The Fed Throws A Spit Ball

As the American Lost Decade(s) unfold, the Federal Reserve’s options to influence economic output dwindle. Today, the Fed confirmed the economic horizon will remain bleak. It also announced it would sell $400 billion of its near dated Treasuries and buy longer maturity ones. In a nut shell, Bernanke is trying to keep today’s free money and ‘bend’ the long term interest rates lower. The move (like earlier QE2) will have little impact in real economic output. The markets understandably aren’t impressed and fell on the grim forecast:

The Fed will replace some shorter-term debt in its portfolio with longer-term Treasuries in an effort to further reduce borrowing costs and keep the economy from relapsing into a recession, confirming market speculation that policy makers were planning an “Operation Twist” similar to a program in 1961.

“Markets took note of the Fed’s downward revision of the economic outlook and upgrading of downside financial risks,” Mohamed A. El-Erian, chief executive officer at Pacific Investment Management Co. in Newport Beach, California, wrote in an e-mail. Pimco is the world’s largest bond-fund manager. “While Fed purchases can influence Treasury and mortgage valuations, it is limited in its ability to deliver economic outcomesz” . . .

The Fed also said today it will reinvest maturing housing debt into mortgage-backed securities instead of Treasuries. “The mortgage story is the most important part,” said William Larkin, a fixed-income money manager who helps oversee $500 million at Cabot Money Management Inc. in Salem, Massachusetts. “This goes right to the source. This will create a wave of refinancings on the mortgage side.”

In short, the Fed’s move will not impact the real economy but might have some impact on artificial economic activity like re-financing, although that market segment is not infinitely elastic — i.e., many have already re-financed and now weigh the costs (aggravation as well as real) versus marginal benefit. Naked Capitalism also notes the flattening long term rate will undercut the basic business model of the banking system as a whole.

Around The World, Mid August, 2011

Our friends at Balloon Juice are tracking the SEC shredding scandal. John Cole writes:

I’m beginning to doubt the rumors there was a “red phone” inside the SEC that could be called by those in the know to get investigators to back off. It would just be redundant.

Jaime writes that the Cossaks have been called to defend the Steppe once more. Most in Eastern Europe will still remember their slaughter of Germans trapped in the Korsun Pocket in 1944. Still, it’s a long time to coast on a rep.

Jerry Pournelle examines the concept of “Islands of Liberty” as a both a viable political response to Obama and source for good fiction.

Dan Simmons explains his fascination with dystopian novels. His newest, available now, is “Flashback”.

Leon Hadar compares today’s Movement to Reagan and Goldwater eras. His conclusion? We won’t see a Reagan-sized win in 2012.

Alex at Yorkshire Ranter ponders how could Cameron blithely use up the Metropolitan and other police forces’ strategic reserve so quickly?

Dan Goure Gets It Wrong: Align Geo-Strategic Commitments First, Then DoD Budget

Dan Goure, VP of the Lexington Institute think tank, advises the Pentagon to draw a hard line against further budget cuts.

Defense has already been tagged with over $800 billion in spending cuts since the Obama Administration took office. These include almost $400 billion in savings from program terminations and restructuring that were announced in 2009, another $78 billion in efficiency savings that the department was not allowed to retain and around $350 billion in cuts announced this past April (and confirmed in last week’s debt pact). It is unclear how much more the Pentagon will be asked to absorb in budget cuts in the second round of deficit reductions due out from a special Congressional Committee in the Fall . . .

There needs to be a defense-led argument for how to do deficit reduction without harming national security. How much can we afford to reduce defense without placing security fundamentally at risk? . . . The Pentagon needs to draw a line in the sand. If Congress or the American people wish to cross that line, so be it. But DoD needs to make the consequences of such a decision for national security very clear (emphasis added).

Utterly wrong. The national command level question must be to re-consider (a) what is an appropriate American geo-strategic footprint that (b) we can we afford and then (c) how to allocate budgets among State, DoD and others. What are core American interests? Secondary interests? Tertiary. And why are these interests militarized? Do we even remember anymore?

Goure argues that DoD is really an entitlement – something we should pay regardless of seeming need. An interesting reveal of internal psychology. Goure is a nice guy, a creative fixture of the national security scene. Several ‘D.C. friends’ and their spouses have worked with him or for him over the years. He’s a creative mind whose loyalties are to the defense establishment as opposed to any external ideology like Neocons.

He’s right that blind cuts in a trigger mechanism would be harmful. It’s not a rational resource allocation. Worse, blind cuts still leave U.S. over-extended commitments and guarantees across the globe. Without the means to honor them. Worse than paper tiger. Uncertainty among friends and foes as to U.S. intentions is a recipe for international systemic upheaval.

He’s also right that key capabilities might be lost. Some might be critical. Others only seemingly so because the hold they exert on memory and the past. We heard many of the same arguments when Bill Perry ‘consolidated’ the defense industry in the 1990s. Aligning a defense budget and capabilities to a realistic American geostrategic footprint will help identify which design teams, capabilities and infrastructure merit a roll of the dice.

Status Quo’s End

What Goure and others can’t conceive of is status quo’s end. Defense as entitlement? It’s *been* socialized entitlement since Reagan I. This ends/means gap has been Topic A within the national security community since 1984. What’s disconcerting about Goure’s piece? When the moment finally came, he blinked. One expects more. Although he like most are understandably caught off guard by Movement radicalism. Perhaps this is a visceral fire-fighter’s response to the immediate blaze. Still, if someone like Goure is staking out this turf, it’s a not a good sign about the overall conversation. Nothing to date indicates the feeble NSC/WH team has any strategic depth. State? Without a WH on its side, lucky to be in the conversation.

The Hill? Reid counting on ‘war savings’ from drawdowns from Afghanistan and Iraq? Mechanistic. The wars failed. Some kind of drawdown (no matter how slow rolled) pre-baked.

Larger strategic opportunities are before us. What of the international system? If the U.S. military is no longer a subsidized, underlying public good what is the alternative system architecture? What are the upsides and downsides? Regional blocs? Trans-geographic economic zones? Who are the players? Why would they want to join rather than hug the U.S. free ride to its last gasp? If ever there was a time for creative deep think, it is now.

Some Cold War relics are no brainers. NATO? Why? Russia’s GDP is $16,800 per capita. Italy’s alone – credit crisis included – is $28,000. Even Lithuania’s is higher. If NATO sans U.S. (Chinese funded) kinetic power can’t resolve Libya across the Med, it shows how much they’ve been a free ride, not a rationale for for further U.S. subsidy. If Poland has realized its future is with the German economic sphere rather U.S. military, why can’t Washington? U.S. can return to a ‘balancer’ role, offshore. These grand strategic questions are far larger and more important than industrial welfare issues like the F-35, etc.

And so on. And then take a hard look at the services, their priorities and then the reduced budget is aligned.

Finally, what about Leon Panetta? Leon proved at the Agency that he’s good at playing the game. At DoD he’s got 5 real constituencies. First is the president (although with Obama that’s not a hard rule). Second is ‘the building’ (Pentagon). Third are the services. Fourth is the Hill. And 5th is industry. He’s got to prove to ‘the building’ and services he’s got their back. Otherwise he and the political system overall could face overtly covert insurrection. We weren’t surprised by Panetta’s hard line stance.

His opening gambit has to be hardline. Unlike Obama, Panetta knows one doesn’t fold at the beginning. What footprint, number and what budget components he has in mind as ‘wins’, ‘compromise’, ‘acceptable’ and ‘lose’ none of us know.

There’s little reason so far to believe the U.S. has the will and perspective to undertake any of the above sequential aligning of commitments with means/ends. History shows blunt force trauma always works in the end (‘mushroom clouds’, ‘niger’, etc.). If so, it must be one of the faintest of silver linings.

A Glimpse Of Future Now

On Sunday afternoon, during a cruise in a reservoir adjoining the Volga River, a ship called the Bulgaria capsized and sank, killing more than 125 people, including dozens of children who got trapped below deck in a playroom. As passing ships picked up survivors in the water and news of the disaster spread, the nation fell into mourning, and some observers brought up the sinking of the Titanic in an effort to express the scale of Russia’s grief. But the comparison fails for one important reason. The Bulgaria was not a masterpiece of engineering on its maiden voyage, as the Titanic had been in 1912. The cruise ship was 56 years old when it sank on Sunday, becoming another example of the rotting Soviet-era equipment and infrastructure — barely kept up yet still in use — that have made such disasters so familiar in Russia today.

Wait, there’s more.

What Medvedev failed to mention was the scope of Russia’s broader infrastructural decay, an issue that arises after every major industrial catastrophe, but quickly tends to fade again. In the past two years alone, Russia has seen a huge methane blast at a coal mine (about 90 dead), a turbine explosion at its largest hydro-electric dam (75 dead), another Antonov plane crash in Siberia (11 dead), as well as a handful of major blackouts, gas blowups and the countless deaths caused every year by the dire state of Russia’s roads.
All these accidents are normally blamed on human error or misconduct, which allows the government to save face by firing or jailing the guilty parties. But many businessmen have started lobbying for the government to pay attention to the country’s deeper infrastructural needs (instead of splurging on vanity projects like the 2014 Olympic Games in Sochi). One of them is Alexander Lebedev, a billionaire who owns a fifth of Aeroflot, Russia’s national airline. The sinking of the Bulgaria, he says, is just the latest symptom of Russia’s skewed priorities. “The industrial base of the country is still mostly a product of Stalin, Khrushchev, Brezhnev,” the three longest-serving leaders of the Soviet Union, “and that was not such high quality in the first place,” Lebedev tells TIME. “If you scratch the surface of the city of Moscow for example … everything is very old.”

Ok Stiftung, bringing late news to the show, again — we can hear it now. Would you be surprised if we mentioned to you that the Washington Metro is already collapsing and failing? That if a foreign power imposed this technological terror subway on any American city it would be an act of war? Difficult to gauge the full magnitude of suckage. Suffice to say, some paunchy wonks in wrinkled khakis were sighing very loudly while ostentatiously looking at their watches. So you see the danger.

How nice to know then that the D.C. Metro’s “plan” is to pay almost a billion dollars to a Japanese company for new subway cars (from ‘Unsuckdcmetro’ site). Metro’s following tradition. The original 1977 cars were from Italy. Still, in time of near economic paralysis one would think somewhere, somehow an American company could be found to build subway cars. Maybe the next set will be from Russia.

When the Metro first opened it was like going to EPCOT Center. Bechtel made these amazing tunnels. No coins, using futuristic farecards. Carpeted cars. Blinking lights signaling an arriving train. Sure, the Peanut Farmer was around but Metro proved America built the future. The debut system covered a few stations only. It’s still comparatively tiny in terms of overall track mileage. The City’s might be grittier but it can take you almost anywhere. (WASP Georgetown, for example, refused a station, afraid ‘undesirable elements’ might emerge like a CoD re-spawn point from Hell. And how well-heeled McLean, VA howled in protest a new extension might disturb their outsourced-wealth).

Sad to see the system literally fall apart before our eyes. It’s not uncommon for breakdowns to strand commuters for 40 minutes. Americans also apparently can’t keep an escalator in operation. A couple of stations are deep. The Vladgrad subway is even deeper than the Metro because of the water table. Somehow, the above reports notwithstanding, that subway in our memory is more reliable than 21st century American.

No Longer Rome, Not Yet Greece. Andora?

In a press conference today the president vented his frustration at the latest example: partisan cliffhanging about lifting the country’s debt ceiling. The obstacles lie both in Washington, where the heart of the problem is the supermajority hurdle in the Senate, and in many individual states. A magnificent constitutional framework of checks and balances, designed to prevent the return of British tyranny, has atrophied into a system that makes reform almost more difficult than revolution.

And this, too, is familiar from history. Over time, superpowers acquire dysfunctionalities which they can carry because of their sheer plenitude of wealth and power, rather as a super-strong athlete can carry deficiencies in technique. When your strength wanes you suddenly need the technique; but it may be too late to get it back. Beside technique, there is the all-important confidence. But the old American can-do optimism is shaken. Even those who most loudly proclaim American exceptionalism strike a note of cultural pessimism. “It’s breaking my heart,” emotes Glenn Beck, “to see this nation basically going down the tubes.”

One has to be tolerant of Continental Schadenfreude. History’s perverse humor is revealed by Dominique de Villepin and Chirac as our Greek chorus. Timothy Garton Ash actually thinks there’s a way out of the American cul de sac. But he wonders if political dysfunction will win out.

Obama and the Democrats will go to the polls on the message ‘we suck less.’ That was the Peanut Farmer’s, too.

Why We’re In Deeper Trouble Than Even Justin Wolfers Thinks (Long)

Justin Wolfers offers sobering empirical analysis to support his 4 conclusions:

1. The slump began in late 2006. And indeed, we were hardly enjoying good times through early 2006.

2. It’s a big slump, and GDP per capita fell by over 7 percent.

3. We remain a long way below the previous peak.

4. It’s going to take a long while to return to where we were back in 2006. Most forecasters are expecting GDP to grow by around 3 percent, implying per-capita growth closer to two percent. At those rates, average incomes in 2013 will (finally!) be back around the levels of 2006.

He has some nice charts. Check ’em out.

Unfortunately, both he and the Fed think that the last few years are essentially cyclical — i.e., connected to and integrated with economic behavior and welfare/consumption before and to come. Things are grim to be sure, but we’ll get back (in 2013, go team). If only it were so.

We Are Not In A Normal Cyclical Downturn But A Structural Collapse

First, as you know Dear Reader, the Stiftung has argued for years that the American economy ceased generating real (as opposed to phantom, transient, financially engineered) income and per capita growth since the mid-1990s. Second, financial engineering hid this structural dysfunction from 1994-2011 by constantly generating bubbles to obscure the real underlying atrophy and decay.

Wolfers is optimistic about 2013 because his return data point, 2006, is actually itself a bubble popping high point. Don’t look down, it’s a long, long way to fall.

For the Stiftung, our economic narrative is thus: (a) the First Tech/Telecom Bubble (1994-2001); (b) the National Security Boom (2001-present); (c) Tax Cut -Redistribution (2001-present); (d) the Second Real Estate Bubble (2002-2007); and (e) the bailouts/USG and Fed subsidies (2008-present). Bernanke all but assured in recent appearances that money will continue to be free – as in close to zero % cost of borrowing. Under normal circumstances, if we were in a cyclical moment, the Fed would not only watch out for but want to see inflation. On cue, a Second Tech Bubble is getting ready for its close up.

We’re Not On The Same Economic Curve Anymore

Our predicament is not related to normative, linear macro-economic narratives. But because we collectively don’t realize that, the U.S. continues to make illusory and dangerously erroneous choices along an inflated baseline curve. Our real welfare curve is an order of magnitude smaller. It’s highly unlikely the U.S. will hit Wolfers’ mark in 2013 because there’s literally no there, there.

To be blunt, many of the jobs vaporized since 2008 are not coming back. Those few that do will be significantly reduced. People really haven’t internalized any of this yet.

[Read more…]

Obama As Goldilocks: Now, About That Debt Ceiling . . .

Admit it. It’s OK today finally in polite circles. Because Paul Krugman woke up the other night.

And Lo! Verily. So cameth this divine vision down unto his Nobel winning noggin that truly, he who dost caveth before all hath no spine. ‘Why hast thou forsaken your flock?’, he cried. ‘Have we not offered Chenin Blanc and Brouilly both avec Camembert de Normandie‘?

What have they done with President Obama? What happened to the inspirational figure his supporters thought they elected? Who is this bland, timid guy who doesn’t seem to stand for anything in particular? (April 10, 2011)

Thus did Krugman hear the reply as if carried on the wind borne by a twin DR-103 stack. But without mid or presence controls and five pre-amp ECC83 and four EL-34 output tubes per head. For the reply did packeth punch without cascading gain sizzle:


And it was good. Around the dried and empty barrels of Kool Aid and blogs, there was much weeping and gnashing of teeth. Down unto his Twitter followers’ great-great-grandchildren.

The American Bubble Machine’s Last Gurgles

Obama drops a sham budget the same day China officially overtakes Japan as the World’s second largest economy. The latter is pre-baked old news. That China will surpass the U.S. in a mere 10 years? Some might wonder why the delay?

Obama tactically is wise to play budget kabuki with Republicans now. They’re disorganized, fumbling votes. Tactical politics dictate only open with the first card. Make the Republicans get their act together before trying to make a deal. Shows he’s learned a little bit from the stimulus fiasco. Still, a small a game with small players. Neither offers a way out for America’s long term economic problems. The first step must be to wean the American addict off its bubble addiction.

Round And Round It Goes

Consider: Deng Xiaoping accelerated China’s economic reforms in and around 1980. The same time as America abandoned traditional capitalism for plutocratic crony casino gambling. The game started with the then new fax machine and spreadsheet technology. Together, Wall Street didn’t need to be Wall Street anymore. And a 28 year old could gin up arguments for ‘unlocking’ wealth by tearing down. Hence, the 1980s M&A/LBO bubble. We were friends with one of the real life players fictionally portrayed in Stone’s ‘Wall Street’. Stone was not that far off. When we got there some people really did spread out lines at 2:30 AM to make it through another 24 hours churning out mounds of mind numbing, mostly unread paper for a closing. This first bubble popped the same time as its sisters, the S&L boondoggle and the first real estate run up.

By the early to mid 1990s, the American economy started its long migration to the Pearl River Complex. Consulting companies like the current Accenture held huge conferences teaching how to out source to China. The structural damage all carefully camouflaged. Post Netscape IPO and tout le monde reached for the NASDAQ ring. Boom, fraud, the usual routine. ENRON, Ebbers at WorldCom, etc. We had a friend working with then-AT&T CEO Armstrong who was going crazy facing pressure to match WorldCom’s (faked) numbers.

They say Clinton’s America created 20 million new jobs. True. Many of them, however, based on illusions and sock puppets peddling dog food. We all know the dot com bubble popped. And the CLEC (competitive local exchange carrier) flame out. By 2001 America economically flat lined, albeit with a budget surplus.

Two bubbles quickly helped obscure the reality that the American economy no longer creates long term wealth and jobs. First came the fear/threat national security boom followed by the real estate/financial swindle. Net result? No net new jobs created. Underscore that — we are exactly back where we started. With one exception – unprecedented wealth concentration.

The Patient’s Flatlining! Get Those Paddles! Stat!

Obama may claim he’s creating new jobs. Or ‘making investments’. But the American economic structural atrophy is not and can not be tackled by a federal budget. Or Potemkin ‘retraining’ programs. We must first begin with hard truths. The American economy doesn’t create much real value. For us or for export. We need a comprehensive macro economic development vision to cure our bubble addiction. Executed across industry by industry, down each silo from component and subcomponents to final assembly, etc. With tax, tariff and budgets aligned accordingly. Not the reverse.

Obama’s budget is thus D.O.A. regardless of the Republican counter. Neither have a plan to stop the bubble addiction. Neither can afford to. It’d mean telling the American people they are indeed rodents in the spinning wheel, going nowhere.

Some Rightists share this concern. They argue America needs a return to ‘Hamiltonian’ policies. Helpful but insufficient. Quaint even. Hamilton’s ad hoc market interventions helped nurture burgeoning American comparative advantage. Japan, China, the Four Tigers – all gouged the heart out of the American ‘free trade’ tragedy of the commons. Corporate America was not only complicit but eager partners. Does anyone really think ‘Hamiltonian’ policies could have handled “>Japan’s original post-war wealth creation model copied by others? Or the current Chinese juggernaut? What’s precisely the American comparative advantage now?

A problem with junkies is they never admit they’ve a problem. So now comes another fake boom, the ‘social media’ economy. Overstated? Zynga is the company that makes games for Facebook. It’s now being valued at between $7-$9 billion. It was a mere $4 billion 10 months ago. Facebook is now valued higher than Amazon and tails only Google on the Web. Don’t forget Twitter. It’s a company that doesn’t have a real business model or a path to sustainable revenue. It’s average revenue per user (ARPU) is 28 cents. Now said to be ‘worth’ $8-$10 billion. Most likely as a part of Google, etc.

There’ll be economic spin offs from this newest bubble. There always is. Cheerful cable talking heads touting some index going up. The question few will ask is what’s any different from the other bubbles? Valuations suggest it’s the same old song. How long will the associated economic activity last? Where does the final ‘wealth’ end up? Or just the chimera of hope and change? You know where the Stiftung stands.

All of which is to say the looming budget fracas is relatively uninteresting. Cutting the deficit or ‘investing’ in education or even on random projects like high speed rail are beside the point. Without a comprehensive macro economic vision and actual politics to implement it, the budget ‘battle’ is like the old WWF. Which reduces 2012 down to Republican Light vs. Republican Right.

Oh joy.

Chinese Policy On America – Let Them Drift Away . . .

Much ado regarding Chinese CP Chairman Hu’s visit to the States. We’ve all seen the Chinese military’s slap at Gates during his recent visit. Testing their still embryonic 5th generation fighter also a pointed embarrassment — again — to the undeniably shaky Chinese civilian control over the PLA and its sprawling infrastructure.

Hu’s doing his final rounds as President, stepping down soon. This visit for a variety reasons always was going to be more tonal than substantive. The hard decisions on policy and direction will await his successor. For the Chinese, kicking the can further down the road has the added benefit of being smart geopolitics. The soft and hard power curves are moving their way on sheer inertia alone. The junky still remains addicted to both Chinese credit and cheap Chinese trinkets. Even Obama’s vaunted ‘green’ industry that he said will produce ‘thousands of good, high wage jobs’ is already stamped ‘Made in China’. A provision regarding restricting government contracting and Chinese goods a symbolic blip. Doesn’t alter the above.