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We Face the Worst Financial Crisis in History

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We Face the Worst Financial Crisis in History, Says Head of the Bank of England

Gary North

Oct. 8, 2011

The headline in the London Telegraph is a shocker: World facing worst financial crisis in history, Bank of England Governor says.

Frankly, I have never read a headline like this. This is the highest-level figure I have ever heard of who used language this strong. It is unprecedented.

He could be wrong, of course. But when the head of the model of all modern central banks says this, we are facing a major problem. It is so big that it has persuaded him to go public with his concerns.

The world is facing the worst financial crisis since at least the 1930s "if not ever", the Governor of the Bank of England said last night.

Sir Mervyn King was speaking after the decision by the Bank's Monetary Policy Committee to put £75 billion of newly created money into the economy in a desperate effort to stave off a new credit crisis and a UK recession.

Economists said the Bank's decision to resume its quantitative easing [QE], or asset purchase programme, showed it was increasingly fearful for the economy, and predicted more such moves ahead.

Sir Mervyn said the Bank had been driven by growing signs of a global economic disaster.

"This is the most serious financial crisis we've seen, at least since the 1930s, if not ever. We're having to deal with very unusual circumstances, but to act calmly to this and to do the right thing."

I cannot imagine Bernanke saying this. Even in the midst of the 2008 crisis three years ago, he said almost nothing. He let Paulson do the talking.

So, what is the problem? The Eurozone.

Announcing its decision, the Bank said that the eurozone debt crisis was creating "severe strains in bank funding markets and financial markets".

The Monetary Policy Committee [MPC] also said that the inflation-driven "squeeze on households' real incomes" and the Government's programme of spending cuts will "continue to weigh on domestic spending" for some time to come.

The "deterioration in the outlook" meant more QE was justified, the Bank said.

Central banks inflate. They do little else. But they do not justify their policies with rhetoric this intense.

This is bad news for pensioners, of course: more inflation.

By the way, the reporter actually explained the Bank's action -- and explained it accurately. Now, that's news!

Under QE, the Bank electronically creates new money which it then uses to buy assets such as government bonds, or gilts, from banks. In theory, the banks then use the cash they gain to increase their lending to businesses and individuals.

By increasing the demand for gilts, QE pushes down the interest rate yields paid to holders of these and other bonds. Critics of the policy say it pushes up inflation and drives down sterling.

There is opposition to the move.

The National Association of Pension Funds yesterday called for urgent talks with ministers to address the negative impact of lower gilt yields on pension funds. Joanne Segars, its chief executive, said QE makes it more expensive for employers to provide pensions and will weaken the funding of schemes as their deficits increase. "All this will put additional pressure on employers at a time when they are facing a bleak economic situation," she said.

Ros Altman, of Saga, said the latest round of QE was "a Titanic disaster" that would increase pensioner poverty. As well as fuelling inflation, she said, falling bond yields would make annuities more expensive, "giving new retirees much less pension income for their money and leaving them permanently poorer in retirement".

The MPC also voted to keep the Bank Rate at its historic low of 0.5 per cent, another decision that hurts savers. Yesterday, protesters outside the Bank's headquarters smashed a giant piggy bank to symbolise the situation of pensioners and others forced to raid savings to keep up with the rising cost of living.

King of course justified the Bank's action. He is a Keynesian, and for Keynesians, there must be inflation, always.

Asked about the plight of savers, Sir Mervyn said it was more important to support the wider economy than to support them. He suggested that savers would not be helped by deliberately pushing the British economy into recession. Yesterday's decision was the first move on QE since 2009, during the global credit crisis, when the Bank injected £200?billion into the economy.

Price inflation is moving up sharply.

The Bank is supposed to keep inflation near a target of 2 per cent. Inflation now stands at 4.5 per cent, and the Bank admitted it is likely to hit 5 per cent as soon as this month. The Bank's own research shows that as well as stimulating the economy, QE pushes up prices.

Sir Mervyn insisted that yesterday's move was still consistent with the 2 per cent inflation target, saying that the slowing economy means inflation could actually fall below that mark "by the end of next year or in 2013".

Because the policy subsidizes the government, the government cheered.

George Osborne, the Chancellor, welcomed the Bank's move, saying: "The evidence shows that it [QE] will help keep interest rates down and boost demand and that will be a help for British families."

When the Bank of England holds rates this low, despite criticism, there is a crisis brewing. Bernanke gets no criticism from the Establishment. He can get away with boring speeches. King cannot. He and the other decision-makers at the bank perceive that Europe is at the edge of the abyss.

The pound fell.

In the USA, anyone who uses this sort of language is dismissed as a crank. Mervyn King is not a crank. He represents the Establishment in Great Britain.

Those of us who see the European debt crisis as King does have no authority in the USA. The experts cannot easily dismiss King. So, they will ignore him.

If you want to understand why King said what he did, read this. If the Greeks quit, Europe will have to raise the equivalent of a trillion dollars in euros in one day, and $2 trillion in euros over the next three years. A banking collapse would be likely if this money were not forthcoming.

Would it come? Of course. The European Central Bank would illegally create it.

On that day, own gold.

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Why Europe's debt crisis is a storm warning for Wall Street

The debt crisis engulfing Europe is heading for the US, former Wall Street bond trader Michael Lewis warns in his latest book

By Paul Harris


Monday 10 October 2011 14.30 EDT

The fire alarm goes off as Michael Lewis descends in the lift from his hotel room. As a security guard warns nervous-looking guests that the screaming sound was not a drill, it seemed the perfect introduction for a man whose new book about Europe's debt crisis is flying off American shelves.

"The world does seem to be falling apart," Lewis says. Even the briefest glance at the headlines would seem to confirm that opinion. As civil unrest flares in a near-bankrupt Greece and European leaders struggle to avert "contagion", it is hard not to worry that the Great Recession caused by the collapse of debt-laden banks might – horribly – be just a prelude to the even greater disaster of debt-laden countries toppling like dominoes.

That cheerful scenario is precisely the subject of Boomerang: Travels in the New Third World, Lewis's jaunty yet scary account of his travels in four countries at the heart of the crisis. He visits Iceland to investigate just how a tiny island nation in the middle of the North Atlantic could go through one of the most spectacular banking boom-and-busts in history. He trawls through the sorry tale of the Irish real estate bubble and the epic tragedy that is Greece before examining Germany: Europe's reluctant rescuer. But finally, and harrowingly, he ends his journey back in the US, warning that Americans have little reason to feel safe from the danger. Instead, they are simply last in line.

To put it mildly, Lewis – whose position as a former bond trader gives him more than just journalistic insight – sees big trouble ahead. "There is going to be a change in the idea that each generation of Americans is going to live a lot better than the one before it," he says. "Imagine an America where you have got a long recession. It does not become a Great Depression, but you get negative growth or low growth or no growth for a long time and high unemployment. What does that generate? It generates anger."

Indeed it does. Just a 20-minute taxi ride south from the fancy New York hotel where Lewis is tucking into high quality Japanese food, the Occupy Wall Street movement has now camped out in a downtown Manhattan park for more than three weeks.

From small beginnings, the protests have spread to dozens of American cities. There have been hundreds of arrests and speculation that a new political movement – a sort of Tea Party of the left – is being born. Lewis welcomed the phenomenon. "If you ask the average Wall Street boss what he thought of those people, he'd say it was a joke," he says. "I don't think it's a joke. I think there is actually an incredible frustration and legitimate anger in the country that arises from the unfairness of the treatment of the financial sector."

That treatment, Lewis says, is the real joke. He points out how Wall Street banks, having helped cause the Great Recession and then been bailed out to the tune of hundreds of billions of taxpayer dollars, have now set about gutting attempts to reform their industry. "It is outrageous. It is totally outrageous and it is so obvious that you can say it until you are blue in the face and you think there's no hope for change in the world. But now this protest in lower Manhattan happens and it seems to me there are a lot of people who share the sentiment."

Of course, one person who is not suffering is Lewis himself. Boomerang is one of the most spectacularly well-timed books in recent publishing history, and Lewis is rapidly becoming one of America's most successful modern writers. His first work, xxxx's Poker, was an account of his disillusioning time as a bond trader in the late 1980s. It was intended as a cautionary tale of foolish excess, though, perhaps presciently, Lewis was shocked when some young graduates saw it more as a sort of handbook to working in the finance industry. But Lewis, who now covers business issues for Vanity Fair, has never restricted himself to just finance. His book about baseball, called Moneyball, has just been turned into a film starring Brad Pitt.

Another tome, about American football, featured material that eventually became the Oscar-nominated movie The Blind Side. He is currently working on a potential TV show for HBO. Such is Lewis's success that New York magazine ran a profile of him this week under the headline: "It's good to be Michael Lewis."

Not that it goes to his head. He speaks in the chatty, friendly style of a professional journalist, with an accent hinting at his southern roots in New Orleans. He exudes a charm and affability that is present throughout the pages of Boomerang. It allowed him to travel to the destinations on his "economic disaster tour" and meet everyone – from the prime minister of Iceland, to sneaking into the Greek monastery where the monks' dodgy financial shenanigans inadvertently helped bring the Greek crisis into being. Yet, far from kicking him out, the monks ended up happily showing him around. He is good company throughout the book, though he has received a lot of flak for indulging in national stereotypes – both expected and unexpected – as a sort of explanation for why different countries made the mistakes they did. In particular, he has been slammed for a lengthy examination of why German attitudes towards money and human excrement mirror each other (a public sense of order masking a secret fascination with the dark side, since you ask).

But such sideshows are merely that: a distraction from the main theme of the book, which is simply that the European crisis now unfolding is eventually heading for America's shores. To illustrate the point, Lewis opens the book with an introduction to one of the most unnerving characters in modern American finance: Texan hedge fund manager Kyle Bass. Lewis found Bass while working on his previous book on the banking crisis, The Big Short. He interviewed Bass in 2008 after realising he had made a fortune predicting the bursting of the American real estate bubble. While everyone else had piled in to the boom, Bass had bet against it, and it had earned him a fortune. But Bass by then had moved on and would only talk about the coming debt crisis that would, he predicted, eventually overwhelm Europe, probably starting in Greece.

And what was Bass's investment advice to prepare for this? It was to buy guns and gold; and on a second visit in 2011, Lewis found Bass had not changed his mind. Indeed, he had purchased 20m nickels, solely for the value of their metal. It is scary stuff, especially as each day brings fears of a Greek default another step closer. Though even Lewis shies away from saying that Bass is going to be right about everything. His vision of an almost literal doomsday scenario is not one Lewis shares. "It does not necessarily mean sitting on top of your pile of gold and shooting people who get near your broccoli patch," Lewis says. He believes the US government will act to stem the crisis heading its way. It may mean tough times, even a fundamental realigning of what Americans expect out of life, but it will not be a Greek-style imminent collapse.

"Americans are pretty self-preservatory," he says. "The crisis will create pressures here that will arrest the crisis before it causes the US treasury to stop paying its bills." But then Lewis pauses: "I think. I don't know." By then the hotel fire alarm that had greeted Lewis's arrival had long been turned off. There had been no real fire. Hopefully, the same will be true for some of the direst warnings in his book.

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The Way Forward

Moving From the Post-Bubble, Post-Bust Economy to Renewed Growth and Competitiveness

By Daniel Alpert, Westwood Capital; Robert Hockett, Professor of Law, Cornell University; and Nouriel Roubini, Professor of Economics, New York University

October 10, 2011 |

New America Foundation

Notwithstanding repeated attempts at monetary and fiscal stimulus since 2009, the United States remains mired in what is by far its worst economic slump since that of the 1930s.1 More than 25 million working-age Americans remain unemployed or underemployed, the employment-to-population ratio lingers at an historic low of 58.3 percent,2 business investment continues at historically weak levels, and consumption expenditure remains weighed down by massive private sector debt overhang left by the bursting of the housing and credit bubble a bit over three years ago. Recovery from what already has been dubbed the “Great Recession” has been so weak thus far that real GDP has yet to surpass its previous peak. And yet, already there are signs of renewed recession.

It is not only the U.S. economy that is in peril right now. At this writing, Europe is struggling to prevent the sovereign debt problems of its peripheral Euro-zone economies from spiraling into a full-fledged banking crisis – an ominous development that would present an already weakening economy with yet another demand shock. Meanwhile, China and other large emerging economies--those best positioned to take up worsening slack in the global economy--are beginning to experience slowdowns of their own as earlier measures to contain domestic inflation and credit-creation kick in, and as weak growth in Europe and the United States dampen demand for their exports.

Nor is renewed recession the only threat we now face. Even if a return to negative growth rates is somehow avoided, there will remain a real and present danger that Europe and the United States alike fall into an indefinitely lengthy period of negligible growth, high unemployment and deflation, much as Japan has experienced over the past 20 years following its own stock-and-real estate bubble and burst of the early 1990s.3 Protracted stagnation on this order of magnitude would undermine the living standards of an entire generation of Americans and Europeans, and would of course jeopardize America’s position in the world.

Our economic straits are rendered all the more dire, and the just mentioned scenario accordingly all the more likely, by political dysfunction and attendant paralysis in both the United States and Europe. The political stalemate is in part structural, but also is attributable in significant large measure to the nature of the present economic crisis itself, which has stood much familiar economic orthodoxy of the past 30 years on its head. For despite the standoff over raising the U.S. debt ceiling this past August, the principal problem in the United States has not been government inaction. It has been inadequate action, proceeding on inadequate understanding of what ails us.

Since the onset of recession in December 2007, the federal government, including the Federal Reserve, has undertaken a broad array of both conventional and unconventional policy measures. The most noteworthy of these include: slashing interest rates effectively to zero; two rounds of quantitative easing involving the purchase of Treasuries and other assets, followed by Operation Twist to flatten the yield curve yet further; and three fiscal stimulus programs (including the 2008 Economic Stimulus Act, the 2009 American Recovery and Reinvestment Act, and the 2010 Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act) and the 2008 Troubled Asset Relief Program to recapitalize the banks.

These actions have undeniably helped stabilize the economy—temporarily. But as evidenced by continuing high unemployment and the weak and now worsening economic outlook, they have not produced a sustainable recovery. And there is no reason to believe that further such measures now being proposed, including the additional tax relief and modest spending found in the administration’s proposed American Jobs Act – which look all too much like previous measures – will be any more successful. Indeed, there is good reason to worry that most of the measures tried thus far, particularly those involving monetary reflation, have reached the limits of their effectiveness.

The questions now urgently before us, then, are these: First, why have the policies attempted thus far fallen so far short? And second, what should we be doing instead?

Answering these questions correctly, we believe, requires a more thorough understanding of the present crisis itself – its causes, its character, and its full consequences. Regrettably, in our view, there seems to be a pronounced tendency on the part of most policymakers worldwide to view the current situation as, substantially, no more than an extreme business cyclical decline. From such declines, of course, robust cyclical recoveries can reasonably be anticipated to follow in relatively short order, as previous excesses are worked off and supply and demand find their way back into balance. And such expectations, in turn, tend to be viewed as justifying merely modest policy measures.

Yet as we shall show in what follows, this is not an ordinary business cycle downturn. Two features render the present slump much more formidable than that – and much more recalcitrant in the face of traditional policy measures.

First, the present slump is a balance-sheet Lesser Depression or Great Recession of nearly unprecedented magnitude, occasioned by our worst credit-fueled asset-price bubble and burst since the late 1920s.4 Hence, like the crisis that unfolded throughout the 1930s, the one we are now living through wreaks all the destruction typically wrought by a Fisher-style debt-deflation. In this case, that means that millions of Americans who took out mortgages over the past 10 to 15 years, or who borrowed against the inflated values of their homes, are now left with a massive debt overhang that will weigh down on consumption for many years to come. And this in turn means that the banks and financial institutions that hold this debt are exposed to indefinitely protracted concerns about capitalization in the face of rising default rates and falling asset values.

But there is more. Our present crisis is more formidable even than would be a debt-deflation alone, hard as the latter would be. For the second key characteristic of our present plight is that it is the culmination of troubling trends that have been in the making for more than two decades. In effect, it is the upshot of two profoundly important but seemingly unnoticed structural developments in the world economy.

The first of those developments has been the steady entry into the world economy of successive waves of new export-oriented economies, beginning with Japan and the Asian tigers in the 1980s and peaking with China in the early 2000s, with more than two billion newly employable workers. The integration of these high-savings, lower wage economies into the global economy, occurring as it did against the backdrop of dramatic productivity gains rooted in new information technologies and the globalization of corporate supply chains, decisively shifted the balance of global supply and demand. In consequence, the world economy now is beset by excess supplies of labor, capital, and productive capacity relative to global demand. This not only profoundly dims the prospects for business investment and greater net exports in the developed world — the only other two drivers of recovery when debt-deflation slackens domestic consumer demand. It also puts the entire global economy at risk, owing to the central role that the U.S. economy still is relied on to play as the world’s consumer and borrower of last resort.

The second long term development that renders the current debt-deflation, already worse than a mere cyclical downturn, worse even than other debt-deflations is this: The same integration of new rising economies with ever more competitive workforces into the world economy also further shifted the balance of power between labor and capital in the developed world. That has resulted not only in stagnant wages in the United States, but also in levels of income and wealth inequality not seen since the immediate pre-Great-Depression1920s.

For much of the past several decades, easy access to consumer credit and credit-fueled rises in home values – themselves facilitated by recycled savings from emerging economies’ savings – worked to mask this widening inequality and support heightening personal consumption. But the inevitable collapse of the consumer credit and housing price bubbles of course brought an end to this pattern of economic growth and left us with the massive debt overhang cited above. Government transfer payments and tax cuts since the crash have made up some of the difference over the past two years; but these cannot continue indefinitely and in any event, as we argue below, in times like the present they tend to be saved rather than devoted to employment-inducing consumer expenditure. Even current levels of consumption, therefore, will henceforth depend on improvements in wages and incomes. Yet these have little potential to grow in a world economy beset by a glut of both labor and capital.

Only the policymakers of the 1930s, then, faced a challenge as complex and daunting as that we now face. Notwithstanding the magnitude of the challenge, however, this paper argues that there is a way forward. We can get past the present impasse, provided that we start with a better diagnosis of the crisis itself, then craft cures that are informed by that diagnosis.5 That is what we aim here to do. The paper proceeds in five parts:

Part I provides a brief explanatory history of the credit bubble and bust of the past decade, and explains why this bubble and bust have proved more dangerous than previous ones of the past 70 years.

Part II offers a more detailed diagnosis of our present predicament in the wake of the bubble and bust, and defines the core challenge as of the product of necessary de-levering in a time of excess capacity.

Part III explains why the conventional policy tools thus far employed have proved inadequate – in essence, precisely because they are predicated on an incomplete diagnosis. It also briefly addresses other recently proposed solutions and explains why they too are likely to be ineffective and in some cases outright counterproductive.

Part IV outlines the criteria that any post-bubble, post-bust recovery program must satisfy in order to meet today’s debt-deflationary challenge under conditions of oversupply.

Part V then lays out a three-pillared recovery plan that we have designed with those criteria in mind. It is accordingly the most detailed part of the paper. The principal features of the recovery plan are as follows:

First, as Pillar 1, a substantial five-to-seven year public investment program that repairs the nation’s crumbling public infrastructure and, in so doing, (a) puts people back to work and (B) lays the foundation for a more efficient and cost-effective national economy. We also emphasize the substantial element of “self-financing” that such a program would enjoy, by virtue of (a) massive currently idle and hence low-priced capacity, (B) significant multiplier effects and © historically low government-borrowing costs.

Second, as Pillar 2, a debt restructuring program that is truly national in scope, addressing the (intimately related) banking and real estate sectors in particular – by far the most hard-hit by the recent bubble and bust and hence by far the heaviest drags on recovery now. We note that the worst debt-overhangs and attendant debt-deflations in history6 always have followed on combined real estate and financial asset price bubbles like that we have just experienced. Accordingly, we put forward comprehensive debt-restructuring proposals that we believe will unclog the real estate and financial arteries and restore healthy circulation – with neither overly high nor overly low blood pressure – to our financial and real estate markets as well as to the economy at large.

Third, as Pillar 3, global reforms that can begin the process of restoring balance to the world economy and can facilitate the process of debt de-levering in Europe and the United States. Key over the next five to seven years will be growth of domestic demand in China and other emerging market economies to (a) offset diminished demand in the developed world as it retrenches and trims back its debt overhang, and (B) correct the current imbalance in global supply relative to global demand. Also key will be the establishment of an emergency global demand-stabilization fund to recycle foreign exchange reserves, now held by surplus nations, in a manner that boosts employment in deficit nations. Over the longer term, we note, reforms to the IMF, World Bank Group, and other institutions are apt to prove necessary in order to lend a degree of automaticity to currency adjustments, surplus-recycling, and global liquidity-provision.7

To read the full paper, click on link:


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