1.5 billion deficit in the state budget dragged on for months, finally ending in the face of a government shutdown and with tax increases — deeply difficult, Ms. Granholm said, but unavoidable.

This year, there were more distractions: For months, a scandal enveloped Kwame M. Kilpatrick, then the mayor of Detroit. Eventually, as Ms. Granholm began proceedings to determine if he should be removed, Mr. Kilpatrick resigned and pleaded guilty to felony charges — but not, she said, before more economic damage had been done, with conventions canceled and businesses not wanting to move to Detroit. “One crisis at a time,” she said in the interview.

For now, all eyes here are on whether Congress will provide $25 billion in emergency aid to the automakers, and whether lawmakers will do it soon enough, before some industry experts fear one of the Big Three may collapse. The mere possibility makes Ms. Granholm wince. The likely result, she said, would be catastrophic on residents, so many of whom work in the industry and all its offshoots.

“It would be such a huge, huge strain on our safety net,” she said. “It would be of double Katrina-like proportions. We would absolutely need assistance.”

But she said she felt confident that the aid would be granted. Still, she said, Michigan is a cautionary tale against putting a state’s entire hopes in a single industry.

“Now, we love our auto industry,” she said. “But if we had worked harder on diversifying this economy long ago, then if one of the legs of the stool starts to get wobbly, at least you’ve got three other legs to stand on.”

Paulson: Rescue Package Not for Automakers
NYTIMES
By THE ASSOCIATED PRESS
November 12, 2008
Filed at 12:19 p.m. ET

WASHINGTON (AP) -- Treasury Secretary Henry Paulson called autos a ''critical industry in this country'' on Wednesday but said the government's $700 billion financial rescue program wasn't designed to help automakers.

Asked about Democratic congressional leaders' plan to rush financial aid to the industry, Paulson cautioned that ''any solution has got to be leading to long-term viability'' for auto companies.  He said Congress could try to make funding more available to the auto industry as part of a $25 billion loan program approved in September to develop fuel-efficient vehicles.

House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid are pushing for something more sweeping to help the industry, which is suffering under the weight of poor sales, tight credit and a sputtering economy.  Pelosi said Tuesday she was confident that lawmakers meeting next week in a lameduck session would consider ''emergency and limited financial assistance'' for the auto industry under the $700 billion bailout measure that passed Congress in October. She urged the outgoing Bush administration to support a compromise.

''In order to prevent the failure of one or more of the major American automobile manufacturers ... Congress and the Bush administration must take immediate action,'' said Pelosi, D-Calif.

Reid, D-Nev., said that Democrats were ''determined to pass legislation that will save the jobs of millions'' as part of a postelection session. ''This will only get done if President Bush and Senate Republicans work with us in a bipartisan fashion, and I am confident they will do what is right for our economy,'' he said.

The Bush administration has concluded that the bailout bill that passed earlier does not allow loans to the auto industry.  White House spokeswoman Dana Perino said the companies had made business decisions ''over the years that have led to this situation, but we have gone as far as we can with the authority Congress has given in order to help industries.'' But she said the White House was open to helping the auto industry.

Lawmakers are expected to take up the issue when they return to the Capitol for a postelection session beginning next week.  Democratic leaders will need to convince some skeptical lawmakers who question whether a bailout would cause changes in the auto industry or simply lead to more handout requests from other industries.

''Once we cross the divide from financial institutions to individual corporations, truly, where would you draw the line?'' asked Sen. Jeff Sessions, R-Ala.

Michigan Gov. Jennifer Granholm said Wednesday that the crisis in the auto industry is urgent, arguing that ''the national economy rests on this.''

''This industry supports one in 10 jobs in the country,'' Granholm said Wednesday on CBS' ''Early Show.'' ''If this industry is allowed to fail, there would be a ripple effect throughout the nation.''

She added: ''This government decided that it was going to step in and throw $700 billion at the financial sector. We're just asking for a fraction of that.''

Pelosi said any assistance to the industry should include limits on executive compensation, rigorous government review authority and other taxpayer protections.  Her request for legislation came less than a week after General Motors Corp. and Ford Motor Co. posted bleak third-quarter earnings reports. GM, the nation's largest automaker, posted a $2.5 billion quarterly loss Friday and warned that it may run out of money by the end of the year without government aid.

''We're in a situation where there's a great unknown about what will happen,'' said Sen. Debbie Stabenow, D-Mich. ''And a great concern that at least one of the companies will find themselves in a situation where they cannot make it until January 20,'' when President-elect Obama is inaugurated.

GM spokesman Greg Martin said the automaker was ''ready to work with Congress and the administration to secure the immediate support we need to bridge the current economic crisis.''

Obama has urged the Bush administration to do more to help the industry and aides said he raised the issue with President Bush on Monday in an Oval Office meeting. Officials familiar with the conversation said the president replied he was open to the idea.

Congress approved legislation in late September to provide $25 billion in loans to domestic automakers and suppliers to upgrade factories to build more fuel-efficient vehicles. But the funding has stalled and supporters of the industry say it will not be sufficient to help the companies with their immediate financial problems.

Executives with GM, Ford and Chrysler LLC and the president of the United Auto Workers union pressed Pelosi and Reid to provide an immediate $25 billion loan to keep the companies operating and a separate $25 billion to help cover future health care obligations for retirees and their dependents.

Pelosi's statement did not specify the size of the aid package. She has tasked Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, to draft legislation, and a companion effort is under way in the Senate.
imes

Sen. Carl Levin, D-Mich., said lawmakers from his state are crafting legislation that would allow the auto industry to receive $25 billion in loans under the $700 billion bailout program.


Why is this graphic so grave?

Foreign demand for Treasury securities falls
YAHOO
By MARTIN CRUTSINGER, AP Economics Writer
Feb. 16, 2010

WASHINGTON – The government said Tuesday that foreign demand for U.S. Treasury securities fell by the largest amount on record in December with China reducing its holdings by $34.2 billion.

The reductions in holdings, if they continue, could force the government to make higher interest payments at a time that it is running record federal deficits.

The Treasury Department reported that foreign holdings of U.S. Treasury securities fell by $53 billion in December, surpassing the previous record of a $44.5 billion drop in April 2009.

The big drop in China's holdings meant that it lost the top spot in terms of foreign ownership of U.S. Treasuries, dropping to second place behind Japan.  Japan also reduced its holdings of U.S. Treasuries, cutting them by $11.5 billion to $768.8 billion in December, but that amount was still more than China's December total of $755.4 billion.

The $53 billion decline in holdings of Treasury securities came primarily from a drop in official government holdings, which fell by $52.3 billion. The holdings of foreign private investors fell by $700 million during the month of December.

For all of 2009, foreign holdings of U.S. Treasuries dipped by $500 million. In 2008, foreigners had increased their holdings of U.S. Treasuries by $456 billion as a global financial crisis triggered a flight to the safety of U.S. government debt.  That flight to safety had driven down the interest rates that the government was having to pay on its debt to record lows with rates on some short-term securities dipping into negative territory for brief periods.

The Obama administration on Feb. 1 released a new budget plan which projects that the deficit for this year will total a record $1.56 trillion, surpassing last year's record of $1.4 trillion deficit. The trillion-dollar-plus deficit have been caused by a deep recession, which has reduced government tax receipts, and the massive spending that has been undertaken to jump-start the economy and stabilize the financial system.

The administration has pledged to begin addressing the huge government deficits with Obama saying he will soon appoint a commission to recommend ways to trim future deficits.

Overall, the Treasury Department said that foreign net purchases of long-term securities totalted $63.3 billion in December, down from $126.4 billion in November. This category covers Treasury securities and private company bonds.

China's holdings are a result of the huge trade deficits the United States runs with China. The Chinese take the dollars Americans pay for Chinese products and invest them in Treasury securities and other dollar-denominated assets.

American manufacturers argue that China's huge dollar reserve reflect a strategy by the Chinese government to keep its currency artifically low against the dollar as a way to boost Chinese exports and dampen demand in China for American products.
Payback Time: Wave of Debt Payments Facing U.S. Government
NYTBy EDMUND L. ANDREWS
November 23, 2009

WASHINGTON — The United States government is financing its more than trillion-dollar-a-year borrowing with i.o.u.’s on terms that seem too good to be true.

But that happy situation, aided by ultralow interest rates, may not last much longer.

Treasury officials now face a trifecta of headaches: a mountain of new debt, a balloon of short-term borrowings that come due in the months ahead, and interest rates that are sure to climb back to normal as soon as the Federal Reserve decides that the emergency has passed.

Even as Treasury officials are racing to lock in today’s low rates by exchanging short-term borrowings for long-term bonds, the government faces a payment shock similar to those that sent legions of overstretched homeowners into default on their mortgages.

With the national debt now topping $12 trillion, the White House estimates that the government’s tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. Other forecasters say the figure could be much higher.

In concrete terms, an additional $500 billion a year in interest expense would total more than the combined federal budgets this year for education, energy, homeland security and the wars in Iraq and Afghanistan.

The potential for rapidly escalating interest payouts is just one of the wrenching challenges facing the United States after decades of living beyond its means.

The surge in borrowing over the last year or two is widely judged to have been a necessary response to the financial crisis and the deep recession, and there is still a raging debate over how aggressively to bring down deficits over the next few years. But there is little doubt that the United States’ long-term budget crisis is becoming too big to postpone.

Americans now have to climb out of two deep holes: as debt-loaded consumers, whose personal wealth sank along with housing and stock prices; and as taxpayers, whose government debt has almost doubled in the last two years alone, just as costs tied to benefits for retiring baby boomers are set to explode.

The competing demands could deepen political battles over the size and role of the government, the trade-offs between taxes and spending, the choices between helping older generations versus younger ones, and the bottom-line questions about who should ultimately shoulder the burden.

“The government is on teaser rates,” said Robert Bixby, executive director of the Concord Coalition, a nonpartisan group that advocates lower deficits. “We’re taking out a huge mortgage right now, but we won’t feel the pain until later.”

So far, the demand for Treasury securities from investors and other governments around the world has remained strong enough to hold down the interest rates that the United States must offer to sell them. Indeed, the government paid less interest on its debt this year than in 2008, even though it added almost $2 trillion in debt.

The government’s average interest rate on new borrowing last year fell below 1 percent. For short-term i.o.u.’s like one-month Treasury bills, its average rate was only sixteen-hundredths of a percent.

“All of the auction results have been solid,” said Matthew Rutherford, the Treasury’s deputy assistant secretary in charge of finance operations. “Investor demand has been very broad, and it’s been increasing in the last couple of years.”

The problem, many analysts say, is that record government deficits have arrived just as the long-feared explosion begins in spending on benefits under Medicare and Social Security. The nation’s oldest baby boomers are approaching 65, setting off what experts have warned for years will be a fiscal nightmare for the government.

“What a good country or a good squirrel should be doing is stashing away nuts for the winter,” said William H. Gross, managing director of the Pimco Group, the giant bond-management firm. “The United States is not only not saving nuts, it’s eating the ones left over from the last winter.”

The current low rates on the country’s debt were caused by temporary factors that are already beginning to fade. One factor was the economic crisis itself, which caused panicked investors around the world to plow their money into the comparative safety of Treasury bills and notes. Even though the United States was the epicenter of the global crisis, investors viewed Treasury securities as the least dangerous place to park their money.

On top of that, the Fed used almost every tool in its arsenal to push interest rates down even further. It cut the overnight federal funds rate, the rate at which banks lend reserves to one another, to almost zero. And to reduce longer-term rates, it bought more than $1.5 trillion worth of Treasury bonds and government-guaranteed securities linked to mortgages.

Those conditions are already beginning to change. Global investors are shifting money into riskier investments like stocks and corporate bonds, and they have been pouring money into fast-growing countries like Brazil and China.

The Fed, meanwhile, is already halting its efforts at tamping down long-term interest rates. Fed officials ended their $300 billion program to buy up Treasury bonds last month, and they have announced plans to stop buying mortgage-backed securities by the end of next March.

Eventually, though probably not until at least mid-2010, the Fed will also start raising its benchmark interest rate back to more historically normal levels.

The United States will not be the only government competing to refinance huge debt. Japan, Germany, Britain and other industrialized countries have even higher government debt loads, measured as a share of their gross domestic product, and they too borrowed heavily to combat the financial crisis and economic downturn. As the global economy recovers and businesses raise capital to finance their growth, all that new government debt is likely to put more upward pressure on interest rates.

Even a small increase in interest rates has a big impact. An increase of one percentage point in the Treasury’s average cost of borrowing would cost American taxpayers an extra $80 billion this year — about equal to the combined budgets of the Department of Energy and the Department of Education.

But that could seem like a relatively modest pinch. Alan Levenson, chief economist at T. Rowe Price, estimated that the Treasury’s tab for debt service this year would have been $221 billion higher if it had faced the same interest rates as it did last year.

The White House estimates that the government will have to borrow about $3.5 trillion more over the next three years. On top of that, the Treasury has to refinance, or roll over, a huge amount of short-term debt that was issued during the financial crisis. Treasury officials estimate that about 36 percent of the government’s marketable debt — about $1.6 trillion — is coming due in the months ahead.

To lock in low interest rates in the years ahead, Treasury officials are trying to replace one-month and three-month bills with 10-year and 30-year Treasury securities. That strategy will save taxpayers money in the long run. But it pushes up costs drastically in the short run, because interest rates are higher for long-term debt.

Adding to the pressure, the Fed is set to begin reversing some of the policies it has been using to prop up the economy. Wall Street firms advising the Treasury recently estimated that the Fed’s purchases of Treasury bonds and mortgage-backed securities pushed down long-term interest rates by about one-half of a percentage point. Removing that support could in itself add $40 billion to the government’s annual tab for debt service.

This month, the Treasury Department’s private-sector advisory committee on debt management warned of the risks ahead.

“Inflation, higher interest rate and rollover risk should be the primary concerns,” declared the Treasury Borrowing Advisory Committee, a group of market experts that provide guidance to the government, on Nov. 4.

“Clever debt management strategy,” the group said, “can’t completely substitute for prudent fiscal policy.”


Lawmakers: Unrealistic public is budget challenge
BLOOMBERG NEWS
By The Associated Press
By PAUL DAVENPORT - Dec 8, 2010

PHOENIX (AP) — Legislators from around the country said Wednesday that unrealistic public expectations are one of the challenges they face as states' budget troubles continue.

Many people's eyes glaze over when there's talk of state budget complexities, said Pennsylvania Rep. Dwight Evans. "The problem with the budget is that the people want (what) they're not willing to pay for. It's as simple as that."

Cash-short states have already cut spending, but lawmakers said it's not clear if the public will go along with more service cuts.

The state leaders spoke at a meeting of approximately 60 legislators and state fiscal officials that was held in conjunction with the National Conference of State Legislatures gathering in Phoenix. The NCSL released a report Wednesday on a 50-state survey that found improving economies are producing small increases in revenue.

But most states face projected budget gaps in the next fiscal year and many for years to come, the report said.

Long-term service reductions are "the new economic reality" but it could take time for the public to accept that, said Oregon state Sen. Richard Devlin, who recently stepped down as that state's Senate majority leader.

Utah state Rep. Ron Bigelow said there are years of budget cleanup work to do but only a short "window of opportunity" for lawmakers to trim more spending and consider tax increases before the public balks.

"They're going to say, 'Why can't you fix it?,'" Bigelow said.

Kansas Sen. John Vratil said his state's revenue was finally starting to rebound after three years of declines but that did not eliminate the need for more cuts.

"We're really faced with a dilemma in having to act against what we know is the position of the public because they also will violently oppose a tax increase," Vratil said. "And when you get right down to it, the time is going to have to come when the public realizes there's no free lunch and if you want services, you've got to pay for it."

A South Carolina legislator said the public's patience with budget cuts will wear thin and could even turn in a surprising direction.

If continued cuts pack classrooms with students and block admissions to nursing homes, "I'm predicting ... that the public will be lined up to my door demanding that we raise taxes," said state Sen. Hugh Leatherman.

Several lawmakers said it could be a decade before states' finances recover, with Arizona state Rep. John Kavanagh saying that state's revenue could recover in about five years but will need more time to repay the massive debt it's incurring.

Arizona lost a third of its revenue during the Great Recession.

"The public is not going to be happy because everybody want to have great schools, police all over the place and beautiful parks and buildings, but you can't pay for it," he said. "We may be a decade away from the good times."

Copyright © 2010 Associated Press. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

Economists warn against more aid
Washington Times
Stephen Dinan
Originally published 04:00 a.m., April 12, 2010, updated 04:29 a.m., April 12, 2010

States say they've been kept afloat during the economic downturn by critical federal aid, but, with stimulus money set to run out soon, a report from conservative economists argues that another infusion would postpone, and could worsen, states' eventual reckoning with troubled budgets.

Last year's stimulus bill designated hundreds of billions of dollars to states, either directly or indirectly. The aid peaked this year before dropping dramatically. States say they're still hurting, though, and Congress is trying to figure out how much more aid to extend, and for how long.

Chris Whatley, director of the Council of State Governments' Washington office, said the consensus is that Congress will provide higher Medicaid reimbursements to states for six months past the December expiration but that a broader round of spending to include education and other programs is unlikely.

"That's basically out the door," he said. "There are those who are certainly trying to revive it, but I don't know many in the state community who are counting on that."

Jonathan Williams, director of the tax and fiscal policy task force at the American Legislative Exchange Council, said continued federal aid will only feed "the do-something disease in Washington," where the federal government sees a problem and decides taxpayer money can help.

In a new report on states' fiscal stability, Mr. Williams and several other conservative economists said the stimulus amounted to a "get-out-of-jail-free card" for state lawmakers who let their budgets grow too fast while the economy was strong but were reluctant to make cuts during slimmer times.

"The recession should have been the wake-up call: Pull back on spending. Unfortunately, the stimulus money is interfering with this normal, albeit painful, corrective step to get states permanently back on more sustainable spending paths," they said in their report.

Part of the problem, Mr. Williams said, is that federal money comes with strings. For example, if states accepted primary and secondary education money, they were not allowed to make cuts in much of their school funding. In other instances, Mr. Williams said, states have imposed new taxes on doctors or patients at hospitals to qualify for more health care funding.

With the federal government already running a deficit, it is in essence borrowing against future taxpayers.

"It's kind of like using your MasterCard to pay off your Visa," Mr. Williams said. "The federal government can't give to states anything it hasn't already taken away from state taxpayers."

State officials argue, though, that they had to make painful cuts even with the federal aid.

Mr. Whatley said that aid ended up plugging between 30 percent and 40 percent of states' budget holes, leaving plenty of room that had to be made up either through higher taxes or spending cuts.

Stimulus funding for states was near $50 billion in fiscal 2009. The funding peaks this year at $108 billion and then drops to slightly more than $60 billion in 2011, according to Stateline.org. Money for education and health programs dominates in those three years.

Federal transfers generally account for about a quarter of states' total budgets. Under the stimulus, that portion rose to about a third of state spending.

Nick Johnson, director of the liberal-leaning Center on Budget and Policy Priorities' state fiscal project, said state revenues are slower to recover from recession, particularly with unemployment rates remaining high. That's because so much of state budgets go to safety-net programs such as Medicaid.

Higher federal Medicaid payments expire in December, and Mr. Johnson said there's no question that state revenues won't have improved dramatically by then.

That puts the fight back in Congress.

The House in December passed a bill that included $23 billion for state teachers, but the Senate has not followed suit.

House Appropriations Committee Chairman David R. Obey, Wisconsin Democrat, has said the federal government should not squander its help to states by cutting off funding now.

More than 100 House Democrats have signed on to co-sponsor the Local Jobs for America Act, which includes the $23 billion in state education money that the House already passed, plus $75 billion that states and localities would use for hiring.

"Local communities are having to choose between raising taxes to sustain essential services or firing more workers," said Rep. George Miller, California Democrat and chairman of the House Education and Labor Committee, who wrote the bill. "We should not ask students to forgo a year of education or tell families that their safety will be compromised because local governments have to lay off teachers and police officers."


Link to DEBT CEILING article re: U.S. Senators who voted "no" in 2006


From the New Haven REGISTER source for AP article from April 10, 2011

The Four National Debts
By Kevin D. Williamson
Posted on April 20, 2011 4:00 AM

As I have argued (repeatedly, endlessly, ad nauseam, I know!), our real national debt is not that $14.3 trillion we always hear about, but more like $140 trillion. Another thing to keep in mind: That $14.3 trillion is not just one national debt, but four of them.

There are two flavors of national debt: debt held by the public and intragovernmental debt. The first category — securities held by investors, basically — is the one we mostly worry about. (I worry about the other one, too, but that’s another story.) If I may be permitted to express it in its full glory, the debt held by the public as of April 15 amounts to $9,679,202,714,701.01. (Love, love, love that penny on the end — can’t say Treasury isn’t minding the details! Wasn’t it Ben Franklin who said, “Mind the pennies and the trillions will take care of themselves”? Or something like that?)

That debt held by the public is really four debts, because we have four main ways of financing our borrowing: Treasury bills, Treasury notes, Treasury bonds, and Treasury Inflation Protected Securities (TIPS). Bills are the shortest-term security, the attention-deficit-disorder case of the U.S. sovereign-debt world, maturing in one year or less. Notes, like liberal-arts graduates, mature in one to ten years, and bonds, like a mortgage (remember mortgages?), go from 20 to 30 years. TIPS are a mixed bag, in five-year, ten-year, and 30-year versions. TIPS are a relatively new thing, having been introduced in 1997. They’ve grown popular, from accounting for $33 billion of the national debt in their first year to $640 billion as of March 2011.

Now, when you’ve got $9,679,202,714,701.01 in debt floating around out there in the marketplace, and you’ve got S&P sort of frowning in a meaningful way at your ledger, and bond funds are wishing you the very best of British luck as they dump your debt and refuse to buy any more, but you just can’t help yourself and have to buy a shiny new windmill whenever you see one — in that sort of a situation, you might be keenly interested in how much of your debt is financed through short-term bills vs. how much is locked into 20- or 30-year rates with the long bond. We are starting to have that discussion just now. And it ain’t pretty: The average maturity is 59 months, and about $1.7 trillion of the publicly held debt is in short-term notes, which presents real, sobering risks of the standing-on-a-ledge variety should interest rates spike up.

Here’s the thing: It costs more to finance your debt with 30-year bonds than with 30-day bills. (Yeah, I know, they’re 28-day bills, but cut a poet some slack.) That’s because investors, like men with options, are commitment-shy. If you’re going to lock your investment down for 20 or 30 years, you want a pretty high rate of return. But for 28 days? Less so. But there’s a tradeoff: Interest rates change, sometimes dramatically and often unexpectedly. When the 28-day bill comes up and you still haven’t balanced the budget, you have to refinance that debt. Ben Bernanke and Ramesh Ponnuru are working hard to keep Washington’s short-term borrowing rate at basically zero right now, so there’s a lot of incentive to use short-term rather than long-term financing. Sometimes that works out well: The Clinton administration pushed a lot of our debt into shorter-term instruments back in the 1990s and helped save a bundle on borrowing costs. (The other way to save a bundle on borrowing costs: Stop borrowing.) But sometimes taking the short-term deal and leaving yourself open to unexpected changes in debt-service costs is really, really stupid: Ask somebody who signed up for one of those brilliant adjustable-rate mortgages that take you from free money to pawn-shop rates overnight. A lot of people, myself included, worry that we’ve got too much short-term debt and should use more long-term financing to protect ourselves from interest-rate risk, even if it costs more to do so. Why? Because debt service is one of those checks the government absolutely has to write, and you don’t want surprises. That’s how you get the sort of fiscal crisis that leaves you with banana-republic finances while the Canadians laugh at you.

Incidentally, the Obama administration may be the world-champion deficit spenders, but maturity rates actually hit their low during the Bush administration: In 2008, average maturity was only 48 months. In 2000, long-term bonds accounted for 21 percent of the total debt; by 2009, bonds were down to just under 10 percent of the debt. They’ve climbed a bit since then, up to 10.3 percent. (If you want to check my math, there’s a spreadsheet o’ Treasury figures here.)

The real action seems to be in the medium range, in the notes: In 2008, we owed about $2.8 trillion on those; by 2010 it was $5.6 trillion, and it was $5.8 trillion as of March 2011. Let’s hope we get our finances in order before those come due.


Moody's Downgrades State Bonds; Malloy Chief Complains
By CHRISTOPHER KEATING, Hartford Courant
12:58 PM EST, January 20, 2012

HARTFORD

After the largest tax increase in Connecticut state history, the Moody'srating agency has downgraded the state's bonds.

The downgrade prompted a sharp rebuke from Ben Barnes, the budget chief for Democratic Gov. Dannel P. Malloy.

Barnes released the following statement Friday:

"Moody’s is wrong in its analysis of the state’s finances, and wrong to change Connecticut’s credit rating.  Connecticut has done all the right things to shore up our finances, and Moody’s has responded with a downgrade intended to satisfy their internal corporate need to deflect attention from their historic lack of credibility.

"Connecticut has always paid its debt, and remains an attractive issuer of public debt.  Investors appreciate Connecticut’s strong income levels, conservative debt management practices, and fiscally conservative leadership.''

The news richocheted quickly throughout Wall Street and the financial world with an article in The Bond Buyer, an influential financial publication for insiders. The news was also carried by publications like The Hartford Business Journal and The Courant.

Upon hearing about the reaction regardingMoody's, one Capitol insider said, "He's confusing them with Lisa.''

Barnes continued, "Moody’s lowered the rating for Connecticut below where it has been since April 2010 even though Connecticut’s fiscal health has significantly improved during that period.  Recall that in 2010 Connecticut faced looming multi-billion deficits into the future, had pension funding ratios in the low 40s, had spent the entire rainy day fund, and was in the middle of a series of budgetary gimmicks which Governor Malloy has spent his first year in office undoing.

"Today, we have a structurally balance budget, have converted to GAAP, have fully funded our current pension obligations and seen their funding ratio rise, have negotiated significant pension benefit concessions from organized labor, have negotiated significant employee contributions to retiree health benefits, and have begun to add jobs to the state economy.

"Moody’s Investor Service decision today to lower their rating of Connecticut’s General Obligation debt from Aa2 (negative) to Aa3 (stable) is unfortunate.  It reflects their continued reaction to their central involvement in the financial scandals that led to the deepest recession since the Great Depression.   Coming on the eve of our budget release, without an imminent bond sale, suggests that the move is motivated by factors other than Connecticut’s creditworthiness.

"Moody’s, which receives approximately $170,000 per year in fees from the State for their bond rating services, is one of three agencies that rate Connecticut debt.  The others, Standard & Poor’s and Fitch, continue to rate Connecticut debt as AA (equivalent to Aa2 from Moody’s.)"
 
Copyright © 2012, The Hartford Courant
State Debt Woes Grow Too Big to Camouflage
NYTIMES
By MARY WILLIAMS WALSH
March 29, 2010

California, New York and other states are showing many of the same signs of debt overload that recently took Greece to the brink — budgets that will not balance, accounting that masks debt, the use of derivatives to plug holes, and armies of retired public workers who are counting on benefits that are proving harder and harder to pay.

And states are responding in sometimes desperate ways, raising concerns that they, too, could face a debt crisis.

New Hampshire was recently ordered by its State Supreme Court to put back $110 million that it took from a medical malpractice insurance pool to balance its budget. Colorado tried, so far unsuccessfully, to grab a $500 million surplus from Pinnacol Assurance, a state workers’ compensation insurer that was privatized in 2002. It wanted the money for its university system and seems likely to get a lesser amount, perhaps $200 million.

Connecticut has tried to issue its own accounting rules. Hawaii has inaugurated a four-day school week. California accelerated its corporate income tax this year, making companies pay 70 percent of their 2010 taxes by June 15. And many states have balanced their budgets with federal health care dollars that Congress has not yet appropriated.

Some economists fear the states have a potentially bigger problem than their recession-induced budget woes. If investors become reluctant to buy the states’ debt, the result could be a credit squeeze, not entirely different from the financial strains in Europe, where markets were reluctant to refinance billions in Greek debt.

“If we ran into a situation where one state got into trouble, they’d be bailed out six ways from Tuesday,” said Kenneth S. Rogoff, an economics professor at Harvard and a former research director of the International Monetary Fund. “But if we have a situation where there’s slow growth, and a bunch of cities and states are on the edge, like in Europe, we will have trouble.”

California’s stated debt — the value of all its bonds outstanding — looks manageable, at just 8 percent of its total economy. But California has big unstated debts, too. If the fair value of the shortfall in California’s big pension fund is counted, for instance, the state’s debt burden more than quadruples, to 37 percent of its economic output, according to one calculation.

The state’s economy will also be weighed down by the ballooning federal debt, though California does not have to worry about those payments as much as its taxpaying citizens and businesses do.

Unstated debts pose a bigger problem to states with smaller economies. If Rhode Island were a country, the fair value of its pension debt would push it outside the maximum permitted by the euro zone, which tries to limit government debt to 60 percent of gross domestic product, according to Andrew Biggs, an economist with the American Enterprise Institute who has been analyzing state debt. Alaska would not qualify either.

State officials say a Greece-style financial crisis is a complete nonissue for them, and the bond markets so far seem to agree. All 50 states have investment-grade credit ratings, with California the lowest, and even California is still considered “average,” according to Moody’s Investors Service. The last state that defaulted on its bonds, Arkansas, did so during the Great Depression.

Goldman Sachs, in a research report last week, acknowledged the pension issue but concluded the states were very unlikely to default on their debt and noted the states had 30 years to close pension shortfalls.

Even though about $5 billion of municipal bonds are in default today, the vast majority were issued by small local authorities in boom-and-bust locations like Florida, said Matt Fabian, managing director of Municipal Market Advisors, an independent consulting firm. The issuers raised money to pay for projects like sewer connections and new roads in subdivisions that collapsed in the subprime mortgage disaster.

The states, he said, are different. They learned a lesson from New York City, which got into trouble in the 1970s by financing its operations with short-term debt that had to be rolled over again and again. When investors suddenly lost confidence, New York was left empty-handed. To keep that from happening again, Mr. Fabian said, most states require short-term debt to be fully repaid the same year it is issued.

Some states have taken even more forceful measures to build creditor confidence. New York State has a trustee that intercepts tax revenues and makes some bond payments before the state can get to the money. California has a “continuous appropriation” for debt payments, so bondholders know they will get their interest even when the budget is hamstrung.

The states can also take refuge in America’s federalist system. Thus, if California were to get into hot water, it could seek assistance in Washington, and probably come away with some funds. Already, the federal government is spending hundreds of millions helping the states issue their bonds.

Professor Rogoff, who has spent most of his career studying global debt crises, has combed through several centuries’ worth of records with a fellow economist, Carmen M. Reinhart of the University of Maryland, looking for signs that a country was about to default.

One finding was that countries “can default on stunningly small amounts of debt,” he said, perhaps just one-fourth of what stopped Greece in its tracks. “The fact that the states’ debts aren’t as big as Greece’s doesn’t mean it can’t happen.”

Also, officials and their lenders often refused to admit they had a debt problem until too late.

“When an accident is waiting to happen, it eventually does,” the two economists wrote in their book, titled “This Time Is Different” — the words often on the lips of policy makers just before a debt bomb exploded. “But the exact timing can be very difficult to guess, and a crisis that seems imminent can sometimes take years to ignite.”

In Greece, a newly elected prime minister may have struck the match last fall, when he announced that his predecessor had left a budget deficit three times as big as disclosed.

Greece’s creditors might have taken the news in stride, but in their weakened condition, they did not want to shoulder any more risk from Greece. They refused to refinance its maturing $54 billion euros ($72 billion) of debt this year unless it adopted painful austerity measures.

Could that happen here?

In January, incoming Gov. Chris Christie of New Jersey announced that his predecessor, Jon S. Corzine, had concealed a much bigger deficit than anyone knew. Mr. Corzine denied it.

So far, the bond markets have been unfazed.

Moody’s currently rates New Jersey’s debt “very strong,” though a notch below the median for states. Moody’s has also given the state a negative outlook, meaning its rating is likely to decline over the medium term. Merrill Lynch said on Monday that New Jersey’s debt should be downgraded to reflect the cost of paying its retiree pensions and health care.

In fact, New Jersey and other states have used a whole bagful of tricks and gimmicks to make their budgets look balanced and to push debts into the future.

One ploy reminiscent of Greece has been the use of derivatives. While Greece used a type of foreign-exchange trade to hide debt, the derivatives popular with states and cities have been interest-rate swaps, contracts to hedge against changing rates.

The states issued variable-rate bonds and used the swaps in an attempt to lock in the low rates associated with variable-rate debt. The swaps would indeed have saved money had interest rates gone up. But to get this protection, the states had to agree to pay extra if interest rates went down. And in the years since these swaps came into vogue, interest rates have mostly fallen.

Swaps were often pitched to governments with some form of upfront cash payment — perhaps an amount just big enough to close a budget deficit. That gave the illusion that the house was in order, but in fact, such deals just added hidden debt, which has to be paid back over the life of the swaps, often 30 years.

Some economists think the last straw for states and cities will be debt hidden in their pension obligations.

Pensions are debts, too, after all, paid over time just like bonds. But states do not disclose how much they owe retirees when they disclose their bonded debt, and state officials steadfastly oppose valuing their pensions at market rates.

Joshua Rauh, an economist at Northwestern University, and Robert Novy-Marx of the University of Chicago, recently recalculated the value of the 50 states’ pension obligations the way the bond markets value debt. They put the number at $5.17 trillion.

After the $1.94 trillion set aside in state pension funds was subtracted, there was a gap of $3.23 trillion — more than three times the amount the states owe their bondholders.

“When you see that, you recognize that states are in trouble even more than we recognize,” Mr. Rauh said.

With bond payments and pension contributions consuming big chunks of state budgets, Mr. Rauh said, some states were already falling behind on unsecured debts, like bills from vendors. “Those are debts, too,” he said.

In Illinois, the state comptroller recently said the state was nearly $9 billion behind on its bills to vendors, which he called an “ongoing fiscal disaster.” On Monday, Fitch Ratings downgraded several categories of Illinois’s debt, citing the state’s accounts payable backlog. California had to pay its vendors with i.o.u.’s last year.

“These are the things that can precipitate a crisis,” Mr. Rauh said.


Cooper Union - site of Abraham Lincoln's address
Obama stirring up 'VAT' of tax trouble
NYPOST
By CHARLES HURT, Bureau Chief
Last Updated: 9:18 AM, April 22, 2010
Posted: 3:23 AM, April 22, 2010

WASHINGTON -- On the eve of his trip today to New York City to push for Wall Street regulation, President Obama refused to rule out employing a European-style value-added tax to give the federal government enough money to pay debts.

"There's been a lot of talk around town lately about the value-added tax. That is something that has worked for some countries," Obama said in a CNBC interview.

It would be "novel" to introduce it in the United States, the president told CNBC's John Harwood -- but declined to say yet whether he supports or opposes the idea.

"Before, you know, I start saying, 'This makes sense or that makes sense,' I want to get a better picture of what our options are," Obama said, referring to the commission he has empaneled to offer ideas on reducing the government's massive debt.

The executive director of that panel also left open the likelihood of a VAT, a type of national sales tax assessed on every step of a product's path to the market.

"We need to talk through all sides of this equation," Bruce Reed told Fox News. "We intend to look at everything."

The 18-member commission is led by former Clinton White House Chief of Staff Erskine Bowles, a Democrat, and former Wyoming Sen. Alan Simpson, a Republican.

In the interview ahead of today's appearance at Cooper Union in Manhattan, Obama also "categorically" denied any involvement or prior knowledge of the Securities and Exchange Commission's civil suit brought last week against Goldman Sachs. Many of his fellow Democrats have been quick to use the case as ammunition to ram through Congress an overhaul of financial regulation.

"We are not Johnny-come-latelies to this issue," Obama said, noting that he has called for regulation reforms since before he took office.

And the SEC, he said, is an independent agency. "We found out about [the suit] on CNBC," Obama told Harwood.

The president also was asked if he was embarrassed by the nearly $1 million he has collected in campaign donations from Goldman employees or the fact that his former White House counsel is now lobbying on the company's behalf.

"No," he said flatly. "I raised a lot of money from a lot of people."

The president's spokesman Robert Gibbs told reporters yesterday he has not heard anyone inside the White House suggest that Obama should return any of the Goldman money.

Obama will visit the city today to deliver a speech on the importance of passing the Democratic financial-regulation reform bill that is currently moving through the Senate but has failed to attract a single Republican supporter.


Special Report: The haves, the have-nots and the dreamless dead
YAHOO
By Emily Kaiser
22 October 2010

WASHINGTON (Reuters) – In 2007, when the world was on the brink of financial crisis, U.S. income inequality hit its highest mark since 1928, just before the Great Depression.

Coincidence? Maybe not.

Economists are only beginning to study the parallels between the 1920s and the most recent decade to try to understand why both periods ended in financial disaster. Their early findings suggest inequality may not directly cause crises, but it can be a contributing factor.  This raises a host of social, economic and political questions. Should public policy aim to reduce inequality, and if so by what means? Does concentrated wealth at the top of the income spectrum generate asset bubbles, or vice versa? Could raising taxes or interest rates ward off financial meltdowns?

Americans are generally not bothered by inequality because they believe with hard work, they, too, can strike it rich. Government policies aimed at spreading the wealth rarely get much support. (Remember 2008, when then-candidate Barack Obama's campaign-trail comment about redistributing the wealth catapulted "Joe the Plumber" into media stardom?)

"It is usually only left-leaning rich people that care about inequality in the U.S.," said Carol Graham, a senior fellow at the Brookings Institution think tank who studies the economics of happiness.

Those attitudes may be subtly shifting, although it is unclear that this is anything more than just a temporary knee-jerk reaction to the latest bout of turmoil.  Public opinion polls show voters mixed on whether to back higher taxes on the wealthiest households, as President Obama has proposed. The issue is so contentious that Congress put off its decision until after the November 2 midterm elections.

Resentment toward Wall Street is simmering as bankers' paychecks swell to pre-crisis levels while unemployment remains more than twice as high as it was in 2007. Some politicians have been voted out of office simply because they supported the $700 billion bank bailout enacted in 2008.  Yet there is nowhere near majority backing for the sort of progressive New Deal policies passed during the Great Depression, which helped narrow the wealth gap and keep it contained until it resumed widening in the 1970s.

This time around, the wealth disparity narrowed in 2008 because rich households took a heavier hit from the financial crisis, but Census Bureau data shows it turned around immediately. In 2009, inequality was at the highest level since Census began tracking household income in 1967.

America has one of the largest wealth gaps among advanced economies. Based on an inequality measure known as the Gini coefficient, the United States ranks on a par with developing countries such as Ivory Coast, Jamaica and Malaysia, according to the CIA World Factbook.

TRACKING THE DIVIDE

Emmanuel Saez, a University of California, Berkeley, economist who was awarded a 2010 MacArthur Foundation "genius" grant for his work on income inequality, said recession-induced income declines for the super-rich tend to be fleeting unless there are "drastic" regulatory and tax policy changes.  His research with co-author Thomas Piketty shows the top 1 percentile of households took home 23.5 percent of income in 2007, the largest share since 1928, but that slipped back to 20.9 percent in 2008. (Unlike Census, Saez relies on IRS tax data, which is released with a two-year lag, so he does not yet have figures for 2009.)

During the last period of economic expansion, 2002 to 2007, the top 1 percent enjoyed 10.1 percent annual income growth, adjusted for inflation. For the other 99 percent, the growth rate was just 1.3 percent, Saez found. That meant the top 1 percent received 65 cents of every dollar in income growth.

"We need to decide as a society whether this increase in income inequality is efficient and acceptable and, if not, what mix of institutional reforms should be developed to counter it," he concluded.

COMMON THREADS

There is little agreement among economists about what precisely links high inequality to crises, which helps explain why so few officials saw the financial upheaval coming.  Rapid expansion of credit is one common thread.  Robert Reich, a Berkeley public policy professor and a labor secretary under President Bill Clinton, thinks stagnant middle-class wages led households to pull equity from their homes and overload on debt to maintain living standards.

Raghuram Rajan, a professor at the University of Chicago's Booth School of Business and a former chief economist of the International Monetary Fund, believes governments tend to promote easy credit when inequality spikes to assuage middle-class anger about falling behind.

"One way to paper over the rising inequality was to lend so that people could spend," Rajan said.

In the 1920s, it was expansion of farm credit, installment loans and home mortgages. In the last decade, it was leveraged borrowing and lending, by home buyers who put no money down or investment banks that lent out $30 for each $1 held.

"Housing credit gave you an instrument to assist those falling behind without them feeling they're beneficiaries of some sort of subsidy," Rajan said. "Even if their incomes are stagnant, they feel really good about becoming homeowners."

BUBBLES AND YACHTS

Another theory is that concentration of wealth at the top sends investors searching for riskier interest-bearing savings. When so much cash is sloshing around, traditional safe investments such as Treasury debt yield very little, and wealthy investors may seek out fatter returns elsewhere.

Mark Thoma, who teaches economics at the University of Oregon, wonders if the flood of investment cash from the ultra-rich -- both in the United States and abroad -- encouraged Wall Street to create seemingly safe mortgage-backed securities that later proved disastrously risky.

"When we see income inequality rising, we ought to start looking for bubbles," he said.

Kemal Dervis, global economy and development division director at Brookings and a former economy minister for Turkey, said reducing inequality isn't just a matter of fairness or morality. An economy based on consumption needs consumers, and if too much wealth is concentrated at the top there may be times when there is not enough demand to support growth.

"There may be demand for private jets and yachts, but you need a healthy middle-income group (to drive consumption of basic goods)," he said. "In the golden age of capitalism, in the 1950s and 60s, everyone shared in income growth."

MISSING THE LINK

The fact that economists are even examining the link between inequality and financial crises shows just how much the thinking has changed in the wake of the Great Recession.  Paul Krugman, the Nobel prize-winning economist, said that before 2008, when he spoke of inequality approaching levels last seen before the Great Depression, it would inevitably lead to questions about whether another crisis was looming.

"No, I'd say -- there really isn't a clear reason why high inequality should lead to macroeconomic crisis," he recalled in a presentation to a conference on income inequality in June.

Now, he says, he is considering whether inequality somehow creates macroeconomic vulnerability.  Krugman certainly wasn't the only one who dismissed the idea of a connection between inequality and crisis before the latest episode.

Ajay Kapur, a Deutsche Bank strategist, spotted the inequality parallels between the 1920s and the most recent decade, but didn't see the meltdown coming. The former Citigroup strategist created a stir five years ago when he built an investment strategy around his thesis that essentially divided the world into two camps: the rich and the rest.

Kapur told clients in 2005 that the United States and a handful of other economies were developing into "plutonomies" where the wealthy few powered economic growth and consumed much of its bounty, while the "multitudinous many" shared the leftovers.

Plutonomies come around only once or twice a century, he argued -- 16th century Spain, 17th century Holland, the Gilded Age. The last time it happened in the United States was during the "Roaring 1920s".

There was money to be made by buying shares of luxury companies that made toys for the rich, he told clients, suggesting a basket of stocks that included upscale retailer Burberry and luxury home builder Toll Brothers.

"When I presented this to clients, they said, 'Okay, this is interesting because you're telling me what happened in the 1920s is happening right now, and you obviously know what happened after 1929, right?'," Kapur said in an interview.

His response? That can't happen again because we know better now.

"To be perfectly honest.... I certainly didn't think it would all melt down in 2007. I'd be lying if I said that."

Kapur still isn't convinced there is a direct connection, and points out that 2007 and 1928 are only two data points and it's dangerous to draw conclusions from such a small sample.

SEEDS OF INEQUALITY

Inequality doesn't always lead to financial crisis, which makes it difficult for policymakers to know when it might be growing into a serious problem that ought to be addressed.  Many of the root causes -- technological advances, financial innovation, higher education -- are social goods, not ills, so it makes little sense to attack them.  The traditional view among economists is that combating inequality would hurt growth. Many argue that inequality is "if anything, favorable to -- or at least a necessary by-product of -- economic growth," as Federal Reserve Bank of Dallas researchers wrote in a 2008 paper on inequality.

In the decades before the Great Depression, advances in mass-production and transportation enabled large-scale factories to churn out more goods with fewer workers.

In the past two decades, the big change was the explosion of personal computing and the Internet. The ability to instantaneously transmit masses of information over thousands of miles meant workers no longer needed to be in the same place, and jobs could easily shift to low-cost locales such as Bangalore, India, or Shenzhen, China.  Demand for unskilled labor fell. The relatively small segment of the population with the qualifications to compete -- in the 1920s, a high school diploma; in today's economy, a college degree -- earned more money, widening the wealth gap.

Unemployment data bears that out. Even before the latest recession started in late 2007, the jobless rate for those with only a high school diploma was more than double the rate for those with at least a Bachelor's degree. As of September 2010, unemployment among high school graduates was 10 percent; for those with a four-year college degree it was just 4.4 percent.  This suggests one government response to inequality should be to channel more money into education, said Jack Ablin, chief investment adviser for Harris Private Bank in Chicago.

Ablin said only a small sliver of his high net-worth clients inherited their wealth, so simply comparing wealth concentration between the 1920s and now may be a bit unfair.

"Becoming wealthy in the olden days was almost genetic," he said, referring to wealth handed down from generation to generation.

I CAN BE BILL GATES

The work hard, get rich formula is deeply embedded in the American psyche, which helps explain why Americans have generally tolerated inequality.

For every dynastic family name such as Kennedy or Rockefeller, there are those who reached the top through creativity and sweat, from Sam Walton who built the global Walmart empire from a single dime store in Arkansas, to Google founders Larry Page and Sergey Brin who started their company in a garage.  Rags to riches tales are an integral part of what makes the United States a beacon to immigrants who dream of a better life. No one embodies that better than President Obama, whose mother once turned to food stamps to feed her family, yet he was able to attend top-tier universities and aspire to the most powerful office in the world.

Graham, the Brookings economist who studies happiness, said most Americans, including the poor, believe that hard work is more important than luck in getting ahead.

"If I work hard enough, I too can be Bill Gates," is how Graham explains the philosophy.

The only groups that don't share that view and consistently rank toward the bottom on measures of happiness are the long-term unemployed and those without health care, she said.  Both groups grew during the recession. As of September, there were 6.1 million people who had been out of work for more than six months, more than four times as many as there were at the start of the recession.  Deborah Coleman is one of the long-term unemployed. There is no disguising the anger felt by the 58-year-old former telecommunications company manager in Cincinnati, who has been out of work for more than two years.

"Am I pissed that I have lost everything while the rich on Wall Street are still living it up? You bet I'm pissed," she said. "I'm one of the many people who've lost everything and then been swept under the carpet."

TAXING THE RICH

Graham does not yet have enough data to determine whether attitudes toward inequality shifted after the financial crisis, but she suspects there has been very little movement.

The debate over whether to extend Bush-era tax cuts for the wealthiest households may provide an early litmus test. Obama has proposed keeping the lower tax rates only for families making less than $250,000, but Republicans and a handful of Democrats went them extended for all.  Obama's framing of the issue suggests the White House does not see much voter support for using tax policy to even out income inequality.

On the campaign trail in 2008, Obama told Joe Wurzelbacher, who became known as Joe the Plumber, that if the economy is good for those at the bottom, it's going to be good for everyone. His comments about redistribution sparked fury among conservatives who saw it as evidence the future president harbored socialist leanings.  Since that "spread the wealth" gaffe, Obama has chosen his words more carefully and regularly points out that he is no modern-day Robin Hood.  Ending the tax breaks for the wealthiest "isn't to punish folks who are better off -- God bless them -- it is because we can't afford the $700 billion price tag," Obama said recently.

His opponents say imposing higher taxes would kill the economic recovery because the rich spend, invest and hire more than everyone else, faintly echoing the plutonomy theme laid out by Deutsche Bank's Kapur.

DREAMLESS DEAD

Like cholesterol, there is a "good" and a "bad" kind of inequality, according to Francois Facchini, an economist at the University of Paris.  The "good" kind is aspirational. It encourages people to strive toward success, like Graham's Bill Gates analogy. The "bad" kind fosters disillusionment, a feeling that no matter how hard you work, you cannot win.

Pollster John Zogby sees a growing number of Americans falling into the second category. He calls them the "Dreamless Dead," those who no longer believe in the existence of the American Dream of hard work begetting success.  Those who work hard but fail to get ahead lose faith in the dream, he said. Beginning in the 1990s, Zogby noticed an increase in the percentage of people who said they were working in jobs that paid less than previous positions.

"That's when I started to zero in on the American Dream because my assumption was it was going up in smoke," he said.

In the early 1990s, 14 percent of those polled by Zogby said they were making less money than they had before. After the recession, the percentage had more than doubled.

Janet Townsend, who has worked at General Motors for 34 years, is one of those faced with the prospect of a drastic pay cut. She was told she'd have to take a 50 percent wage reduction because GM wanted to sell the Indianapolis plant where she works to a private investor. Union workers opposed the deal. The plant will be shut next year.

"I haven't seen any auto executives or Wall Street bankers taking a paycut, in fact their pay seems to keep going up," she said. "This country is built on the principles of life, liberty and the pursuit of happiness.

"But when a corporation tries to make me take a 50 percent pay cut, then you're taking away my right to pursue happiness while enhancing your own."

A NEWCOMER TO WASHINGTON

If inequality can lead to financial catastrophe and voter outrage, should Washington try to stop it from getting too wide?  Obama's avoidance of spread-the-wealth comments would indicate the White House does not think there is political backing for policies aimed explicitly at redistribution.  However, at least one new arrival to Washington's policy-making scene, Fed Vice Chairman Janet Yellen, has expressed concern that extreme inequality could ultimately undermine American democracy.

"Inequality has risen to the point that it seems to me worthwhile for the U.S. to seriously consider taking the risk of making our economy more rewarding for more of the people," she wrote in a 2006 speech.  The public policy response depends on what the root problem really is. Thoma, the University of Oregon economist, said it still isn't clear whether bubbles cause inequality or inequality causes bubbles.  If it is the former, Yellen and the Fed could play a role in preventing disaster by raising interest rates or tightening regulation when they see evidence of a dangerous asset price bubble building.

Fed Chairman Ben Bernanke has argued that interest rates are too blunt of an instrument to prick asset bubbles because they could tip the entire economy into recession rather than targeting a narrow source of instability.  If inequality is the core issue, more progressive taxes or investing in education programs might be more effective.

ON AVERAGE, YOU'RE DOING OKAY

Before policymakers can act, they will need to get better at identifying unsafe imbalances.

The most commonly used measuring tools, such as per capita income, can be misleading because they report at averages. Data on average income, for example, can be skewed by huge gains at the top, making spending power appear higher than it really is.  Willard Wirtz, who was President John F. Kennedy's labor secretary in the 1960s, is often credited with saying: "When you have your head in the freezer and your feet in the oven, on average you are doing okay."

Steve Landefeld, director of the Bureau of Economic Analysis which produces thousands of reports including GDP, has proposed adding more data series that might serve as an early warning system that imbalances were building.  One bright red flag that policymakers seem to have missed pre-crisis was the disconnect between swiftly rising house prices and stagnant wages for most middle-class workers.

TESTING SOCIAL COHESION

Left alone, income inequality looks likely to continue rising at least through this year. The stock market has already regained more than half of the ground lost between an October 2007 all-time high and a March 2009 trough. Those gains flow disproportionately to the wealthy.

Meanwhile, the overall unemployment rate will probably end the year about where it started, at 9.7 percent, while the education gap widens. The jobless rate for college graduates has come down by 10 percent since January; for those who didn't finish high school, it has risen 1 percent.

This pattern has been in place for more than a decade and it has not generated much popular support for addressing income inequality. That may change as strained U.S. finances eventually force officials to choose where to cut spending.

In the next five years, the government debt burden may reach a critical point where it is growing at a faster rate than the economy, pushing up taxes and diverting money that could be spent more productively on research or education.  Credit rating agency Moody's has warned that the budgetary decisions facing the United States and many other rich countries may "test social cohesion."

"Will society accept the measures that need to be taken to stabilize the debt position of the government?" Moody's analyst Steven Hess said in an interview.

"Economic growth is not going to get the country out of the negative debt trajectory it now faces," he said.

Means-testing social security payouts so that less money goes to the wealthiest would be one way to help curb the deficit and income inequality at the same time. Other ideas might include phasing out tax write-offs for mortgage interest for higher-income homeowners.

Both options are likely to be considered by a federal deficit commission that is due to report its findings in December. Its recommendations, however, are not binding, so Congress may choose an entirely different path -- one that does less to address inequality.

Hess said he did not expect the sort of riots and protests that have marked austerity pushes in Greece and other parts of Europe, but said inequality can heighten social tension.

Kapur, the strategist behind the plutonomy thesis, said the forces that put the United States into his plutonomy category appear to have peaked, and he has shifted his investment focus to emerging markets where returns look sweeter.  Although he did not see the financial crisis coming back in 2005, he accurately predicted what would eventually undermine his investment strategy. Time will tell whether he also foreshadowed shifts in U.S. attitudes toward inequality.

"Perhaps one reason that societies allow plutonomy is because enough of the electorate believe they have a chance of becoming a Pluto-participant," he wrote back then.

"Why kill it off if you can join it? In a sense, this is the embodiment of the 'American Dream'. But if voters feel they cannot participate, they are more likely to divide up the wealth pie, rather than aspire to be truly rich."



The Financial Page - Dodger Mania
The New Yorker
by James Surowiecki
July 11, 2011

Greece is a fairly small country, but for the past year it has been causing an awfully big uproar. Burdened by a pile of government debt that could force it into default (and the European banking system into a meltdown), Greece has had to adopt ever more stringent austerity plans in order to secure a bailout from the European Union. Explanations of how Greece got in this mess typically focus on profligate public spending. But its fiscal woes are also due to a simple fact: tax evasion is the national pastime.

According to a remarkable presentation that a member of Greece’s central bank gave last fall, the gap between what Greek taxpayers owed last year and what they paid was about a third of total tax revenue, roughly the size of the country’s budget deficit. The “shadow economy”—business that’s legal but off the books—is larger in Greece than in almost any other European country, accounting for an estimated 27.5 per cent of its G.D.P. (In the United States, by contrast, that number is closer to nine per cent.) And the culture of evasion has negative consequences beyond the current crisis. It means that the revenue burden falls too heavily on honest taxpayers. It makes the system unduly regressive, since the rich cheat more. And it’s wasteful: it forces the government to spend extra money on collection (relative to G.D.P., Greece spends four times as much collecting income taxes as the U.S. does), even as evaders are devoting plenty of time and energy to hiding their income.

Greece, it seems, has struggled with the first rule of a healthy tax system: enforce the law. People are more likely to be honest if they feel there’s a reasonable chance that dishonesty will be detected and punished. But Greek tax officials were notoriously easy to bribe with a fakelaki (small envelope) of cash. There was little political pressure for tougher enforcement. On the contrary: a recent study showed that enforcement of the tax laws loosened in the months leading up to elections, because incumbents didn’t want to annoy voters and contributors. Even when the system did track down evaders, it was next to impossible to get them to pay up, because the tax courts typically took seven to ten years to resolve a case. As of last February, they had a backlog of three hundred thousand cases.

It isn’t just a matter of lax enforcement, though. Greek citizens also have what social scientists call very low “tax morale.” In most developed countries, tax-compliance rates are much higher than a calculation of risks would imply. We don’t pay our taxes just because we’re afraid of getting caught; we also feel a responsibility to contribute to the common good. But that sense of responsibility comes with conditions. We’re generally what the Swiss behavioral economist Benno Torgler calls “social taxpayers”: we’ll chip in as long as we have faith that our fellow-citizens are doing the same, and that our government is basically legitimate. Countries where people feel that they have some say in how the state acts, and where there are high levels of trust, tend to have high rates of tax compliance. That may be why Americans, despite being virulently anti-tax in their rhetoric, are notably compliant taxpayers.

Greeks, by contrast, see fraud and corruption as ubiquitous in business, in the tax system, and even in sports. And they’re right to: Transparency International recently put Greece in a three-way tie, with Bulgaria and Romania, as the most corrupt country in Europe. Greece’s parliamentary democracy was established fairly recently, and is of shaky legitimacy: it’s seen as a vehicle for special interests, and dedicated mainly to its own preservation. The tax system had long confirmed this view, since it was riddled with loopholes and exemptions: not only doctors but also singers and athletes were given favorable rates, while shipping tycoons paid no income tax at all, and members of other professions were legally allowed to underreport their income. Inevitably, if a hefty chunk of the population is cheating on its taxes, people who don’t (or can’t, because of the way their income is reported) feel that they’re being abused.

The result has been a vicious circle: because tax evasion is so common, people trust the system less, which makes them less willing to pay taxes. And, because so many don’t chip in, the government has had to raise taxes on those who do. That only increases the incentive to cheat, since there tends to be a correlation between higher tax rates and higher rates of tax evasion.

Even while dealing with protests and open riots, the new Greek government is trying to change things. It is rationalizing its tax-collection system. It has simplified taxes and done away with some of the loopholes. And it has stepped up its enforcement efforts in ways large and small—tax officials have, for instance, been sending helicopters over affluent neighborhoods looking for swimming pools, as evidence of underreported wealth. These efforts have made some difference: the self-employed seem to be reporting more of their income, and the evaders have had to step up their game. (There’s now a burgeoning market in camouflage swimming-pool covers.)

But a social inclination toward tax evasion, once established, is hard to eradicate. One fascinating study, by the economist Martin Halla, showed that tax morale among second-generation American immigrants reflected their country of origin. And getting tough can backfire. Research suggests that overemphasizing enforcement can actually weaken tax morale, by making taxpaying seem less like a freely chosen part of the social contract.

The reason tax reform will be such a tall order for Greece, in sum, is that it requires more than a policy shift; it requires a cultural shift. Pulling that off would be quite a feat. But the future of the European Union may depend on it.

Taxes go unpaid as deficits increase
$400 billion is uncollected by government each year
By TONY PUGH McClatchy Newspapers
Article published Jul 4, 2011

Washington - At a time when higher taxes or deeper government spending cuts seem to be the only options available to close the gaping federal deficit, going after more than $400 billion a year in uncollected taxes should be a no-brainer.

But in the nation's capital, the so-called "tax gap" hardly rates a mention in the official discussion of America's fiscal woes.

In government parlance, the "tax gap" is the difference between the taxes owed and what's actually paid on time. In their most recent analysis, from 2001, the Internal Revenue Service estimated that only about 84 percent of federal taxes were voluntarily paid on time that year, leaving a gross tax gap of $345 billion, or roughly 16 percent, uncollected.

Late payments and IRS collection efforts brought in another $50 billion, which cut the net tax gap to $290 billion in 2001. But similar estimates point to a gross tax gap of $410 billion to $500 billion in 2010, said Benjamin Harris, a research economist at the Brookings Institution, a center-left research group.

"You could go a long way toward solving our budget mess by closing the tax gap, but the problem is, it's not easily closed," Harris said.

The IRS plans a new analysis of the tax gap later this year or early next year, but the trends are clear.

In the past 20 years, the U.S. economy has grown more complex, blurring the lines between personal and business income and creating more opportunities for tax scofflaws. Congress limits the IRS budget, and sophisticated tax cheats realize their chances of detection are relatively low. Others say that most who misreport their earnings do so inadvertently because of the complexity of the tax code.

Better, more targeted IRS enforcement could probably cut the tax gap by 10 percent without any fundamental changes to the IRS, Harris estimates. Cutting the gap further would require more thorough IRS reporting, increased tax withholding and more money for IRS enforcement.

But the political will to bolster the feared IRS collection apparatus and turn it loose on American citizens just isn't there.

"The government could close the tax gap entirely by putting IRS agents in every family's living room and in every small business. But this is a price that a liberty-loving people and their representatives are rightly unwilling to pay," said Sen. Orrin Hatch of Utah, the senior Republican member of the Senate Finance Committee, which helps write America's tax laws.

The Obama administration wants to increase the IRS budget from $12.1 billion to $13.3 billion in fiscal 2012 and add 5,000 new IRS agents. About $240 million would go for "new, revenue-generating tax enforcement initiatives aimed at closing the tax gap," according to a Treasury Department budget request. The measures would reap an estimated $1.3 billion in extra annual tax revenue by 2014.

But House Republicans, spurred by the anti-tax sentiment of tea party activists, voted to cut the IRS budget by $600 million in fiscal year 2012, citing the need to cut the budget deficit.

IRS Commissioner Doug Shulman told lawmakers that the proposed GOP cuts would cause tax collections to fall by $4 billion because they'd require slashing the agency's enforcement budget.

But Curtis Dubay, senior tax policy analyst at the Heritage Foundation, a conservative think tank, said Shulman was simply "posturing" to preserve IRS funding.

Strengthening IRS enforcement is a mistake, Dubay said, because "the tax gap is not the result of people illegally evading taxes. It's the result of an overly complex tax code that gets more and more complex every day."

Whether by willful evasion or unintentional mistakes, businesses and individuals that fail to report, underreport or underpay their taxes cause honest taxpayers to pay more - about $2,200 apiece - to make up the revenue shortfall. That basic unfairness erodes confidence in the tax system, which lowers taxpayer morale and, in turn, increases noncompliance.

The biggest losers are America's wage earners and salaried workers, who pay an estimated 99 percent of their fair tax burden because their taxes are automatically withheld from their pay and reported by a third party, their employers.

But individuals with business income - mainly self-employed, sole proprietors who get paid in cash - misreport roughly 54 percent of their actual income by either underreporting it, or claiming deductions, credits and exemptions to which they aren't entitled.

"This is incredible," Harris said. "You kind of feel like a sucker as a wage earner. Here you are paying taxes because someone else is paying you, but if someone else is getting paid on their own, they pay taxes at half the rate."

These taxpayers escape an estimated $110 billion in taxes each year, according to 2001 IRS estimates. Experts agree the amount has surely grown since then.

"And you can do all the audits you want, but this money is never going to show up," Harris said. "This is what makes the tax gap so hard to close."

In testimony last week before the Senate Finance Committee, David Kirkham, the president of Kirkham Motorsports in Provo, Utah, said it's "undeniable" that some of his business acquaintances underreport their income, mainly because of the complex tax code but also because they feel the system is unfair.

"They feel like other people are getting away with it," Kirkham said. "Let's face it, when (General Electric) is not paying taxes ... what does the average little guy think?"

The beauty salon industry offers a telling example of the problem. Unlike other industries with significant income from tips, many salon staffers are classified as "self-employed" workers, not company employees. This allows them to self-report their income and tips instead of the shop owners.

Kris Carpenter, the owner of the Sanctuary beauty salon in Billings, Mont., felt her employees were reporting only 25 percent of their actual tips. "It's easy," Carpenter said of the practice. "Anything that's cash disappears."

To fight the problem, Carpenter in 2001 began using sales software that reported tip income. In the past 10 years, the shop has reported $1.7 million in tip income to the IRS, an amount Carpenter found "astounding." In 2010 alone, Sanctuary paid nearly $16,400 in taxes on more than $225,000 in tip income.

But her honesty hasn't been rewarded. Not only have those tax payments made it harder to remain profitable, but Carpenter also said many employees have left her shop to be self-employed workers in salons where the income-reporting requirements aren't as strict.

"The ease of not reporting income and tip income along with the common misconception that 'tips are gifts, not income,' puts my business at a competitive disadvantage," Carpenter told the Finance Committee.

The Tax Equalization and Compliance Act sponsored by Sen. Olympia Snowe, R-Maine, would tighten tip-reporting practices in the salon industry.

One niche industry helps taxpayers avoid paying taxes altogether. Between 1 million and 1.5 million Americans are believed to have undeclared offshore accounts where untaxed income is hidden and accessed through credit and debit cards, said David Callahan, a senior fellow at Demos, a liberal research and advocacy group in New York.

Others hide money in phony offshore companies under the guise of payments for business services.

Callahan said the Taxpayer Bill of Rights made it easier to cheat by requiring the IRS to show evidence of intent to prove tax evasion.

"Sophisticated people know that if you cheat on your taxes and get caught, you're going to have to pay the money back. But if you say 'I lost my receipts,' 'I didn't understand how the deductions work,' you're off the hook," Callahan said, with "a slap on the wrist."

The IRS has stepped up efforts to catch these typically affluent cheaters. In the past three years, the agency has nearly doubled its audit rate on wealthy filers who earn more than $10 million a year.

Under a 2009 amnesty program, nearly 15,000 taxpayers avoided prosecution by disclosing their holdings in offshore accounts and agreeing to pay penalties and six years of back taxes on the undeclared income. A similar amnesty program expires on Aug. 31, but this round of offenders face stiffer penalties than the last group.

Compliance with tax laws increases when income-reporting requirements increase. But efforts to shore up lax reporting standards have faced strong opposition, even though the IRS civilian oversight board called it "a reasonable approach to increasing tax revenues at minimum expense," in its 2010 report to Congress.

A provision of the 2010 health care act would have required all businesses, tax-exempt organizations and government entities to file an IRS form for every vendor that they purchase more than $600 in goods from in a year.

About 40 million businesses, including 26 million sole proprietorships, would have been subject to the new law, which was expected to generate billions of dollars to help offset the cost of the health care bill. But critics said it placed too large a burden on small businesses and National Taxpayer Advocate Nina Olson, who helps citizens with problems before the IRS, said the measure "may turn out to be disproportionate as compared with any resulting improvement in tax compliance."

Lawmakers from both parties voted to kill the measure and President Barack Obama went along, signing its repeal.

Last week, Olson said Congress could simplify the tax code to make sure everyone pays their fair share. That would lower taxes for everyone. Among her recommendations: repeal the alternative minimum tax for individuals; consolidate complicated tax incentives for education and retirement savings; curb enactment of temporary tax provisions and standardize the home-office deduction.

Obama and top lawmakers from both parties have called for overhauling the tax code, but there's been little effort to do so this year.

Economy Faces a Jolt as Benefit Checks Run Out
NYTIMES7
By MOTOKO RICH
July 10, 2011

An extraordinary amount of personal income is coming directly from the government.

Close to $2 of every $10 that went into Americans’ wallets last year were payments like jobless benefits, food stamps, Social Security and disability, according to an analysis by Moody’s Analytics. In states hit hard by the downturn, like Arizona, Florida, Michigan and Ohio, residents derived even more of their income from the government.

By the end of this year, however, many of those dollars are going to disappear, with the expiration of extended benefits intended to help people cope with the lingering effects of the recession. Moody’s Analytics estimates $37 billion will be drained from the nation’s pocketbooks this year.

In terms of economic impact, that is slightly less than the spending cuts Congress enacted to keep the government financed through September, averting a shutdown.

Unless hiring picks up sharply to compensate, economists fear that the lost income will further crimp consumer spending and act as a drag on a recovery that is still quite fragile. Among the other supports that are slipping away are federal aid to the states, the Federal Reserve’s program to pump money into the economy and the payroll tax cut, scheduled to expire at the end of the year.

“If we don’t get more job growth and gains in wages and salaries, then consumers just aren’t going to have the firepower to spend, and the economy is going to weaken,” said Mark Zandi, chief economist of Moody’s Analytics, a macroeconomic consulting firm.

Job growth has remained elusive. There are 4.6 unemployed workers for every opening, according to the Labor Department, and Friday’s unemployment report showed that employers added an anemic 18,000 jobs in June.

In Arizona, where there are 10 job seekers for every opening, 45,000 people could lose benefits by the end of the year, according to estimates from the state Department of Economic Security. Yet employers in the state have added just 4,000 jobs over the last 12 months.

Some other states will also feel a disproportionate loss of income unless hiring revives. In Florida, where nearly 476,000 people are collecting unemployment benefits, employers have added only 11,200 jobs in the last year. In Michigan, employers have added about 40,000 jobs since May 2010, but about 267,000 people are claiming jobless benefits.

Throughout the recession and its aftermath, government benefits have helped keep money in people’s wallets and, in turn, circulating among businesses. Total government payments rose to $2.3 trillion in 2010, from $1.7 trillion in 2007, an increase of about 35 percent.

While some of that growth was in Social Security and disability benefits as the population aged, the majority resulted from payments to people continuing to suffer from the recession, said Mr. Zandi. Unemployment benefits, including emergency and extended benefits, are more than three times their prerecession level, he said. The nearly 20 percent of personal income now provided by the government is close to a record high.

Approved by Congress last December, the final extension of jobless benefits — for a maximum of 99 weeks for each unemployed person — is scheduled to conclude at the end of this year. A handful of states, like Wisconsin and Arizona, have already cut off weeks 80 through 99 for their residents. Meanwhile, more of the long-term unemployed are bumping up against the 99-week limit.

Consumers account for an estimated 60 to 70 percent of the country’s economic activity, but two years into the official recovery, businesses are still complaining that people simply are not spending enough.

“Regardless of why people have less money to spend, it affects all retailers in all industries,” said Michael Siemienas, spokesman for SuperValu, which operates grocery chains including Cub Foods, Shop ’n Save and Save-A-Lot. Mr. Siemienas said that the number of SuperValu’s customers using electronic benefit transfers to pay bills had grown over the last year.

Because benefit payments tend to be spent right away to cover basic needs like food and rent, they provide a direct boost to consumer spending. In a study for the Labor Department, Wayne Vroman, an economist at the Urban Institute, estimated that every $1 paid in jobless benefits generated as much as $2 in the economy.

For many of the nearly 7.5 million people collecting unemployment benefits, those payments are keeping them afloat. Laura Metz, 42, was laid off from a clerical job paying $15.30 an hour at a home health care provider near her home in Commerce, Mich., nearly 15 months ago. She has been collecting $362 a week in unemployment insurance and about $50 a month in food stamps.

That covers the basics. But Ms. Metz stopped making her mortgage payments last year on the modest home she shares with her 19-year-old son. A program that allowed her to make a lower monthly payment has expired, and she is waiting to see if the lender will modify her loan. She can no longer make her student loan payments for her bachelor’s degree or master’s in business administration, and she has downgraded her Internet and cable service and cut back on car trips and snacks.

Ms. Metz, who has been applying for administrative jobs, has been shocked at the dearth of opportunities. A decade ago, when she applied for clerical jobs, “as soon as I walked up, there was a sign saying ‘We’re hiring,’ but it’s not like that now,” she said. “It’s really, really difficult.”

Businesses that rely heavily on low-income shoppers worry that their customers will have little to spend. Najib Atisha, who co-owns two small grocery stores in Detroit, said people receiving government assistance made up about a third of his customers downtown and as much as 60 percent at his store on the west side of the city.

“Of course, we’re hoping that things will turn around, but it’s always easier to lose jobs than it is to gain jobs,” Mr. Atisha said. “I think it’s going to take twice as long to rebound as it took to get where we are now.”

Some business groups argue that extending unemployment benefits has had deleterious effects on employers and potential workers.

“It’s having a chilling effect on hiring,” said Wendy Block, director of health policy and human resources at the Michigan Chamber of Commerce. “At one point, our unemployment taxes were just a blip on the balance sheet, but when you’re talking over $500 a head, this is significant.” Last year, Michigan spent $6.2 billion on jobless benefits, according to the National Employment Law Center.

Some economic studies show that people who collect unemployment benefits are less likely to look for or accept work until their benefits are close to running out.

“Unemployment insurance extends the typical amount of time that people will spend off the job and not looking for work,” said Chris Edwards, an economist at the Cato Institute, a libertarian organization.

In Michigan, Ms. Metz said that if all else failed, she would have to move in with her parents, who live on a fixed income. But she is determined to find work before her benefits run out and plans to expand her search to include light industrial manufacturing. “It’s getting close to the end,” she said. “And I got to do what I got to do.”