EOM

He would have trillions still he could spend on the people's needs rather than saving Citigroup, BOA, Fannie Mae, Freddie Mac, AIG, Goldman etc. It used to be just a handful of crazy people thought it was a mistake to rescue the big banks, and that they ought to be thrown instead into the bankruptcy courts who could sort out all the claims. Yes, the economy would suffer severely, but it would be a quicker agony than this long drawn out process.

Now even respectful people are saying this. Today Kansas City Fed president Thomas Hoenig said this:

We have seen the formation of a powerful group of financial firms. We have inadvertently granted them implied guarantees and favors, and we have suffered the consequences. We must correct these violations.

That's pretty powerful stuff coming from the Fed. It certainly indicates an element of regret, and suggests that sentiment is brewing in Washington to break up these monied interests.

In the meantime, the bond market is now beginning to regurgitate all the paper being stuffed down its throat. This is not going to be a pretty sight. Obama may be forced into addressing the deficit. If he must, he should impose higher taxes on the wealthy, eliminate the preferential treatment for hedge fund managers, cancel the 2001 tax cuts, boost both the capital gains and estate taxes, and then look seriously at cutting the programs that have the least affect on the average person. That includes some of the big weapons programs of the Pentagon, shutting down several hundred Pentagon bases, winding down the two wars in the Middle East, and cutting out much of the financial industry props. He might consider cutting tax deductions on home mortgages - this will be his only chance when the real estate industry is too crushed to make an effective protest.

What money he can possible spare needs to go to ongoing unemployment benefits, subsidies for kitchens that feed the homeless, and so on. Things that affect large numbers of people, especially those at the end of their rope.

That is incredible. I consider that more newsworthy than just about anything I've seen lately. The Fed talking about real world consequences for bad behavior.

The "implied guarantees and favors" are, I supposed, that $23 trillion in total commitment/risk that has been granted to solve the banking problem. I've wondered lately if that's somehow the true source of the credit problem.

We're in a FUBAR situation. Time to reinvent the wheel. It couldn't be worst than this, if done with a high degree of intelligence and public interest.

It tells us what we need to know about regulatory capture. One day the Fed woke up and discovered the banks they were regulating had become the masters of the regulatory process, able even to circumvent the Fed and go straight to the Treasury for bailouts of themselves and their customers.

I suspect Hoenig is throwing a quiet criticism at Bernanke in this statement as well. Bernanke is the one who has destroyed the Fed's solvency. Wait until the governors realize that fact!

he should impose higher taxes on the wealthy, eliminate the preferential treatment for hedge fund managers, cancel the 2001 tax cuts, boost both the capital gains and estate taxes, and then look seriously at cutting the programs that have the least affect on the average person.

So far he's done the opposite, and he proposes to continue doing the opposite. His stimulus plans include more tax cuts. His big deficit reduction plan is a bipartisan commission to look at reducing Social Security, Medicare, and Medicaid, the programs that have the most effect on the average person. Tax increases on anything other than labor-based payroll and the military budget are specifically excluded from consideration.

who badly needs remedial math lessons

I always interpreted Rubin's comments in the 1990s about the bond vigilantes to refer to the force of the global bond market in its entirety, not to some group of people who control the market. It is, other than the FX market, the deepest market in the world and one where the largest bank can have influence on prices maybe for a day or two.

Back then, the portion of the market controlled by foreign central banks was small, so the bond vigilantes represented the private sector. Today, the central banks own up to 30% of the market, and could if they wish tank the Treasury market and push our interest rates much higher. Of course, they would take an enormous loss on their holdings if they did that, so it is not likely to happen. Given this, today's market is just as much in the hands of the private sector as under Clinton.

I think Rubin and Summers felt they had some educating to do with Clinton about the bond market and the need to be careful abut budget deficits because the bond market would force rates higher. By the same token, Clinton was enormously benefited when he did raise taxes to do something about the deficit. The bond market responded immediately with higher prices/lower rates, and following that up, Greenspan started lowering short term rates. The economy took off after that point.

The bond vigilantes have not been dormant this decade. They have continued to push long term yields higher despite the 0% rate policy of Bernanke for overnight money. The consequence is we have a record steep yield curve, which spooks a lot of people because normally that foretells inflation. We had a hiatus in 2007 and 2008 during the credit crisis, when everyone, especially individuals, wanted to own Treasuries for safety. But since then, rates have crept right back up and are threatening to go to new highs for the decade.

I doubt that Summers is out of his depth on this one, though once again he must think he has got to educate the president on the importance of the bond market. I suspect Summers understands very well the inflection point we are facing, and Geithner might too. The president has been talking about doing something about the deficit, but no action has been taken. We are going to see what these guys are made of later this year, when they have to decide between higher rates imposed by the bond market, or lower rates and reduced government spending, which could reignite the recession.

...

Would you need to use a proxy to destroy the Euro and the European Union, Demand a revaluation of the Renmimbi, and and pour a lot of shit on the Yen by pointing out Japanese public debt?

Would making everybody else's currency and government bonds worthless / dubious make T-bills and Federal Bank notes smell sweeter?

Seems like you might not have to make the hard decisions in that case. Lower trade deficit, more economic stability than the Eurozone, less public/private debt than them and Japan too. Additional stimulus and military spending (the only manufacturing that isn't offshored), maybe some more tax cuts for "small" businesses like GE . . .

The US is issuing massive amounts of Treasury securities precisely because there is a liquidity trap at work.

The liquidity trap is a monetary phenomenon whereby the central bank tries to induce banks to lend by freeing up reserves and flooding the banking system with excess liquidity. The trap refers to the fact that the liquidity becomes trapped in the banks and does not make its way into the broader economy as loans to businesses and individuals.

This is precisely the situation we have now. Monetary reserves have exploded in this recession as the Fed has bought trillions of securities and placed Fed funds in the hands of the banks in exchange. This cash normally would be lent out, but banks aren't lending. They can't find enough customers with decent credit, and they don't have the capital given their losses to lend much anyway. So the money gets placed right back with the Fed or used to buy Treasuries. It is trapped.

To make up for the lost lending, the Treasury is issuing huge amounts of Treasuries and pouring the proceeds directly into the economy as cash-for-clunkers money, housing rebates, mortgage modifications, construction projects, unemployment benefits, and of course bailouts for bankrupt financial institutions. The Treasury stimulus is in most respects the mirror image of the liquidity trap: the government is taking up the slack for the banks.

we are feeding on ourselves. Faced with financial starvation, we have started chowing down on the fat reserves of our own body (metaphorically speaking). Is that an accurate perception?

Also, I think some of the commentor's suggestions, while good, are not going to be applied by Washington. My thinking here agrees with Fareed Zakaria:
Budget fixes are simple -- and unthinkable
http://www.cnn.com/2010/OPINION/02/04/zakaria.budget.deficit/

Washington is too paralyzed, and too out-of-touch with reality.

As Fakaria points out, what would make sense in the real world becomes just another football to kick around in the alternate universe inside the beltway.

Many politicians even realize this, but the process in Washington has broken down. The separate arms of government no longer perform their checks and balances.

Government in this country could not be more alien to me if it was located on the dark side of the moon.

So I am still seeing that the breakdown must happen before the leeway is created to actually start fixing things.

That's scary and I don't want it to happen. But I'm just not seeing that our so-called leaders have the courage to co-operate with each other or to actually serve the public instead of just repay the political debt to whoever can contribute the most to their campaigns.

There is a chart you can create using data from the Fed Flow of Funds statement. You take the change in GDP for a year and divide it by the change in debt. This produces the amount of GDP that can be generated by an additional dollar of debt.

This chart shows the ratio to be about 6x in the 1960s; for every dollar of debt, the economy generated six times that in GDP growth. The ratio has been declining ever since and was going to cross below the zero line around 2015 given the trend. However, we crossed that point earlier - last year - given the huge amount of deficit spending under Bush and Obama.

When you are below that zero line, debt no longer works its magic. Additional debt destroys GDP growth. This is in part because you are paying now so much in interest on your debt that it overwhelms investment. You have eaten your seed corn and are in serious trouble. The only way out is to destroy debt through defaults or inflation.

This is why the US is now stymied economically. It cannot move forward, and Obama's solutions are prolonging the problem. We have to eliminate substantial amounts of debt before we can grow the economy again.

We're pretty much where you thought we'd end up when we wussed out on nationalizing the banks.

I would add that this "destruction of debt" via defaults (deflation) is an incredibly painful process. The last time this beast was unleashed in full was the Great Depression - there are few nice ways to organize deflation on the scale that is required (not impossible to do, just extremely difficult to navigate.) The USA does not have a strong manufactoring base anymore, so deflation would be an especially vicious dinner guest at this time. Obama and team are trying for inflation just as hard as they can, but when the well is dry you're going to end up thirsty no matter how hard you dig.

I'm sure if the sh&^ hits the fan, the country will pull together and Sarah Palin / Glenn Beck will throw in with the good fight. And flying pigs, we'll need some flying pigs ;)

In 1934 for $7, the same price as a goat; this was in the Midwest. Deflation ==> Cash is King

IF the cost of debt in the US were high relative to GDP but it is not. Interest is running around $500B or 3.3% of GDP. The numbers all look large inside of the US spending pie, but the US spending pie is very small relative to the overall US economy. I will have to look at this more.

The other odd thing to keep in mind is that the interest that the Fed pays on their Treasuries is taxable. So that means they get over $100B of the interest they pay BACK. (Not taxable State and Local).

Don't get me wrong the debt issue is a problem and I am a huge proponent of eliminating all tax benefits associated with debt. I would like to see an end to the deductibility of interest on housing as this has directly led to overpriced housing. I would not allow interest to be allowed to show up on a companies income statement any more than their principal payments. These should not be deductible events. As this is the tax benefit that subsidizes leveraged takeovers and creates the problem of too big to fail.

Trustbusting
and taxation of interest would do a lot to fix these problems.

Added to this is the delay in inflation pressures because there is so much slack in the economy. It's like the loose rope of a water skier. The boat begins to move but the skier sits in place until the rope tightens. The issue here though is the boat is going to be going so damn fast that when that rope tightens it is going to yank that skier (inflation) out of the water so fast it could make our heads spin. But not this year and not next.

This sounds like deflation morphing into hyperinflation.

The numbers mean little if the value of the currency by which they are measured falls drastically. A hyperinflationary depression is a depression nonetheless.

I did inhale.

Bernanke has been very assurative and sanguine about the Fed being able to contain inflation if it 'runs away'

But then he was very sanguine about the housing bubble not bursting. The proof will be in the pudding. The Fed has a hell of a lot of tightening in a whole lot of areas in about 24 months. If they get it wrong in either direction the country either double dips or hits a runaway inflation scenario.

As far as the dollar goes, I really am not concerned about dollar levels. The dollar is like the standard against which value is measured. As far as dollar pricing goes whether up or down the US wins. If it is down then the US can export more. If it is up then the cost of imported goods and oil goes down. Everything gets measured against the US so there are mechanisms that bring value back in an equal portion no matter what the dollar does. I have described it as playing volleyball with a five year old. No matter how the five year old sets the rules you can win at the game.

Inflation would be internal to the US economy and that could be a huge problem.

Just saying, even as the Euro falls the price of oil is staying around $80.

The Euro is falling relative to the US, oil is denominated in dollars. Look at what the price of oil is doing in Euros, it is going up.

Europe by the way is the one with the debt problem, far worse than the US, and they have no additional taxing capacity to get out of it, and no internal population growth to grow out of it, and no solid EU structures to stabilize between the countries, and no ability to control monetary policy like the US has, and no global currency to give them wiggle room.

My guess is that current development of oil projects requires a price around $80 a barrel to keep the investment going. In other words the oil companies need a certain cash flow for the huge projects even though that oil will only be profitable at $100/barrel. It means that any kind of deflation cannot be allowed to influence the price of oil too much or the current oil development projects like those in the Atlantic off South America's coast will collapse and we will run out of energy. This may be one of the things compelling the Obama administration's policies.

Oil holding at $80, productivity going through the roof, interest rates at all time lows, health care tax benefits to businesses, income tax return refunds, massive hiring by the Fed for the census, and a bunch of stuff I can't even think of right now...

The first quarter profits for publicly traded companies is going to go through the roof. April and May will be very very good for the stock market.

There is certainly logic to your argument. The reflationary stimulus of the Fed has to go some place, and so far equities seems to be the market of choice. Given the unprecedented amount of stimulus involved, and its persistence (Bernanke can't seem to utter anything other than "extended period" of accommodation), it's no surprise assets are being juiced vigorously.

We have seen this movie before, though, the latest version from 2001-2006 involving the housing market. This next version is the Federal Deficit Bubble version - the last act of a nation desperate to maintain its lifestyle and avoid the consequences of its debt binges.

I can certainly agree the stock market may benefit from irrational exuberance. In fact I heard that very term used today on TV by someone who wants nothing to do with this market. I also heard the person next to him say you absolutely have to be in this market to ride the momentum. It is obviously the only way to make money.

When I hear stuff like the "obvious" being stated my bubble radar goes wild. Watching the bond market the past few days, and seeing us flirt with the support line of the past year, makes me wonder if we aren't facing a mini-crash in the bond market soon. Can the stock market ignore a 7.5% yield on Treasuries versus 4.75%? Usually higher yields are a death knell for the stock market.

But we do live in unusual, bubbly times, where bubbles can inflate and inflate. While I would quibble that reducing the cost of borrowing for corporations is enough to generate an explosion in the Dow, I can't disagree that bubble dynamics can add 2,000 points to the index in a manner of months.

Bear in mind that 80% of the volume of the S&P 500 in the past few months has been in bank stocks, principally Citigroup (which is almost every day the largest volume traded), then JPM, BAC, and WFC. Banks control the computer programs that drive the largest amount of volume through the market, and routinely day after day there have been large computer buy orders coming into this market at times when action has quieted down, and often at 3:30 ET before the close. This is not a market with a broad base of participation, but it is a market which seems to suit the needs of the biggest players - the banks.

I noticed in Bernanke's testimony today he acknowledged the tens of billions of dollars of profit he is earning on his trillion dollar + mortgage security portfolio. He said he is earning over 3% on these securities and his cost of funds is close to zero. All this profit is sent to the Treasury, and it helps also the inevitable losses they will take on defaulting securities.

How interesting. Who sets his cost of funds? Bernanke himself. His conflict of interest here is enormous, because he can unilaterally define his profitability by where he sets short term rates. For the first time, the Fed has its own personal profit motive influencing its monetary policy, despite anything it says to the contrary and its best efforts to ignore this profit. This is yet another reason for him to keep interest rates at zero for "an extended period" - until his portfolio of mortgage-backed instruments is reduced and/or the losses on the portfolio are recouped.

So yes, this bubble can go on for quite some time. The crack-up, however, which is inevitable, will be something to behold.

But we may not fall over the edge.

Consider. If the debt this time flows into corporations, like GE or like GM or like Ford, and their innovations can successfully reduce the energy mix of the United States in a substantive way. Then the monies will have been 'invested.'

That is the difference between this capital outlays of 2009 and 2010, and the 2001 to 2006 capital outlay. In the Bush regime innovation was being shut down. Government policy was actively shutting down broad band internet, alternative autos, and renewable energy. Instead capital was going to build stick houses in the suburbs. Young men foregoing college so they could go out and hang sheetrock for $50 per hour (would those folks like a do over in their life!).

This time I see the capital flowing TO innovation. IF the United States can find an Energy Miracle as Bill Gates says, then $1 trillion per year can stay in the United States, that has historically drained out of the country year in and year out - twice military spending, money that is literally burned. If the capital is going to public transport, solar, batteries, efficient transport, trains, wind, nuclear, geothermal, redesigned cities, hybrid air travel, building efficiencies, etc. etc. And things we never thought of. Then the deficits become investments and begin to draw a return, just like the portfolios of Bernanke who is working off the toxic assets inside the Treasury portfolio (very unusual but then his specialty was the Great Depression).

I don't like the game, the level of risk seems way higher. But this Country has been kicking the can down the road for a long long time. I can get a glimpse of what these trillions can do if they are well placed within the right industries.

But I can also see the disaster if the end game is not handled just right.

For me the markers are:

Evidence that oil consumption in this country has permanently peaked and is declining along with evidence of sharply rising transport of goods and people via rail

Inflation that never rises above 4% or 5%, because the spiral could get very dodgy after that in this environment. However, I think inflation in the 1.5% to 2% range is actually the sweet spot.

The Fed getting out of the profit making business

China's currency moving to market because they are hurting global growth with their currencies pegged to ours.

The US leaving Iraq by 2012

The Us drawing down Afghanistan being the campaign promise of Obama in the 2012 election.

Military Spending falling below $500 billion at least.

I know I missed some things, but if the investments don't pan out then energy will rise and dollars keep leaving the country. That is the bet, and in the absence of that there will be trouble. Domestic energy production is key to everything in this environment and WE DO NOT HAVE THE TECHNOLOGY TODAY TO DO THAT. It has to be invented.

We will see, won't we.

Why can't we get your ideas to someone in the White House?

Precisely the Obama White House scheme. This is their plan.

In fact it is the plan of the Energy Secretary, it was positioned in the heart of the original stimulus bill, it was at the heart of the GM and Chrysler government led bankruptcy, it is at the heart of the jobs bill, at the heart of the new budget.

If you scan old speeches of Obama the statement of keeping $1 trillion dollars a year in the domestic economy is a remark he makes. That is what the energy legislation, the climate change legislation will be all about. Domestic energy, renewable and job creating.

Is only good if it is because of efficiency or alternative sources. Unfortunately, destruction of energy demand is exactly that: destruction.

I am outlining a POSITIVE investment that creates an alternate SOURCE of Domestic energy.

Consider. Today: car that gets 12 mpg and costs $65 per week to drive vs. car that gets 147 mpg (example of the 2012 Prius)and because 75% of fuel source is electricity cost is $10 per week. Said family now has an extra $55 per week to spend on other goods and services.

Consider that $8 of families energy spending for the car instead of going to Saudi Arabia goes to the South Dakota wind farm. Now, domestic energy produced renew-ably creates three times more jobs than the same amount produced from non renewable sources.

Consider goods transported by rail (aka Buffett's Burlington rail network) vs. trucks on roads. It is ten times more efficient on rail at least, considering the wear and tear trucks subject roads to. The Interstate in fact wears out in most regions of the country because of trucks not cars. Consider that BNSF rail corridor electrifying and now all rail transfer through that corridor comes exclusively from renewable domestic energy (see above).

Consider a home that is LEED certified efficient costing $300 per year for energy vs. $800 per year. Consider the development of a rooftop energy production system that is installed by utilities that provides all of the houses energy needs locally, and all the owner does is lease the equipment. Again the jobs created for this domestically made equipment creates three times more jobs than fossil fuel.

Take every process, every energy throughput and apply the same technology and investment and you work down the export of dollars for energy.

Consider, jet fuel derived from algal ponds that have been engineered to convert carbon dioxide and water into a substrate that can be refined into jet fuel. That has been the three year basic research project of DARPA. They claim to have a working prototype.

Foreign energy declines and domestic energy rises. Available dollars in the pockets of consumers rises at the same time. Win Win.

There is a thing called EROI or Energy Return on Investment. Now suppose for example that I have a car that gets 20 m/g and I trade up for a car that is like a Prius at 40 m/g but domestically made; is that good? Maybe not. Here's the idea drive 10k miles/year using 500 gallons of fuel per year. Now according to ford, 21% of emissions come from making the average car but we can estimate 21% of the energy used by a vehicle comes from its manufacturing assuming the lifetime is 120K miles. That's a conservative guess because those new cars are very clean burning. In order to begin getting a positive EROI on the new car like vehicle; how long would I need to drive it? The new car will only use 250 gallons per year compared to my old guzzler at 500. So 250 gallons to the good but the new car cost in energy, 630 gallons to make. That means, I will start having a positive affect on energy saving in about 2.5 years of driving if I sell now but my car has only 2 years of life left in it. Of course if the car is made overseas its a different thought process but you get the point. This kind of calculation has to be made for everything we do in the future.

The last three items on your list are, at best, a long shot. Obama doesn't have what it takes to stand up to the CMIC. And i note that you did not include returning our civil liberties in your prescription. I'm not sure how we can have a well-functioning economy work in a dysfunctional society. But maybe i'm just not progressive enough to see the Truth.

if I may.

All the great evils of the world come from those who believe they have the Truth. I do not believe in Truth.