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The Feckless Alliance
The Feckless Alliance
by Ted Galen Carpenter
The White House spin machine is working overtime to portray the agreement regarding Afghanistan reached at the weekend NATO summit in Strasbourg as a great victory for U.S. foreign policy. Obama himself expressed satisfaction that "our NATO allies pledged their strong and unanimous support for our new strategy."
The reality is far less reassuring. In fact, Obama failed in his effort to get the European members of NATO to commit significant numbers of additional combat forces to Afghanistan. Instead, what he got was a commitment to send a mere five thousand additional personnel. Even worse, virtually all of them are police officers or military trainers who will be stationed in areas of Afghanistan that experience little, if any, fighting. The European allies steadfastly refused to dispatch any more combat troops. In fact, some NATO members (most notably the Netherlands) plan to withdraw some of the forces they had previously sent to Afghanistan.
Washington needs far more than cheerleading and symbolic military deployments from its supposed NATO partners.
Contrary to the Obama administration's official cover story, the outcome of the Strasbourg summit was disappointing. It was little more than a European diplomatic sop to Washington. America's allies seem determined to persist in their policy of making symbolic rather than meaningful military deployments in Afghanistan. Germany and other countries have placed so many restrictions on the use of the forces they have already committed that U.S. generals express frustration bordering on fury. Several NATO governments insist that their troops be stationed far away from the principal combat areas in southern Afghanistan, or confined to noncombat roles entirely.
Allied pledges of "strong and unanimous support" at Strasbourg are simply more of the same. Michael Mandelbaum once skewered the Clinton administration's approach to world affairs as tending toward "foreign policy as social work." NATO's European members have gone one step farther, apparently viewing military policy as social work. With the partial exception of the British, their contribution to the mission in Afghanistan is increasingly focused on vague "stabilization" efforts and barely disguised nation-building fantasies.
Ted Galen Carpenter is vice president for defense and foreign policy studies at the Cato Institute, is the author of eight books and more than four hundred articles and policy studies on international issues. His latest policy study is "NATO at 60: A Hollow Alliance." He is also a contributing editor to The National Interest.
Washington needs far more than cheerleading and symbolic military deployments from its supposed NATO partners. The willingness of the European allies to wave their pompoms and express diplomatic support for the Obama administration's new approach in Afghanistan will do precious little to defeat al-Qaeda fighters.
The outcome at Strasbourg ought to increase skepticism in the United States about the military utility of NATO going forward–and not just with respect to the Afghan mission. Even some perceptive European officials had previously warned against the kind of feckless behavior evident at the summit. In January 2009, British Defense Secretary John Hutton blasted European governments for failing to bear their fair share of the collective defense burden, particularly in Afghanistan. He issued an especially pointed rebuke to Germany and other allies who seemed to believe that humanitarian and nation-building tasks were an adequate substitute for combat responsibilities. "It isn't good enough to always look to the U.S." to assume dominant security responsibilities, Hutton admonished. "And this imbalance will not be addressed by parcelling up NATO tasks–the 'hard' military ones for the U.S. and a few others and the 'soft' diplomatic ones for the majority of Europeans."
Hutton was right, but if the results at Strasbourg are any indication, his warnings have been ignored. America now has an alliance with nations that apparently believe that posturing and symbolism are adequate substitutes for meaningful military measures. That is a very bad bargain indeed for America, and it is high time that our leaders make a fundamental reassessment of our relationship with such irresponsible security partners.
Optimism Opium
Optimism Opium
by Laura Martin
In an Op-Ed piece in The New York Times (October 16, 1998), Gerald Celente predicted that government intervention to rescue "private corporations deemed ‘too big to fail’," would result in the demise of free-market capitalism.
Back then he called it "Capitalism for Cowards."
Today it’s called stimulus programs and rescue packages.
Back then, Celente warned the bailouts wouldn’t work.
Today, Celente repeats the warning … they still won’t work.
Back then, the government warned that if Long Term Capital Management, a hedge fund, was not rescued, the global financial markets would implode.
Today, with the markets imploding, the government warns that if favored banks, brokerages, leverage buyout firms, insurance companies, etc. are not rescued, the global economy will collapse.
Back then, Gerald Celente accurately forecast, "The global contagion may be temporarily suppressed by doses of monetary amoxicillin, but when an outbreak recurs, it will be in a bailout-resistant and far more virulent strain."
The global contagion was suppressed, the outbreak has recurred, and the more virulent strain is upon us. And, as Celente predicted, it is proving bailout resistant.
Today, Celente forecasts that no amount of monetary amoxicillin can cure the spreading virus.
Trend Warning #1: What’s being pitched today by the government has been tried before. It didn’t work then, and it won’t work now.
Following the Group of 20 summit, Barack Obama, while acknowledging there are no guarantees of success, declared, "I have no doubt, though, that the steps that have been taken are critical to preventing us sliding into a depression."
Given that President Obama cannot provide guarantees, how can he "have no doubt"? Moreover, all of the bailouts, rescue packages, stimulus plans that he has supported/and or initiated to date, have already failed. And since the new plans are but variations upon tried, tested and failed policies, they, too, are destined to fail. The G-20 will not be a "turning point" and while the steps taken may slow, they will not prevent us from "sliding into a depression."
Trend Warning #2: Don’t be seduced by temporary equity market spikes or leading economic indicator upticks. Be especially wary of pitchmen claiming the markets have bottomed and headlines insinuating that the worst is over ("Car sales not as horrid in March" and "Investors jump on good financial news," USA Today, 2 April 2009).
What is being sold as "good financial news is, upon examination, news that is marginally less dismal than expected. Nevertheless, for insiders and professional gamblers, there will be opportunities to briefly ride the market waves.
There may also be ephemeral selling opportunities following accounting rule changes allowing banks to set their own prices for assets regardless of market values, and thus dramatically reduce their losses. This is not a step to recovery. This little reported Financial Accounting Standards Board (FASB) ruling is accounting flimflam, a capitulation that allows banks to set values to their own toxic assets.
Pessimism Porn
Back in 1998, Gerald Celente was virtually alone in forecasting both increased government intervention, its inevitable failure and its catastrophic consequences. In the midst of the dot.com euphoria, with markets flying high, fortunes being made and optimism pandemic, any negative vision was ignored or sloughed off as gloom and doom.
Today, with every element in that decade-old forecast a daily reality and making global headline news, derision has replaced neglect. No longer able to dismiss, they attack. First it was TV clowns, now it is equally unqualified commentators.
Unwilling to face inescapable realities themselves, they try to deflect the public’s attention away from uncomfortable truths with unhappy endings. In his New York Times Op-Ed piece, Ben Schott, having cited Celente for correctly forecasting "The Asian Crisis and other calamities," sneers away his current predictions as "Pessimism Porn." (NYT, 26 March 2009.)
Presumably, Schott is more comfortable with the exhortations to Hope, Confidence and Optimism delivered by the Confidence-Man-in-Chief and his cadre of boosters. But if we are purveying "Pessimism Porn," Schott & Co. are peddling "Optimism Opium."
This pernicious panacea anesthetizes the public. "Optimism Opium" dulls the pain – lost jobs, foreclosure, financial ruin – relaxes anxiety, decreases alertness, impairs coordination, and is highly addictive. Repeated or chronic use results in mental deterioration. Overdoses can result in stupor, coma and death.
America is facing crises far beyond the financial. The implications are momentous. We are witnessing the decline of Empire America.
Insolvency vs. Liquidity, or Austrians vs. Keynesians
by Michael S. RozeffInsolvency vs. Liquidity, or Austrians vs. Keynesians
An economics debate of very great importance is surfacing. Is the government’s economic rationale for bailing out the banks valid? If it is not, then the entire case for the bank bailouts fails.
On one side of the debate are Austrians using Austrian economics, on the other side are Keynesians using Keynesian economics. Gary North writes "The government, which is running a trillion-dollar deficit this fiscal year, is adding ever more debt to save the favored banks. It is buying the banks' insolvency in the name of future taxpayers." North sees the bank problem as insolvency. Concerning FED and government power to create money and "fix the crisis," Lew Rockwell writes "Good liquidity needs to be based on savings and capital, and it cannot be created by decree. Decrees end up creating money out of thin air, which ends up overriding market preferences and generating inflation. Everything officials do to fix the crisis ends up prolonging it." Rockwell sees the FED’s provision of liquidity as impossible to reconcile with preferences, and with the attempt to provide it being counterproductive.
Observing a marked widening of credit spreads for many kinds of bonds, the Keynesians conclude that there is a liquidity problem in bank-held assets. Not accepting or applying either Austrian or finance theory, they fail to appreciate that the re-pricing of bonds from 2007 onwards is due to a higher price of insuring against recession and a correction to prior bubble prices. There is no liquidity problem in the credit markets.
Important new research supports the Austrians and suggests that the government’s rationale for bank bailouts is invalid. This research is highly technical, but it uses mainstream, basic, and widely-accepted finance theory. It shows that the higher required returns (or higher spreads) on toxic credit assets are not unusual in light of increased stock market volatility and other financial factors. The authors
"...conclude that the pricing of investment-grade corporate credit has largely been consistent with that of the equity market when viewed through the structural model. In other words, from the context of the structural model, there should be nothing particularly surprising about the severe widening of credit spreads in the investment grade CDX [credit index] and the underlying cash bond credit spreads. Indeed the observed widening of the CDX spread is, if anything, somewhat low relative to what the structural model forecasts conditional on the market declining by 40% and its long-term volatility doubling. The out-of-sample results challenge the commonly advocated view that the pricing of credit securities has become distressed, and instead suggest that spreads on the synthetic securities are unusually low."
The pricing of the toxic assets of the banks is in line with the pricing of other risky assets. There is no evidence that prices of credit instruments are now reflecting fire sales or distress selling. The evidence, if anything, suggests that the prices are actually on the high side. This means that the liquidity rationale of the Keynesians has no basis in fact.
The findings are sure to be contested in the literature, as most research is. In the end, they will prove robust. They will hold up.
The debate on bank bailouts is broader than economics. It goes to a question of justice. Should one group, taxpayers, be forced to pay for the mistakes of another group, bankers? It goes to a question of freedom versus socialism and fascism. Should banks operate in a profit and loss system and bear the losses that they incur, or should they not, in which case the financial system becomes more socialist and fascist? Even before addressing these questions, if the Keynesian policy does not do what it is claimed, then in economic terms the Keynesian case falls.
The government and FED claim that the financial system lacks liquidity. They say that there is a market pricing defect or failure. This, they say, is why the bad loans (toxic assets) held by the banks are worth more than the prices that they are fetching in the market. These prices, they claim, are fire sale prices. The remedy, they call for and implement, is for the Treasury and FED to supply the banks with liquidity, i.e., bail them out. Thus, the government and the FED are directing trillions of taxpayer dollars to shore up weak banks by buying their bad loans rather than overseeing a judicial-like process of re-organizing the banks and cleaning out these loans in established bankruptcy-like procedures.
The Austrian position is that the financial system does not lack liquidity. The bad loans were overpriced to begin with, largely because the FED and government engineered a speculative bubble. The bubble burst. The loans were repriced in the market. The loans are now worth what they are bringing in the market. Thus, the government has no liquidity justification for bailing out the banks. The government’s economic rationale has no merit. Many banks are insolvent. On the economic merits, they should be allowed to fail, not bailed out.
The study released by Coval, Jurek, and Stafford, appears here. It entirely supports the Austrian position. Their article examines the pricing of the bank toxic assets using the best available sophisticated financial techniques. It is done by researchers who are not Austrian economists. They unambiguously deny the government’s explanation.
Professors Coval and Stafford work at Harvard Business School, both in the area of finance. Professor Jurek is at Princeton in the economics department, where he teaches finance. None of these researchers does research in or associates himself with Austrian economics. None of their 60 references is to Austrian work. Most are to technical finance articles. The article itself makes no mention of Austrian economics.
Are major banks insolvent, or does the financial system lack liquidity? This question is in some ways a no-brainer, because it is obvious that as home prices fall substantially, those banks with very high leverage and lots of mortgage loans made with high loan-to-equity ratios are wiped out. This happens because the equity (home values) behind the loans becomes less than the face value of the loans. Superior and superb analysts like Reggie Middleton recognized this very early and explained it at length (see here.) Furthermore, there are major pools of liquid assets in the economy, such as huge amounts in money-market funds.
Nevertheless, Keynesians argue that the bank assets are being underpriced due to illiquidity. They argue that the bank problem is a liquidity problem, and that this justifies bank bailouts. Austrians view the FED and government as having promoted the bank loans that went bad via inflation and other housing policies. These loans went sour and were revealed as mal-investments when the boom ended and housing prices fell. The problem is not liquidity but bad loans and, in many cases, bank insolvency. This argument then – insolvency vs. liquidity – has emerged as a key difference in the last two years between Austrians and Keynesians.
In the past two years, the Federal Reserve (FED) and two federal government administrations have been disbursing trillions of dollars to banks, insurance companies, other financial institutions, and industrial firms. During this period, officials have again and again insisted that the economy was mal-functioning by not providing liquidity to viable firms. They argued that this lack of liquidity made it necessary to provide government resources to these firms, paid for by taxpayers, and to flood the banking system with Federal Reserve dollars, which, by the way, constitute a very serious inflation of the currency. For example, Ben S. Bernanke, the FED chairman, made the liquidity argument at length on December 1, 2008. A few quotes:
"...to offset to the extent possible the effects of the crisis on credit conditions and the broader economy, the Federal Open Market Committee (FOMC) has aggressively eased monetary policy...The Committee's rapid monetary easing was not without risks. Some observers expressed concern at the time that these policies would stoke inflation... the second component of the Federal Reserve's strategy has been to support the functioning of credit markets and to reduce financial strains by providing liquidity to the private sector – that is, by lending cash or its equivalent secured with relatively illiquid assets.
"To ensure that adequate liquidity is available, consistent with the central bank's traditional role as the liquidity provider of last resort, the Federal Reserve has taken a number of extraordinary steps...
"Judging the effectiveness of the Federal Reserve's liquidity programs is difficult. Obviously, they have not yet returned private credit markets to normal functioning. But I am confident that market functioning would have been more seriously impaired in the absence of our actions."
More recently, the U.S. Treasury on March 23, 2009, issued a white paper on the Geithner Public-Private Investment Program (PPIP). It says
"Troubled real estate-related assets, comprised of legacy loans and securities, are at the center of the problems currently impacting the U.S. financial system...The resulting need to reduce risk triggered a wide-scale deleveraging in these markets and led to fire sales. While fundamentals have surely deteriorated over the past 18-24 months, there is evidence that current prices for some legacy assets embed substantial liquidity discounts...This program should facilitate price discovery and should help, over time, to reduce the excessive liquidity discounts embedded in current legacy asset prices."
The notion of fire sales and liquidity discounts on the bad loans (called legacy loans) is firmly embedded in the rhetoric of U.S. policy makers. They are leaning heavily on this idea to sell the merits of their enormous wealth transfers to banks.
By contrast, the Austrians, as well as other financial analysts, have argued from the outset that the basic problem is not liquidity of the financial system. The argument on the Austrian side is that the banks and other financial institutions have not been in trouble because there is not enough liquidity to buy their loans. They are in trouble because they made bad loans that are worth far less than their values as carried on the banks’ books. The banks are often insolvent. Furthermore, these banks do not want to and refuse to sell these loans at the low values to get the liquid funds they want. They are playing politics. They are getting a better deal (a) by shifting some of these loans to the FED in return for Treasury securities, and (b) getting bailed out by taxpayer funds.
In the Austrian interpretation, the banks have waited while the government came up with various devices to bail them out with other people’s money. The latest is the Geithner PPIP that uses an FDIC guarantee to private parties to buy the bank loans at prices above market value. In the same vein, the accounting regulatory authority known as FASB has just allowed the banks leeway not to carry these bad loans at their market value by voiding the mark-to-market rule.
In April of 2008, Austrian economist Bill Anderson wrote:
"The Fed's latest move – permitting reeling financial institutions to use near-worthless mortgage securities as collateral for about $200 billion in loans – is yet another example of Bernanke's promise to ‘provide liquidity’ at every step, as though the real crisis here is the lack of play money in the nation's financial system...The simple issue is not lack of liquidity. It is the fact that billions – make that trillions – of dollars were malinvested in markets where the increasing values could not be sustained."
In October of 2008, I explained that the FED could not create liquidity in a market without destroying that market. For months, I have referred to the banking system as insolvent, such as here. More recently, I wrote that
"The entire thrust of FED policy as geared to liquidity is questionable. The banking problems center on bad bank loans and the reluctance of lenders to roll over short-term loans to banks whose assets are questionable. Like the TARP loans, the FED loans cannot resolve these problems. They have prolonged them by removing the incentive for banks, which otherwise would have been under greater market pressure, to resolve them. These loans have simply replaced private market capital that might have been supplied under more stringent conditions that would have forced the banks to face the problems and deal with them."
The government and FED story, which parrots the bankers’ story, is that the banks do not really have such bad loans. As their story goes, the loans are really worth more than what they are fetching in the market. The market pricing reflects distress sales or fire sales. The loans should not be marked to market, because the market doesn’t know what it’s doing. The banks were not badly managed in making these loans. If only these loans are given time to work out, their true worth will be discovered. It behooves the taxpayers to tide the banks over. It behooves the FED to take on these loans even if it means inflating the currency.
Coval et al. frame the dispute as follows:
"The government’s view is that a disappearance of liquidity has caused credit market prices to no longer reflect fundamentals...The main objective of this paper is to determine whether fire sales are required to explain prices currently observed in credit markets...A key distinction between the fire sale view and the other possibilities is that only the fire sale view requires that current prices are incorrect."
Their findings are as follows:
"The analysis of this paper suggests that recent credit market prices are actually highly consistent with fundamentals. A structural framework confirms that bonds and credit derivatives should have experienced a significant repricing in 2008 as the economic outlook darkened and volatility increased. The analysis also confirms that severe mispricing existed in the structured credit tranches prior to the crisis and that a large part of the dramatic rise in spreads has been the elimination of this mispricing."
Bank loan assets were overpriced during the boom. The risk premiums were too low. The overpricing of these long-term assets during the boom is consistent with the Austrian view of a speculative bubble. The market break in 2008 corrected the prices to levels consistent with the pricing of other risky assets. Coval et al. write
"In contrast to the main argument in favor of using government funds to help purchase structured credit securities, we find little evidence that suggests these markets are experiencing fire sales."
This implies that
"...many major US banks are now legitimately insolvent. This insolvency can no longer be viewed as an artifact of bank assets being marked to artificially depressed prices coming out of an illiquid market. It means that bank assets are being fairly priced at valuations that sum to less than bank liabilities."
In turn, this means that propping up the prices of toxic assets by flooding the banking system and the banks with money (inflation) serves no economic purpose. But, importantly, it transfers massive wealth from taxpayers to banks:
"...any taxpayer dollars allocated to supporting these markets will simply transfer wealth to the current owners of these securities."
The readable and non-mathematical discussion that begins on p. 16 of their paper pulls no punches. They end up with a conclusion made many times by those adhering to the Austrian analysis:
"...policies that attempt to prevent a widespread mark-down in the value of credit-sensitive assets are likely to only delay – and perhaps even worsen – the day of reckoning."
It is good to see mainstream support for the Austrian position. While it is late in the day to stop these bailouts and reverse them, it is not too late to put an end to the myth that the government is saving the banks by improving market liquidity. If the banks end up being saved by taxpayer dollars, we should know that it is because of an enormous wealth transfer to banks, bank stockholders, and bank creditors. We should know that it is at the cost of inflation and the costs of debt and taxes imposed on American taxpayers now and into the far future.
Baloney from the Bee
Baloney from the Bee
By Christopher Holton
But as we dug deeper into the article, the more we realized that it contained clues to a much larger puzzle.
That’s largely because of the complete lack of curiosity on the part of the reporters and editors at the Bee. This is unfortunately rather typical. So many of the articles on “Islamic” finance amount to fluff pieces which seem like nothing but regurgitations of marketing brochures and public relations press releases.
What makes the situation regarding this particular article so aggravating is the fact that just drilling down slightly raises all sorts of questions, yet the Bee didn’t bother.
The article starts off by assuming that Shariah-Compliant Finance has provided some sort of “shield” against the economic downturn. There is just a world of information out there to refute that, as we have documented on SFW:
• Qatar has had to bail out its banking system, which is almost entirely Shariah-Compliant.
• The UAE and Iran have both had to float conventional bonds to raise money.
• Stock markets throughout the Islamic world–Qatar, UAE, Saudi Arabia, Egypt to name a few–were all down sharply in February.
• Issues of “sukuk,” or Islamic bonds, were down 37% in Q1 2009 as compared to Q1 2008.
The Bee article mentions that Shariah-Compliant Finance prohibits investments in companies in the “weapons” business. This is a stark example of a lack of curiosity on the part of the journalists. That prohibition does not apply to companies that contribute to the “defense of Islam,” as I myself heard at the Harvard Law School celebration of “Islamic finance” in April of 2008. Need an example?
How about Bank Melli of Iran, which we have written about extensively on SFW. Bank Melli is the world’s largest Shariah-Compliant Financial institution. Bank Melli has also been sanctioned by the US, the EU and Australia for its finance operations in support of Iran’s ballistic missile program and support of terrorism.
This information is not hard to find. You actually have to try not to check out some of the claims associated with Shariah-Compliant Finance.
One of the Muslims interviewed in the article explains that his investments in the Shariah-Compliant Amana mutual funds have performed much better than non-Shariah-compliant investments.
The Amana funds have indeed performed extremely well, but not due to their adherence to Shariah. They are down 23% and 29% respectively over the past year
The Dow Jones Islamic Index is down over 33% for the year, as compared to 36% for the Dow Jones Industrial Average; not a lot of difference.
But it is notable that the Shariah-Compliant Iman Fund is down over 40% over the past year, thus it has fared worse than the S&P 500 and the Dow-Jones Industrial Average.
Again, Shariah-Compliant Finance has provided NO safe haven from the financial crisis.
But the story of the Amana Mutual Funds only begins with their performance. There is MUCH more to be curious about when it comes to these funds.
First of all, the Amana Mutual Funds web site has an extensive section on zakah, which is usually referred to as zakat. Zakat is a form of tithing in Islam in which pious Muslims are required to donate a portion of their wealth to the needy, most often these days through Islamic charities.
Here at SFW, we have documented the activities of the dozens of Islamic charities that have been discovered to fund terrorist organizations. No fewer than 27 Islamic charities have been designated as terrorist entities by the US Treasury Department, including the three largest Muslim charities in the US.
Zakat is one of the most opaque aspects of Shariah-Compliant Finance and it is rarely mentioned by Shariah-Compliant financial institutions, even though it is a requirement for Shariah Compliance.
The Amana Funds explain zakat in detail, without actually disclosing anything specific about where the money actually goes or who makes the decisions: http://www.amanafunds.com/zakah_1.html
This is where things start to get disturbing. On the page in which Amana instructs investors as to how much money to devote to zakat, they quote none other than Sheikh Yusuf al-Qaradawi.
To fully explain why this attribution is so troubling, we will repeat our background on Qaradawi here:
There is so much more to know about Sheikh Qaradawi. First of all, he is banned from entering the US and the UK for his ties to terrorist organizations. In 2001, Sheikh Qaradawi was the chairman of the Shariah Advisory Board of Bank al-Taqwa, which was shut down by the United Nations and the US Treasury Department for funneling large amounts of money to several Jihadist terrorist organizations, including Ayman al-Zawahiri’s Egyptian forerunner of Al Qaeda. Much of the money came through a Shariah-Compliant real estate firm in New Jersey and the money was funneled to the terrorist groups as zakat payments to charities.
Earlier this year, the US Treasury Department designated the Union of Good, an umbrella group of 57 charities run out of Saudi Arabia, as a terrorist entity. Qaradawi runs the Union of Good.
Qaradawi has written extensively in support of “martyrdom” operations (suicide bombings) against Israelis and Americans. And here are Sheikh Qaradawi’s views on women’s rights:
Beating is not suitable for every wife; it is suitable for certain wives and for other wives it is not. There is a woman who cannot agree to being beaten, and sees this as humiliation, while some women enjoy the beating and for them, only beating to cause them sorrow is suitable…
In the financial realm, back in October 2008, Qaradawi called for Islamic finance to replace capitalism. In 2006, he told the BBC that he liked to refer to Shariah-Compliant Finance as “jihad with money,” because “allah teaches us to fight our enemies” with weapons and our money.
The mention of Qaradawi on the Amana Funds web site certainly got our attention and it is too bad that the Bee reporters didn’t bother to look into zakat or even Google “Qaradawi.”
Our next step was to look into who Amana’s Shariah advisors are. It turns out that Amana does not disclose anyone by name, but identifies the Fiqh Council of North America as their adviser on Shariah.
The Fiqh Council of North America has a troubling background. It is an outgrowth of the Muslim Students Association, a Muslim Brotherhood front group funded out of Saudi Arabia. It is an affiliate of ISNA, the Islamic Society of North America. ISNA was founded in part by Sami al-Arian, who is now in jail for ties to terror funding. The president of the Fiqh Council of North America, Taha Jaber Al-Alawani, was named an unindicted co-conspirator in al-Arian’s prosecution.
The Justice Department named ISNA an unindicted co-conspirator in the Holy Land Foundation terrorism financing trial in which America’s largest Muslim charity was shut down for funding terrorist organizations.
One of the original trustees of the Fiqh Council of North America was Abdurrahman Alamoudi, who is now serving a 23 year sentence on terrorism charges. Alamoudi had raised millions of dollars for Al Qaeda.
The current chairman of the Fiqh Council of North America, Muzammil Siddiqui, was with the Muslim World League, an entity identified as having ties to Al Qaeda. On October 28, 2000 at a rally in Lafayette Park in Washington D.C., Siddiqui said, “America has to learn — if you remain on the side of injustice, the wrath of God will come!”
Another member of the Fiqh Council of North America, Jamal Badawi, issued a fatwa authorizing a husband to physically punish his wife: “There are cases, however, in which a wife persists in bad habits and showing contempt of her husband and disregard for her marital obligations. Instead of divorce, the husband may resort to another measure that may save the marriage, at least in some cases. Such a measure is more accurately described as a gentle tap on the body, but never on the face, making it more of a symbolic measure than a punitive one.”
The invaluable people at The Investigative Project have much more information on the Fiqh Council of North America:
The G(rasping)-20
The Goal Is Freedom
The G(rasping)-20
By Sheldon Richman • Published: 3 April 2009
We expected little of sense to come out of the G-20 summit, and it met our expectations with flying colors.
When you don’t understand how the economy got into a mess, you are not likely to understand how it can get out. Politicians either can’t or won’t graps the key fact: “the free market” did not cause our problems. How do we know this? It’s logic: the nonexistent cannot be the cause of anything. I’d like someone to show me this free market that brought on all the current turmoil. Please. The banking industry gets most of the blame, but banking has been part of a formal government-sponsored cartel since 1914 and is regulated, as well as privileged, by multiple layers of authorities, among them the Federal Reserve, the Federal Deposit Insurance Corporation, and the Comptroller of the Currency. An international agreement among the major central bankers, the Basel Accord, controls capital requirements and related matters. (Before 1914 a patchwork of regulations existed.) And let’s not forget the regulators in the states. With perhaps a local or exception or two, there has never been an unregulated banking industry in America (or most anywhere else).
This only scratches the surface of the corporate state’s stewardship of the economy. But politicians, who wield power and spend coercively acquired money for a living, have no incentive to see this. How could they? That’s not how the game of politics is played. They have no reason to see things in a way that would counsel against their exercising authority.
So, with complete predictability, the Gang of 20 promised to spend over a trillion dollars they don’t have to “stimulate” the world economy, to help struggling countries through the IMF (its record is so good at that), and other noble purposes. The G-20 also endorsed worldwide inflation by central banks and promised—I love this one—to “take action against” tax havens.
“The era of banking secrecy is over,” said the communiqué, as though that were a good thing. “We stand ready to deploy sanctions to protect our public finances and financial systems.”
The Obama administration led us to believe it was standing firm against a world regulatory authority, which was pushed by French President Sarkozy. But you be the judge. Here’s what the communiqué says:
“We each agree to ensure our domestic regulatory systems are strong. But we also agree to establish the much greater consistency and systematic cooperation between countries, and the framework of internationally agreed high standards, that a global financial system requires…. In particular we agree: … to establish a new Financial Stability Board (FSB) with a strengthened mandate, as a successor to the Financial Stability Forum (FSF), including all G20 countries, FSF members, Spain, and the European Commission…; to reshape our regulatory systems so that our authorities are able to identify and take account of macro-prudential risks; to extend regulation and oversight to all systemically important financial institutions, instruments and markets. This will include, for the first time, systemically important hedge funds; to endorse and implement the FSF’s tough new principles on pay and compensation and to support sustainable compensation schemes and the corporate social responsibility of all firms….”
And more—as if the regulators could have the requisite knowledge to manage economic affairs. This is a regulatory cartel, and to the extent it squelches competition among jurisdictions, it will produce all the evils of a coercive monopoly. That of course is the point. There is to be no safe haven where people can protect their wealth from the grasping politicians.
Economies Aren’t Run
The presumptuous and undistinguished assembly in London—why are they regarded by the media as wise men and women of accomplishment?—aspire to run the world economy, and they know that out-and-out nationalization is not necessary to that end. Of course, they disclaim any such objective. The current White House occupant, Barack Obama, said in his post-conference news conference that he believes in the free market—he did say that!—but that government must set rules to keep it from running “off the rails.”
Well, of course, an economy is not a locomotive and there are no rails. It’s people engaging in exchanges. “Society is purely and solely a continual series of exchanges,” said the eighteenth-century French liberal economist Destutt de Tracy. So Obama’s idea translates into politicians regulating our peaceful, consensual conduct in order to bring about or to avoid certain outcomes. The current economic turmoil has politicians convinced that they must limit risk taken by financial firms. This, pardon me, is a bad joke. It is none other than government itself that has systematically socialized risk in the financial industry and therefore encouraged individuals and firms to undertake greater risks than they would have taken otherwise. The irony is that the more the politicians strive for a risk-free society, the greater the danger to us all. That’s moral hazard, the largest manufacturer of which is the state.
If banks, hedge funds, and other sorts of operations (including government-sponsored enterprises) assume the Federal Reserve or the Treasury will bail them out in a crisis, they will be less risk-averse than they would have been without that guarantee. If depositors see an FDIC sticker on every bank they encounter, they won’t be too particular about which one they entrust with their money. Safety will not be a competitive factor because deposit insurance makes them all appear equal. The bankers know this.
Full Market Discipline
If politicians were really interested in reducing reckless financial activity with the potential for external harm, they would want to see the full force of market discipline at work. The full force. But remember the point about political incentives. Letting market forces discipline banks, insurance companies, automakers, and other firms would leave politicians and bureaucrats little to do. Market discipline—the threat of loss and bankruptcy—is the product of laissez faire, and, loosely translated, that means: “Politicians, keep your cotton-picking hands off peaceful voluntary exchange.”
We face a serious challenge. On the one hand, people who understand markets realize that government regulation—which includes the corporate safety net—was the essential cause of the economic failure. Any seeming irrationality by bankers and financial managers must be grasped in the context of well-understood government guarantees, including the implied promise by the Federal Reserve—the Great Counterfeiter—to buy toxic assets and provide fiat liquidity in a crunch. This was the indispensable underpinning of the government housing policy that encouraged the making and securitizing of dubious mortgage loans (prime and subprime) and the underwriting of those who invested in them.
On the other hand, people who don’t understand markets or who dislike markets can always blame them for any problem that arises. After all, government regulators, no how much power they have, can’t be everywhere watching everything, can they? So as I’ve written elsewhere, “No matter how much the government controls the economic system, any problem will be blamed on whatever small zone of freedom that remains.” (I modestly acknowledge that Laurence Vance has dubbed this, Richman’s Law. I have no objection.) And the “solution” will be—of course—more regulation. Just ask Obama and Treasury Secretary Timothy Geithner. Don’t think of regulation as being imposed. Think of it as the modest price for government privileges and protection.
So the market’s opponents can rely on demagogic sound bites and pervasive economic ignorance, while the market’s defenders must ask people to think. Sad to say, this puts the freedom philosophy at a disadvantage. And so we press on.
Think Again: Japan's Lost Decade
| Think Again: Japan's Lost Decade | |
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As the economic gloom deepens, many American politicians and commentators have invoked the recent history of Japan as a cautionary tale. But the comparison may be more misleading than helpful.
Not exactly. Decades of extraordinarily high growth in postwar Japan culminated in a huge asset price bubble that reached its peak in 1989. When the bubble finally popped in 1990, wiping out billions of dollars in accumulated wealth, the country's growth rates turned anemic. Between 1990 and 2003 Japan dipped into and out of recession. Despite these troubles, though, Japanese GDP in the 1990s ultimately continued to grow at an average of about 1.5 percent per year, measured in real terms. That translates to a 10 percent increase in the size of the economy over the course of the decade, well lower than the much more robust rates of growth in many other industrialized economies during the same period, but hardly a Great Depression. What's more, unemployment never rose over 5.5 percent -- a rate that would be considered quite an achievement in the United States or Western Europe.
The Japanese do refer to the 1990s as the "Lost Decade," but the label is a bit misleading. Productivity did slide, though not dramatically. If anything was lost in the course of those years, it was the sense of pride and exaggerated confidence that marked the previous era of frenetic growth. Japan lost belief in its own ability to create economic miracles. Yet its economy remained remarkably strong. Japanese automobile companies remained some of the world's most profitable. Japanese consumer electronics manufacturers and machine tool producers continued to post good results despite the rise of low-cost rivals elsewhere in Asia.
No. Government policy did exacerbate the slowdown, but the picture is much more complicated. Bureaucrats and politicians certainly spent too much on the wrong sorts of things, especially bridge-to-nowhere-style construction projects with limited usefulness. But economists have concluded that large chunks of the spending -- particularly on useful infrastructure, healthcare, and education -- brought substantial benefits. Adam Posen, deputy director of the Peterson Institute for International Economics, has argued that Japan's 1995 stimulus package actually spurred growth the following year. When the government tightened fiscal policy again soon afterward, growth tailed off again. The lesson: Spend, but spend intelligently.
Many students of the period point to other crippling errors. The Bank of Japan maintained high interest rates for too long after the slowdown became apparent. At one point an overly optimistic government raised taxes prematurely, which certainly prolonged the slump.
Policymakers hobbled by a dysfunctional political system dawdled for years when it came to cleaning up "zombie" companies (bankrupt in all but name) and getting financial institutions to dispose of toxic assets. That failure to take decisive action may have shaved points off Japan's overall growth rates and ended up leaving the country saddled with enormous public debt (peaking at 175 percent of GDP by one recent measure). Yet, a push to force banks to shed their nonperforming loans under the government of Prime Minister Junichiro Koizumi starting in 2001 had notably positive effects on growth.
Hardly. To be sure, Japan has been hit extremely hard by the recent turmoil. At first it looked as though the Japanese economy might have good chances to ride out the crisis better than the United States, because Japanese financial institutions had largely averted the securitized mortgages and dubious derivatives that sent the U.S. economy reeling. But the slump in the United States, China, and Europe -- major markets for Japanese exports -- soon rebounded on Japan with vicious force. In the past few months Japanese exports have collapsed, and growth has nose-dived correspondingly. Japan's economy has been hit much harder than America's.
It's worth noting, though, that this slump comes hard on the heels of the country's longest postwar boom -- a period of growth from 2002 to 2008 that was driven by a strongly performing real economy rather than a credit frenzy.
Even now, Japan is still the world's second-largest national economy. Japan boasts a highly skilled workforce and a powerful array of smart companies. Case in point: Companies like Toyota and Honda have slashed inventories as the demand for cars has plummeted. And yet, drawing on their ample reserves of cash, they've continued their funding of research and development for the next generation of green cars, extending an already formidable lead. When the world's economy picks up again, they'll be perfectly positioned to benefit.
Japanese infrastructure rivals that of any country in the world. The yen remains one of the world's strongest currencies, and Japan remains one of the world's primary creditor nations, a major advantage over the United States, which has chosen to finance its debt externally. One often hears China referred to as "America's banker," yet Japan holds almost as much U.S. Treasury debt as China.
Not really. To be sure, both recessions had their roots in the collapse of an asset price bubble based primarily on real estate. But there are some important differences.
For one thing, U.S. policymakers have so far acted much more decisively than Japan's risk-averse bureaucrats in the 1990s. Economists have taken note of some of the most important lessons of Japan's Lost Decade, such as the dangers of premature fiscal contraction and the need for swift action to clear away the bad debts clogging the financial system. Some economists argue that Japan's corporate debt was actually much bigger than the one now facing Americans.
On the other hand, most of Japan's bad debts were held by corporations, which arguably made the problem easier to tackle once the politicians got down to business. When the Koizumi government finally buckled down to the problem of getting banks to clean up their act, the economy responded with remarkable speed. By contrast, the present U.S. slump is the result of a culture of financial profligacy that enmeshed consumers and homeowners as well as major financial institutions. That could make it much harder to sop up the flood of bad debt.
Moreover, the United States' credit binge has been financed largely by foreigners, adding another element of instability to an already bad situation. Funding the ambitious program of the Obama administration will require convincing overseas creditors -- including the Japanese -- as well as skeptical domestic taxpayers.
Don't bet on it. To be sure, there are plenty of problems. Although many aspects of Japanese society have experienced profound change in recent years, the political system has remained remarkably static.
Politicians seem paralyzed -- even as the global economic crisis poses a whole set of new challenges to Japan's manufacturing-based economy.
And policymakers are even less effectual when it comes to what is probably the biggest threat to Japan's future: a steady demographic slide. The Japanese government has estimated that the population of the country (now 127 million) will drop to less than 100 million by 2050. Thanks to high life expectancy, some forecasts say that the number of Japanese over the age of 65 will rise to 40 percent of the population over the same period. One likely solution to the problem: immigration. But that's unlikely to happen, given the deep-seated Japanese reluctance to allow a large-scale influx of foreign workers.
And yes, the economy has some changing to do as well. Productivity could be dramatically increased by giving women greater work opportunities. Promoting foreign investment -- still shockingly low -- could also boost efficiency. Education reform, as well as measures to encourage entrepreneurship and creativity, would offer a needed dash of flexibility.
Don't count Japan out, though. If there's one thing the country has demonstrated throughout its history, it's an ability to indulge in dramatic, if not downright revolutionary change when circumstances call for it. In the late 19th century, the nation's ruling class drove Japan through a wrenching modernization process that transformed it from an isolated feudal kingdom into a global power in the course of a generation. Virtually overnight after World War II, the country turned its back on hypernationalist militarism and reinvented itself as a peace-loving American protégé and economic powerhouse. In that sense, this latest economic storm could well turn out to be a blessing in disguise.
The Benefits of Failure by Peter T. Leeson
The Benefits of Failure by Peter T. Leeson
The Article of the Day from the Washington Times:
In a market economy, business deaths are like death itself - an unfortunate but inevitable fact of life. However, recent government bailouts have tried to stop the inevitable by intervening in the market, at least temporarily saving failed firms from the economic grim reaper. Before putting the next failed business on life support, it’s worth remembering why it makes sense to let struggling producers expire.
• When failing businesses are allowed to fail, resources are released from employments where they don’t add value and made available for employments where they do.
Resources used for one purpose can’t be used for another. Thus, it’s important that they find their way to the purposes we value most. Enter the profit-and-loss system. Under this system, when producers use resources in ways that are consistent with our wants, they earn profits. When they don’t, they earn losses. If losses are severe enough or accumulate over time, the producers who earn them go under.
Far from cause for concern, this failure is cause for celebration. When ineffective producers fail, resources committed to producing goods we value less are freed for producing goods we value more. Polaroid’s failure released resources for the production of digital cameras; Commodore Computers’ failure released resources for the production of IBM computers; and Chi Chi’s restaurant’s failure released resources for, well, the production of food that tastes good. Who better to sacrifice the resources required to expand production of the things we want than producers of the things we don’t?
If government prevents failing producers from going out of business, resources get “stuck” in employments where they’re less productive. We can’t have as many of the products we care more about because the means needed to make them remain locked in the manufacture of products we care less about. Society suffers as a result.
• When failing businesses are allowed to fail, producers learn how to combine resources in ways that create wealth.
We take it for granted that producers know what we want. But this information doesn’t appear magically. It has to be produced. The profit-and-loss system produces this information - but only when government lets failing businesses fail.
Profits and losses do for producers what traffic signals do for drivers. They tell them when to “go,” “slow down” and “stop” their productive activities. By communicating which resource combinations consumers value most and which they don’t, profits and losses direct “economic traffic,” informing producers how to produce.
If government prevents ineffective producers from failing, the red light on the “economic traffic signal” stops working. Production continues and resources flow when they should halt, destroying wealth instead of creating it.
• When failing businesses are allowed to fail, producers have incentives to combine resources in ways that create wealth.
The profit-and-loss system works because successful producers reap rewards when they combine resources effectively and unsuccessful producers incur costs when they don’t. The prospect of profits from making good decisions and losses from making bad ones encourages producers to make choices that improve our lives.
But if government shields ineffective producers from the consequences of their bad decisions, producers’ incentives become skewed. For instance, when policy permits producers to enjoy the benefits of successful risk-taking but subsidizes the losses of unsuccessful gambles, producers have an incentive to take on more risk than they should. Since they’re no longer responsible to consumers when they make poor choices, the link connecting producers’ and consumers’ interests is weakened and, with it, the economy’s ability to advance.
At a time when failure is the new dirty word and government seems willing to prop up floundering firms at any cost, we would do well to remember the benefits of letting failing businesses go belly up.
Peter T. Leeson is BB&T Professor for the Study of Capitalism at George Mason University and author of the new book, “The Invisible Hook: The Hidden Economics of Pirates.”.
The Fundamental Obstacles to Economic Recovery: Marxism and Keynesianism
The Fundamental Obstacles to Economic Recovery: Marxism and Keynesianism
In a previous article, I explained how falling prices, far from being deflation, are actually the antidote to deflation. They are the antidote, I explained, because they enable the reduced amount of spending that deflation entails to buy as much as did the previously larger amount of spending that took place in the economic system prior to the deflation.
Despite the fact that the freedom of prices and wages to fall is the simple and obvious way to achieve economic recovery, two fundamental obstacles stand in the way. One is the exploitation theory of Karl Marx. The other is the doctrine of unemployment equilibrium, which was propounded by Lord Keynes.
According to Marxism, any freedom of wages to fall is a freedom for capitalists to intensify the exploitation of labor and to drive wages to or even below the level of minimum subsistence. This dire outcome can allegedly be prevented only by government interference in the form of minimum-wage and pro-union legislation. Such legislation, of course, makes reductions in wages simply illegal in all those instances in which the legal minimum wage would have to be breached. It also makes reductions in wages illegal in all those cases in which carrying them out depends on the ability to replace union workers with non-union workers in defiance of existing laws or government regulations. The influence of labor unions on wages pervades the economic system, with government protection of labor unions serving to prevent wages from falling even in companies and industries in which there are no unions. This is because non-union employers must pay wages fairly close to what union workers receive lest their workers too decide to unionize. In that case, the firms would be faced not only with having to pay union wages but also with all of the inefficiencies caused by union work rules.
The Keynesian unemployment equilibrium doctrine claims that it would make no difference even if wages and prices were totally free to fall. In that case, say the Keynesians, all that would happen is that total spending in the economic system would fall in proportion to the fall in wages and prices.
Thus, say the Keynesians, if, in response to an economy-wide fall in total spending of, say, 10 percent, wages and prices also fell by 10 percent, then instead of 90 percent of the original total spending now buying as much as did the original spending, total spending would fall by a further 10 percent. As a result, say the Keynesians, no additional goods or services whatever would be bought; all that would allegedly be accomplished is to make the deflation worse than before, as sales revenues and incomes throughout the economic system fell still further.
In sum, while the influence of Marxism stands directly in the path of a fall in wage rates and prices, by blocking its way with laws and threats, Keynesianism aims to prevent any attempt to overcome these obstacles by allegedly demonstrating the futility and harm of doing so.
Both doctrines are fundamental obstacles in the way of economic recovery and must be deprived of influence over public opinion in order for economic recovery to take place. The prerequisite of this necessary change in public opinion is the existence of a powerful, demonstration of the utter fallaciousness of these doctrines that at the same time proves that a free market is the foundation both of full employment and of progressively rising real wages.
Happily, this demonstration already exists, in full detail. It can be found in my book Capitalism: A Treatise on Economics, in the 269 pages that comprise Chapters 11, 13-15, and 18, which are respectively titled “The Division of Labor and the Concept of Productive Activity,” “Productionism, Say’s Law, and Unemployment,” “The Productivity Theory of Wages,” “Aggregate Production, Aggregate Spending, and the Role of Saving in Spending,” and “Keynesianism: a Critique.”
Milton Friedman’s ‘Pluck’ Gives Hope to Jobless: Kevin Hassett
Commentary by Kevin Hassett
April 6 (Bloomberg) -- The U.S. unemployment rate skyrocketed to 8.5 percent in March, and there is every reason to expect that it will soon be above 10 percent. Given how bad things are, it will probably break the postwar record of 10.8 percent, set in late 1982.
Even if we don’t challenge that record, this recession is already worse than its 1980s counterpart. Back then, unemployment had been quite high for many years before it spiked. The unemployment rate in late 1982 was just 2.3 percentage points higher than it had been a year earlier.
This time, the turnaround in our fortunes has been sudden and sharp. It seems almost impossible, given how bad things are now, that in March 2008 the unemployment rate stood at 5.1 percent -- 3.4 percentage points lower than it is now. That means the surge in unemployment over the past year is even more radical than the one that produced the modern record. The economy has fallen off a cliff.
Almost everyone has now been affected. A recent ABC News/ Washington Post poll found that 60 percent of Americans had a close friend or family member who had been laid off.
Unemployment this high brings with it widespread suffering that hasn’t been felt by an entire generation, suffering that feels worse because recent times were so good. Americans seem to be more somber now than at any moment in my lifetime.
But while the rapid reversal in fortunes is challenging emotionally, the steepness of our fall is cause for hope. The latest evidence from the economics literature shows that steep economic drops might actually portend good news ahead.
Friedman’s Plucking
The reason is that economists have developed models that have, in many ways, confirmed an observation of Nobel Prize- winning economist Milton Friedman.
Back in 1964, Friedman speculated that the economy might be thought of as a plucked string: The farther you pull it, the more forcefully it snaps back. That analogy gave the Friedman idea its name, “the plucking model.”
The economy can go down for many reasons. If the world suddenly and permanently demands less of our best product, then a decline today is a harbinger of bad times ahead.
If, however, panic drives everyone to stop buying just about everything, then buying will resume when the panic subsides, and we could easily -- and quickly -- end up back where we started. A panic like that would fit the bill for a Friedman “pluck.”
So if the economy is going to decline, it’s good news to find out that it’s been plucked. That means a snap-back is imminent.
Butterfly at Ceiling
I find it useful when thinking about the Friedman model to use an alternate analogy. Imagine that you are in a room with an upward sloping ceiling. There is a butterfly in the room that wants to escape, and it follows the ceiling up and up over time.
If the height of the butterfly represents gross domestic product, we can say that the economy is generally trending higher. If it happens to flutter down far away from the ceiling, that means its next movement is likely to be steeply back up.
The hard part, of course, is figuring out whether a given decline is lasting bad news or a temporary pluck.
Until recently, that problem seemed intractable. But over the past few years, econometricians have developed sophisticated models that have solved the problem.
The frontier of this literature has been stretched by a fascinating new working paper by George Washington University’s Tara Sinclair. Sinclair’s model can take the data for an economy and filter out an estimate of whether any plucks occurred.
Cause of Recessions
Looking back at postwar U.S. history, Sinclair finds strong evidence that plucks explain many of our recessions, but not all. That is, she has confirmed that the Friedman analogy is a useful one for policy makers, who can better concoct responses if they know whether one should rationally expect a given slump to reverse itself on its own.
Sinclair told me last week that she recently detected something that may be good news for the outlook going forward: “My updated results show that the ‘pluck’ part of the latest recession began in the fourth quarter of 2008.”
That means that the first part of this recession was a lasting adjustment to the collapse of our financial sector, unlikely to reverse itself anytime soon. On the other hand, the radical declines of the past two quarters are likely transitory, presaging strong quarters to reverse the pluck.
While Sinclair was reluctant to offer a forecast on the outlook, she added that “on average, plucks last just under four quarters.”
With that history as a guide, then, it would seem that the recovery may well be rapid and begin later this year.
Sinclair’s results also imply that the lateness of the pluck means that permanent damage has been suffered. When we do recover, we will go back to where we were late last year, with unemployment in the 7 percent range, rather than to the halcyon days. After that, we can expect a slow and painful drift to full employment.
Sadly, from where we are sitting, 7 percent unemployment looks pretty good, and the news that we have been plucked provides some comfort as more awful news arrives.
(Kevin Hassett, director of economic-policy studies at the American Enterprise Institute, is a Bloomberg News columnist. He was an adviser to Republican Senator John McCain of Arizona in the 2008 presidential election. The opinions expressed are his own.)
Bernanke ‘Green Shoots’ May Signal False Spring Amid Job Losses
April 6 (Bloomberg) -- It will be months before it’s clear whether what Federal Reserve Chairman Ben S. Bernanke calls the U.S. economy’s “green shoots” represent the early onset of recovery, or a false spring.
The Labor Department’s April 3 report that the economy shed an additional 663,000 jobs last month, while the unemployment rate rose to 8.5 percent, will be followed by months more of bad-news headlines, economists say. The recession, now in its 17th month, has already cost 5.1 million Americans their jobs, the worst drop in the postwar era; unemployment may hit 9.4 percent this year, according to the median estimate in a Bloomberg News survey, and may top out above 10 percent in 2010.
The risk is that the jobs picture turns even more bleak than forecast or the drumbeat of bad news still to come causes consumers, whose spending has firmed up in recent months, to hunker down again.
“If something happens to spook consumers and they crawl back into their tortoise shells, that would be terrible news,” says Alan Blinder, former Fed vice chairman and now an economics professor at Princeton University.
Consumer spending, which accounts for more than 70 percent of the economy, rose 0.2 percent in February after climbing 1 percent in January, breaking a six-month string of declines.
“Whether the little wisps of improvement in spending are sustained needs watching,” says Stephen Stanley, chief economist at RBS Securities Inc. in Greenwich, Connecticut.
Interest Rates
Declining interest rates on mortgages and business loans led Bernanke, 55, to tell CBS Corp.’s “60 Minutes” on March 15 that he sees “green shoots” in some financial markets, and that the pace of economic decline “will begin to moderate.”
Fueled by optimism that the economy may finally be stabilizing, the Standard & Poor’s 500 Index last month gained 8.5 percent, the most in seven years. Still, “I would be careful about chasing this rally,” Jason Trennert, chief investment strategist at Strategas Research Partners in New York, said in a March 27 interview.
With the Obama administration borrowing to finance record budget deficits, U.S. debt sales will almost triple this year to a record $2.5 trillion, according to estimates from Goldman Sachs Group Inc.
The borrowings may send 10-year yields as high as 6 percent by the end of 2010 from 2.9 percent on April 4, Trennert says, adding that it’s “hard to get optimistic” about stock prices “if you’re in a situation where it’s reasonable to expect long- term interest rates to be higher.”
Stock-Price Plunge
Another plunge in stock prices is just one of the things economists say might derail any recovery. Others include the disorderly collapse of General Motors Corp., Chrysler LLC or a major financial firm; or the failure of the Obama administration’s bank-rescue plan.
A one-month jump in the jobless rate of more than 0.6 percentage point would be a severe blow to confidence, says Alan Blinder, former Fed vice chairman and now an economics professor at Princeton University. So would monthly job losses that continue to top 600,000 into the second half of the year, says Mark Zandi, chief economist at Moody’s Economy.com in West Chester, Pennsylvania.
Payrolls have been shrinking by more than that every month since December. Losses need to come down below 500,000 in the next few months and drop close to 100,000 by year-end to confirm that the worst of the recession is over, Zandi says.
“If we continue to lose 600,000-plus jobs a month, that will burn out those green shoots pretty quickly,” he says. “If you lose jobs like that, it continues to undermine consumer spending and confidence.”
‘Head Fake’
Joseph LaVorgna, chief U.S. economist at Deutsche Bank AG in New York, says he wouldn’t be surprised to see a first- quarter gain in consumer spending that “may turn out to be a head fake, which isn’t uncommon in a recession.” Spending might turn lower in the current quarter before stabilizing in the second half, he says.
If consumers retrench, “you’d be looking at a very negative scenario again,” says David Hensley, director of global economic coordination at JPMorgan Chase & Co. in New York.
Hensley is watching the savings rate, which reached 4.4 percent of disposable income in January after hovering below 1 percent for most of the past four years. Any further surge in savings would indicate that Americans are still avoiding big purchases.
‘Not Enough Income’
“There’s just not enough income in the system to support both an increase in the savings rate and stable consumer spending,” Hensley says.
First-quarter earnings reports from Citigroup Inc. on April 17 and Bank of America Corp. on April 20 will be among early signposts. Those will be followed at the end of the month by the Treasury Department’s “stress tests” of the two firms and other major banks to identify which ones need additional capital.
Citigroup and Bank of America both reported a strong start to the year, and a rally in their shares last week helped send stock indexes to their highest levels since early February. Disappointing quarterly results might quickly reverse those gains.
What’s more, Stanley says, stress tests showing more than a few banks are too frail to continue would trigger wider credit spreads and tighter lending conditions. The so-called TED spread, the gap between what banks and the Treasury pay to borrow for three months, ended last week at 95.5 basis points, close to the low for 2009 of 90 basis points, reached Feb. 10.
Triple the Level
While that’s down from the peak of 463 basis points on Oct. 10, 2008, it’s still triple the level of two years ago, before the recession began.
The Obama administration is also looking for a solution in the next two months to the auto industry’s woes, perhaps through a merger for Chrysler and a quick and orderly bankruptcy filing for General Motors.
The administration has given Chrysler until May 1 to complete a combination with Italy’s Fiat SpA, and GM has until the end of May to “fundamentally restructure.” If they fail to meet the deadlines and one or the other collapses in a disorderly heap, the ripple effects would be felt throughout U.S. manufacturing, causing the loss of another million jobs and pushing unemployment to 11 percent, LaVorgna says.
The outlook for a second-half pickup also depends on the Treasury successfully executing its plan to help banks remove as much as $1 trillion worth of devalued loans and securities from their books so they can start lending again and resuscitate the economy.
“Basically, it’s a confidence story,” says LaVorgna. “The risk is that banks could deteriorate further and prolong the pain.”
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