Wednesday, June 1, 2011

Poor Economic Data Shakes Wall Street

Observe these quotes from a wall street trader:

"The U.S. economy is hitting the brakes at exactly the wrong time for the Federal Reserve," said Douglas Borthwick, managing director at Faros Trading in Stamford, Connecticut.

"With the expected end of QE2 within reach, the U.S. economy is in a situation where its only form of life support is about to be ripped away from it."

The US economy is hitting the brakes at exactly the wrong time? So when will it ever be the "right time" for the Federal Reserve to stop providing life support? Here is a basic answer: so long as the US economy is structurally flawed there will never be a time for the fed to begin it's exit. Think about what's going on for a moment. The fed has short term rates at zero. The second round of quantitative easing amounting to $600 billion is coming to an end within 4 weeks. $600 billion worth of liquidity has been added to the economy in the past 6 months and STILL the economy begins to stall. Back in the days when the economy would hit a "soft patch" the fed would lower rates which would in turn lower borrowing costs, thereby stimulating the economy. We have had rates to the floor since the end of 2008 leaving the fed with no other tools but asset purchases with thin air money. But now even asset purchases aren't enough. A federal deficit of $1.5 trillion isn't enough. What the hell is it going to take to get this bastard of an economy to get back on track? My answer: debt liquidation. Let the damn cards fall where they may. This 15 jar juggling operation has left the powers that be with no room for error. With GDP being downgraded to 1.8% for the first quarter while over 3% was forecasted by the CBO, watch what happens to the deficit projections. Of course they will be upgraded (how fucking shocking) and more debt will have to be issued just to pay off existing debt.

More from the article:

They also fear the unknown. No matter how much confidence they publicly express about their ability to withdraw the unprecedented monetary stimulus provided during the crisis, many have expressed trepidation about the size of the central bank's balance sheet, now a record $2.76 trillion.

There is a pervasive sense that the more policymakers do the less they achieve — and the trickier an eventual exit becomes.

It was a matter of time until the price increases in energy and gas would sink the current half assed "recovery." The latest ISM and PMI data prove that contraction is imminent. ADP reported job growth was only 35,000 for the month of May while wall street was expecting 175,000 plus in new jobs. Oops. Epic fail on job forecasting. Better luck next month.

The point here is not to believe all the propaganda being proclaimed that the US is back on it's feet and that the issues are cyclical. This country has structural problems and until these structural problems are properly addressed the imbalances will continue to grow until a tipping point is reached. The imbalances are the federal debt, financial and corporate debt, trade deficits and federal deficits. In addition, rampant outsourcing of labor is bleeding the country dry of desperately needed incomes for households. Paul Craig Roberts wrote a brilliant article on outsourcing entitled, How Offshoring Has Destroyed the Economy. Here is a great excerpt:

As a graduate student in economics, I was fortunate to study with a number of professors who had or were subsequently awarded Nobel Prizes. Among these creative people there are two economists whom I did not study under, but whose work I have read, and whose work is of great importance to our economic prospects. The two most important economists of our time, who, without any doubt, deserve the Nobel Prize are Ralph Gomory and Herman Daly.

Ralph Gomory’s book, “Global Trade and Conflicting National Interests,” coauthored with William J. Baumol, a past president of the American Economics Association, is the most important work in trade theory ever produced. This book, and subsequent papers by Gomory, prove beyond all doubt that the free trade theory set out by David Ricardo at the beginning of the 19th century is merely a special case, not a general theory.

Economists learn in their graduate courses that free trade is an unchallengeable doctrine and that only ignorant protectionists dispute the theory. This mindset was sufficient for Gomory’s book to be largely ignored, even though Paul Samuelson, the dean of American economics, acknowledged the critical point that there are situations in which free trade is not mutually beneficial.

The other deserving recipient of the Nobel prize is Herman Daly. On the trade issue, Daly’s point is different from and less revolutionary than Gomory’s. Daly makes the same point that I make, which is that the classic theory of free trade is based on comparative advantage, not on absolute advantage, and that offshoring is based on absolute advantage. Thus, offshoring is not free trade.

Daly’s revolutionary contribution to economics comes from his realization that the production function that is the basis of economic science is wrong.

This production function is known as the Solow-Stiglitz production function. This production function assumes that man-made capital is a substitute for nature’s capital. It follows from this assumption that whatever humans do to use up and destroy the natural environment can be overcome by the resourcefulness of science and technology.

Daly shows that this reasoning is incorrect. If the Gulf of Mexico is destroyed by fertilizer run-offs from agri-business and by oil spills, only nature can correct the problem after many years measured in decades or centuries. In the meantime, humans are without the resource.

Daly’s argument is brilliant in its simplicity. In former times, nature’s capital was enormous, and man’s reproducible capital was small. For example, fish in the oceans were plentiful, but fishing boats were not. Today fishing boats are in excess supply, but ocean fishing stocks are depleted. Thus, the limiting factor is not man-made capital, but nature’s capital. Daly stresses that by leaving ecological and social costs out of the computation of GDP, economists do not have a reliable measure of the effect of economic activity on human welfare.

I hope that you all read the above article as it exposes the lie that outsourcing and offshoring are good for the US economy. Until we plug these losses and kick the oligarchs out of Washington and Wall Street, this country will end up like a nicer version of Mexico.

For the time being, expect the economy to stall as the Fed pauses on it's money printing operations. Some savvy experts are calling for the Fed to return to it's easing operations by late Fall 2011. Let's see how the markets hold up without the juice.


  1. Great points, Subprime! - there doesn't appear to be many options left in toolkit.

    I'm not sure I follow the outsourcing article, though. He appears to be making some point about the tragedy of the commmons rather than outsourcing.

    Outsourcing is just a small component of the problem - the real problem is the devaluation of labor. Technology is a much bigger impact than outsourcing. To the extent that outsourcing was limited, you would see more technology deployed as machines are cheaper than jobs.

    Despite all the talk of everything being made in China, manufacturing employment is actually falling in China. If that doesn't tell you about the rise of the machines, nothing will.

    Not sure what the answer to all of this is...

  2. Lee,

    This is a difficult concept to grasp but here is my understanding:

    Technological advances are good for human society. Take the ATM machine for example. Before we had to use more bank tellers, now we have the machine. The overall costs for all of society are lower because the expenses of the ATM machine are lower than the payroll of the human teller. Thus, all of us have to pay less of our wages (labor) in exchange for retrieving money out of the bank. Basically, falling prices are GOOD for society. Cell phones and computers are another example of falling prices benefiting society. We all give less of our labor in exchange for a computer or phone.

    The problem arises when we have falling prices due to productivity which clashes with our monetary system which requires higher prices, due to increasing amounts of debt. Productivity and technology advances our society with lower prices or less of our labor in exchange for the good or service, while our debt based system requires higher prices (or more labor) in order to sustain itself. I hope this makes sense to you.

    If we lived in a world where money was not created out of debt, then we would have a world of falling prices. With continuously falling prices, our labor (translated into wages) would afford us with stronger purchasing power. It's just that we have all been brainwashed with the idea that slowly rising prices are a good thing. Not true at all, at least based on my research and understanding of life.

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