The Ben Franklin Report: Strains in the Economy

With the latest manufacturing data from the United States showing even more signs of contraction, one of the few thigns that can be said for certain about the overall situation, is that what might have been limited to the financial sector is clearly affecting the very basic sectors of the economy. Also, those were predicting that this affair was going to be a minor correction that would pass in a quarter or at most two, have been revealed as having played a guessing game, as the crisis is instead shaping up to be the worst economic crisis in almost a century. 

Manifestations of the problems are appearing in sales reports of the auto industry, where all of the manufacturers were hit with double-digit drops in sales, especially trucks. On Wall Street, too, there are signs as Circuit City has received a delisting notification from the New York Stock Exchange, and plans to close 155 stores as its death spiral continues to get tighter and tighter. 

Part of the misdirection that was at the heart of the financial crisis is coming unwound, as investors who bought notes from the now defunct Lehman Brothers that were promised to be sound investments worth of inclusion in retirement investment portfolios are now revealed to be worth only pennies on the dollar. Regulators are going to investgiate, but unfortunately, due to the counter-terrorism priorities of the Bush Administration, the FBI has been left critically short-handed as they try to investigate the myriad economic crimes and financial fraud. School districts in Wisconsin were caught up in their own form of financial mismanagement. Buying supposedly safe investments, the now infamous C.D.O.s, school boards all over the state are facing the prospect of cutting services in order to meet financial obligations from the defaults of various corporations.

Strains are also being seen on the macro scale, as the primary contributor to American GDP, the Federal Government, has announced plans to finance the largest budget deficit in history. The government itself won't put a number on how much the deficit will be exactly, but estimated that the total amount of bonds issued would be approximately $550 Billion for the October-December period, including $300 Billion for Federal Reserve liquidity operations. Analysts in the field estimate that the government's borrowing needs for the next fiscal year, which began in August, will total up to $2.1 Trillion. This number stems from funding the $850 Billion deficit projected in the Federal Budget, and approximately $500 Billion to further reinforce the Fed's liquidity operations of the amalgram soup, and the remainder going to roll over securities from state and local governments which are expected to see a significant drop in demand over the next year. The budget deficit is so large partly in thanks to deteriorating economic conditions and the $700 Billion bailout package passed by Congress against almost every economist's better judgment, but doesn't factor in whatever additional stimulus proposal will be passed by the Congress during the lame duck period following the election. 

On the micro scale, individual homeowners and families are also showing severe signs of strain. Throughout the country, but particularly in areas that are hardest hit by the mortgage crisis, more nad more homes are going 'underwater' to use the industry phrase. That is to say, about 1 in 5 of all homes in American are worth less than the balance of the mortgage the homeowner is paying. Families are also having a harder time making ends meet with their utility bills, also. As further evidence, about 44% of families are living paycheck to paycheck, and about 48% have less than $5,000 in liquid assets. So, in the event of a family emergency, medical or otherwise, very few would have any options, especially with bank lending still not an option, despite the Treasury's and Federal Reserve's efforts.

There is no shortage of people who are ready to criticize the Treasury and the Federal Reserve for their management of this crisis and their willingness to bail out institutions that were threatening to go bankrupt. A Nobel Prize-winning economist Robert J. Aumann predicts that more banks and insurance companies will go under because of moral hazard and the lack of consequence. Others say that deflation is the order of the day, also brought about by the various interventions in the free market. My question has been, since this crisis started, where were those in the position to do something about this problem when it started becoming apparent? Why weren't more authorities, for lack of a better word, willing to stand up and make warnings? Unfortunately, someone who is such a position is also at a loss for why pronouncements against the general consensus come in whispers, rather than shouts. 

I'll leave off with the latest scary charts from the Federal Resreve of St. Louis. Good night and good luck.

Click on the charts to see them at full size.

The Dragon is Out of Breath

As such a key part of the processes of globalization which have developed our global economy in the past few decades, the manufacturers of China could not hope to escape the deletrious effects of the global economic crisis. As demand falls all over the world for finished manufactured products, Chinese factories have been hard-hit. Although most economic data coming out of China is stir-fried and seasoned by government officials, the monthly manufacturer's survey is one number that is seen as reliable, and in the past couple of months, worrisome. What could once have been explained away as the slowing down of manufacturing during the Olympic Games is now something far worse. After two back to back contractions of this Chinese Manufacturers Purchasing Managers Index (or PM Index), it is clear that this is no longer simply a statistical abberation or short-term correction. 

The problems are becoming apparent in very embarrassing ways. For instance, in the fourth-largest city, Chongqing, taxi cab drivers went on strike to protest the depreciation of what amounts to their standards of living.  Increased competition, fuel shortages, and inflation have driven down the value of their fares, which have not kept up with inflation. Showing the critical nature of cab drivers in the PRC, the strikers demands were met after only one day. 

More embarrassing to the ruling party are cases of party officials fleeing the country with embezzled funds, which according to reports total at least $100 billion. One official by the name of Yang Xianghong left a delegation in Paris under the pretense of visiting his daughter. A similar phenomenon is also rearing its ugly head in the private sector, as factory owners who find themselves unable to pay off obligations sell off everything they can't take with them and disappear, literally overnight, of course taking time to destroy all records on the way out. Behavior like this is perfectly expectable when considering information asymmetry. For instance, the factory owner who realizes how bankrupt his company is before anyone else finds out, will probably take whatever he can get out of his investment of time and money and leave before accountability catches up. party officials likewise have a particular interest. In times of economic distress, it is easy to imagine why enforcement of laws governing economic crimes, such as embezzlement and other forms of corruption, would become much more strict. As China doesn't have very many extradition treaties with other countries due to its continued use of the death penalty,  officials can live very well for a while, if not for the rest of their lives, off of ill-gotten gains, and of course, the more the amount of gains, the longer the official is able to pay legal fees and perhaps bribes to lengthen the extradition process or remove it as a possibility altogether.

In China's third-largest city where I live, Tianjin, the economic problems are slow to be revealed. Although this city depends on manufacturing for a great deal of its economic activity, development here was a key point in the latest 5-year economic development plan. So while the rest of China may be wilting from the lack of fresh orders from overseas and paltry domestic consumption, Tianjin is still booming. For instance, even though China is entering the downward cycle in the property sector as evidenced by the proliferation of empty buildings for sale and ret, just as occured in the United States in the past two years, I can see five separate large-scale construction projects just from my apartment windows. Clearly, in a nation as large as China, economic slowdowns are uneven at best. 

Victory for the American People

It hasn't been often in the last 7 plus years of the Bush Administration when one could truly say that the power of people defeated the people of power. When special interests took a back seat to those who really run the country, Mr. and Ms. Average. Since the bailout was originally announced, there have been numerous campaigns to stop it, academic disputes, and even the rarest of the rare, a public battle among the normally tightly disciplined Republican party. But, in the end, those who have to face up to the voters on November 4th realized that voting yes was potentially one of the biggest threats to their political careers, regardless of party. If you look at the list of how people voted in this historic vote, those on the 'yes' side will probably have a rough time of it, if not lose their seats to those who chose not to approve the still horrible re-negotiated version of the bailout proposal. In particular, I'm sure Dennis Kucinich (OH-10th) is feeling a little smug, knowing that he predicted the outcome of the vote.

On a slightly different note, I'm not sure why everyone in the world of pundits is characterizing this rejection of the bailout proposal a failure of governance. In common parlance, bills are said to have failed, but that is almost a bureaucratic term. In real terms, this bailout was an ideological battle between those who are in favor of and those who are against nationalization and similar bailouts in the United States. Moreover, this is not a vacuum of leadership in which the U.S. government is flying down a country road like a  '62 Corsair without a driver., as that has been happening for the last 7 years. 

Of course, in a vacuum, comes the punditry. Perhaps the most offensive piece I've read thus far about the political process that brought about this conclusion comes from Rupert Cornwell from the U.K.'s Independent. My favorite metaphor in the article compares the mechanisms of American democracy to Alice Through the Looking Glass. Putting that aside, though, the author clearly doesn't understand the huge popular backlash against the bailout. Sure, in the U.K. and other parliamentary democracies, the Prime Minister isn't approved by the people at large, but in the U.S. the leaders need to be especially accountable. And to say that the bill died in partisan sniveling is obviously disregarding what was essentially a bipartisan effort to keep the American people from having to shovel out $700 Billion or more on a plan that was only designed to correct the dangerous excesses of the richest segments of society. Perhaps, too, the American people have become wary of those who warn about apocalyptic disaster and offer a solution that meets a certain biased politican agenda. 

Kevin Connolly from the BBC, in looking at the reasons behind the bailouts defeat in the House of Representatives, expresses a strange sentiment, that after this bill's defeat and the sense of crisis that it engenders will offer a way out for the bailout proposal, that Main Street hasn't suffered yet. Unfortunately, the people of the United States have been suffering, which is the underlying cause for this economic crisis. With the inflationary impact of cheap money, combined with tepid job growth, primarily in the services sector since the recession of 2001, people were forced to choose between living and surviving, which meant that the mortgage had to go unpaid. Thus, in a trickle up fashion, the banks and other financial institutions, who were holders of arcane financial securities into which these poorly written mortgages were conglomerated, began to suffer the counsequences of their poor lending practices. I think Mr. Connolly underestimates the intelligence of Mr. and Ms. Average and their understanding of this situation, as Mr. or Ms. Average are probably already unemployed, underemployed, or facing the prospect of losing their job in the failing economy. 

From the campaign trail in Iowa, Sen. John McCain who, infamously, suspended his campaign to not show up in Washington for negotiations, has called upon Congress to return to the drawing board and to get back to work right away. Sen. Barack Obama, from a rally outside of Denver, called for calm, saying that things in Congress are never smooth, and instead of imploring or demanding that his colleagues work on the proposal to shore up the wealth of the financial sector, he used a baseball metaphor.  

So panic thus gripped the financial markets, and the Dow Jones suffered its worst lost ever in terms of points. But, have no fear for liquidity, because Helicopter Ben Bernanke has come to the rescue, increasing the amount of dollars in the global financial system by a whopping $630 Billion dollars. To show you a frightening graph that indicates inflation, perhaps even hyperinflation, is just around the corner, here is the Adjusted Monetary Base, courtesy of the St. Louis Federal Reserve. The highlight of a series of moves in the banking industry, Citigroup has purchased Wachovia, after the stock lost more than 80% in trading on Monday. 

Cleveland Ohio: Terrible American City, or the Worst American City?

According to the U.S. Census Bureau, Cleveland is the second poorest city after only Detroit Michigan. The downfall of both cities is linked and ongoing but at least Cleveland doesn't have a mayor under indictment for perjury. Local news outlets are trying to cut the sting of the numbers by pointing out that the same report states the average household income in Cleveland grew over the same period. What they either don't realize or are deliberately not saying is that this means the gap between the rich and the poor is widening at the expense of middle income families.

This is the kind of thing one would expect to see in a major urban center that is still experiencing flight of the middle class out of the city into the suburbs. It is also an increased threat to the American Dream. In a city where poverty is increasing and which has been hard hit by the collapse of the housing market it seems increasingly unlikely that this is a place where a working family can get a leg up and advance their financial standing. Which would explain why people are leaving the area.

All of these things combined cut down the tax base while increasing the demand on government services. This isn't just more people becoming a drain on the welfare state. It's vacant buildings becoming bastions of criminal behavior causing a drain on the under staffed police force. Those same vacant buildings are also a drain on the fire department due to arson, which increases response to emergencies and costs of investigation. Lastly, the city has to buy those buildings and demolish them creating costly legal work on top of paying out settlements to the banks that have foreclosed on these houses. The roads are in bad need of repair, and communities region wide have to replace their sewage systems because they violate clean water standards, spewing human waste into lake Erie. The steel industry is dead, but its rotting corpse is lying unburied across the rust belt of America.

Casual Observations

In my short time here in the great People's Republic of China, I have made one simple, yet probably overlooked, observation. In the U.S. before I left, every commercial outlet, ranging from department stores to shopping malls were offering deep discounts in an effort to support continued consumer spending. Here in Tianjin, the story is the same. Every outlet, regardless of place on the scale of value, is offering similar discounts. While this may just be a simple coincidence, it is at least anecdotal evidence of further economic problems if consumers are unwilling to assume their historic and necessary economic function. I would post a photo, but Google Images isn't cooperating here.

This, of course, is besides the worries of the larger financial institutions here in the PRC about Fannie Mae and Freddie Mac's balance sheet problems.

The World Food Crisis

The world food crisis entered the perception of the average American this week when Costco and Walmart started rationing rice. I came upon rice at half the market rate today in the grocery store and bought up the thirty pounds you see to the left. I also snapped up a gallon of vegtable oil since land used for rice has been converted to the palm oil cash crop and will rise in parity with rice.

The prices of all foods, and all comodities, are linked in this global economy. The staples Wheat, Rice, and Corn have all drasticly gone up in price over the last year. The rise is due to a number of factors that feed back on one another because of the global economy.

In the United States the farm lobby has pushed congress to invest in corn based ethanol. This created an incentive outside of the market for U.S. farmers to dedicate feilds that had been used for producing rice and wheat for food in the past, to corn, that is being burned for fuel. The President spoke of using switchgrass but the money has gone to corn. So this decreases supply of staple foods that the U.S. would otherwise export to the world. With the falling dollar our exports would be very attractive except the cost of rice is fixed to the dollar so it faces the pressures of inflation. The cost of fuel feeds back into the cost of food because of the energy used in transport and processing.

High Gas prices wouldn't effect the hungry as devistatingly if their own countries produced enough food to feed them. Then they wouldn't have to import the food they need from the U.S. Around the world farmer's decisions about what to plant have been influenced by the U.S. economy over the last few years. The black hole of ever increasing imports to America due to ample credit have encouraged foreign farmers to switch to cash crops. Farming has always been a poverty industry since the beginning of time and how can you begrudge an Egyptian farmer who chooses sugar over wheat when its ten times the price?

This global trend to switch to sugar and oil instead of rice and wheat, or poppys in Afghanistan, has driven world food supply even lower. But it has done so in a highly localized way. Major rice exporting countries have cut shipments to ensure they can feed their own people and the major rice importing countries now face a crisis where the whole supply thretans to go into the black market. When the bottom dropped out of the U.S. economy and the falling value of the dollar started an upward trend toward inflation the whole world suddenly realised they had been catering to U.S. luxury demands instead of feeding themselves.

Ben Franklin Report: Unraveling the Knot

Although this article is long, it gives a thorough look at the fundamental conflict of interest between the credit rating agencies and the financial markets that exploded and is, to say the least, now exposing the U.S. economy to further downside risks. However, this is only one part of the calculations behind Gross Domestic Product.

Private spending and business activity is also fairly important when considering the health of a particular economy. While oil futures are a good indicator of what will happen in a few months, after oil has been refined, with near record low refinery utilization rates, into various chemical products, individual corporations earnings are perhaps a better indicator. Bank of America, the giant in discount consumer financing announced a 77% drop in profit for the first quarter of this year, mostly because of concerns with defaulting mortgages. For some anecdotal evidence, one need do no more than compare this graph of subprime mortgage concentrations, with this article about California's foreboding rising in foreclosure rates. Global shippers UPS and FedEx are usually a good indicator of economic prospects.

However, with the ongoing catastrophe that is the hunger crisis, inflation, rather than the lack of available credit, would seem to be the biggest threat to global economic stability. This inflation is, of course, a natural response to the growth in oil prices, as industrialized economies depend on the supply of crude oil in just about every sector.

The situation is exponentially compounded when the currency that is the basis of all of these transactions is rapidly depreciating in value, as seen in record lows versus the Euro. One must wonder if Ben Bernanke and the rest of the Federal Reserve Board are questioning their monetary policy, as economies that are keeping interest rates up to draw capital are seeing their currencies rise in relative value.

Another factor in this fiduciary fiasco is the echo chamber of ideas. Last summer, CEOs declared the housing crisis near its end, and more recently that the crisis was in its last throes. The point that we can take from these statements is that their companies are more important than reasoned, open discourse about the overall state of the economy. And that it is a losing proposition to trust those who are dependent upon a stock price. As long as there are CDOs and other arcane financial creations that do not have a monetary value, banks will continue to be plagued with problems, which will be further complicated by consumer spending withering away under the burn of inflation and unemployment. Surveying a crystal ball to find the answers to when the U.S.' GDP might become positive again is less than useful.

A Crisis Meeting

G7 finance ministers and Central Bankers are scheduled to meet in Washington, D.C. through this weekend to hammer out solutions to the numerous crises facing the world economy. Here's a handy list of items that might be on their agenda.

• General Electric reported losses across almost every sector of operations for the first quarter of the year, and revised revenue for the year downward. The normally stalwart stock is perhaps the strongest indicator yet that the global recession is reaching into every part of the economy.
  
• Bear Sterns has delayed releasing its first quarter results due to the disruptions caused by the merger with JP Morgan. As they are expecting negative results, one can understand their disinterest in transparent financial accounting, but its losses will probably be indicative of the weakest parts of the financial markets.
  
• Head of Germany's Bundesbank, Axel Weber, is concerned about inflation in the Eurozone, and doesn't see any room for interest rate hikes. One can imagine the back and forth between European and American banking officials over the difference in interest rates and other monetary policies.
• According to the IMF, inflation is also expected to tap down growth in emerging nations in Asia. With consumer confidence in the United States slumping, to put it mildly, in the facing of rising import costs, growth in Asia will come to be the growth engine for the world economy.
• The food crisis throughout the developing world, while the most important of the various crises to be discussed, is unlikely going to be at the top of the agenda as finance ministers through the developed world are beginning to see the limitations of their capital.
  
• As mentioned before, the position of Ben Bernanke is likely to come under heavy scrutiny among his colleagues, as the Fed Chairman continues to stand by the notion that banks and other perhaps insolvent financial institutions should be allowed to continue operating, and although the 'originate-to-distribute' system of loans failed at almost every level and started the current credit crisis, the system could be fixed and return to being useful in the future.
• Oil prices, while retreating from their record high of $112 a barrel set earlier this week, are continue to weigh on the economy. However, the larger economic impact is felt by record high gas prices in the United States, edging closer and closer to $4 as the Summer driving season approaches.