Pimco's Tony Crescenzi: only innovation can create jobs lost due to the structural changes in the US economy

Structural rather than cyclical influences on unemployment are running well above normal during the current recession, as is highlighted by the percentage of the unemployed that are “not on temporary layoff.” Data from the Bureau of Labor Statistics show that 53.9% of the unemployed were not on temporary layoff in August, up from 39.1% a year earlier and well above the 30-year average of about 34%. The current level is well above the peak of previous cycles, which tended to move above 40% and was as high as 44.9% in May 1992. Many job losses are occurring in industries with broken business models and jobs won’t return quickly. This will put downward pressure on wages ...In terms of numbers of people, data from the BLS show that 8.1 million people were characterized as "not on temporary layoff" in August, up from 7.880 million in July and 3.72 million a year earlier. The not-seasonally-adjusted figure for "Permanent" job losers totaled 6.406 million, up from 3.609 million. These figures represent a very large proportion of the roughly 7 million decline in nonfarm payrolls (the tally on payrolls is produced via a survey of business; the figures on unemployment and both the "not on temporary layoff" and "permanent" job losers categories are derived from the survey of households).

Stiglitz Says Banking Problems Are Now Bigger Than Pre-Lehman

Joseph Stiglitz, the Nobel Prize- winning economist, said the U.S. has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of Lehman Brothers Holdings Inc.

“In the U.S. and many other countries, the too-big-to-fail banks have become even bigger,” Stiglitz said in an interview today in Paris. “The problems are worse than they were in 2007 before the crisis.”

Stiglitz’s views echo those of former Federal Reserve Chairman Paul Volcker, who has advised President Barack Obama’s administration to curtail the size of banks, and Bank of Israel Governor Stanley Fischer, who suggested last month that governments may want to discourage financial institutions from growing “excessively.”

A year after the demise of Lehman forced the Treasury Department to spend billions to shore up the financial system, Bank of America Corp.’s assets have grown and Citigroup Inc. remains intact. In the U.K., Lloyds Banking Group Plc, 43 percent owned by the government, has taken over the activities of HBOS Plc, and in France BNP Paribas SA now owns the Belgian and Luxembourg banking assets of insurer Fortis.

While Obama wants to name some banks as “systemically important” and subject them to stricter oversight, his plan wouldn’t force them to shrink or simplify their structure.

Stiglitz said the U.S. government is wary of challenging the financial industry because it is politically difficult, and that he hopes the Group of 20 leaders will cajole the U.S. into tougher action.

G-20 Steps

“We aren’t doing anything significant so far, and the banks are pushing back,” he said. “The leaders of the G-20 will make some small steps forward, given the power of the banks” and “any step forward is a move in the right direction.”

G-20 leaders gather next week in Pittsburgh and will consider ways of improving regulation of financial markets and in particular how to set tighter limits on remuneration for market operators. Under pressure from France and Germany, G-20 finance ministers last week reached a preliminary accord that included proposals to claw-back cash awards and linking compensation more closely to long-term performance.

“It’s an outrage,” especially “in the U.S. where we poured so much money into the banks,” Stiglitz said. “The administration seems very reluctant to do what is necessary. Yes they’ll do something, the question is: Will they do as much as required?”

Global Economy

Stiglitz, former chief economist at the World Bank and member of the White House Council of Economic Advisers, said the world economy is “far from being out of the woods” even if it has pulled back from the precipice it teetered on after the collapse of Lehman.

“We’re going into an extended period of weak economy, of economic malaise,” Stiglitz said. The U.S. will “grow but not enough to offset the increase in the population,” he said, adding that “if workers do not have income, it’s very hard to see how the U.S. will generate the demand that the world economy needs.”

The Federal Reserve faces a “quandary” in ending its monetary stimulus programs because doing so may drive up the cost of borrowing for the U.S. government, he said.

“The question then is who is going to finance the U.S. government,” Stiglitz said.

(from bloomberg.com, September 13, 2009)

Bailout Recipient Banks Lending Drops For Sixth Consecutive Month

It was just yesterday that Tim Geithner was lying that banks are constantly increasing lending to consumers. Well, yet another lie refuted. Banks, and not just any banks, but those receiving government bail outs and subsidies, continued constricting lending in July, with total average loan balance outstanding declining by $54 billion from $4,295 billion to $4,241 billion, a 1.3% decline, following a 1.1% decline in June.

As for the reason why loan originations in July declined a whopping 10% after posting a 12.7% increase in June, the government simply noted that this was due to "decreased demand from borrowers."

And so the circular lie continues: the government claims lending is increasing, when in fact, it is not, and when confronted with this fact, the government claims this is due to lack of interest. Furthermore, with retail sales reportedly higher, the consumer is allegedly spending more, with average wages declining, meaning consumer need to borrow to finance purchases, or else eat into their meager savings. Yet all this is occurring on the foreground of a rapidly increasing savings rate. So consumers are not borrowing, they are saving more, yet somehow sales are increasing: the lie is so circular that if there was a Kudlowbot, its head would explode trying to "spin" this null argument.

Last but not least, the primary politically correct reason for bailing out banks was to ensure that they can continue lending. So here are the numbers: $4,434.7 billion in loans outstanding in January, $4,241.4 billion in July: a 4.4% decline, which, all else being equal, would have to be offset by a comparable increase in the rate of savings. However, with wages declining and more and more people becoming unemployed, all else is anything but equal. At least bank CEOs get their precious bail out capital and golden parachute packages (ref: John Thain) as popular media outlets continue spinning lies and spewing factless propaganda.

(from zerohedge.com, September 15, 2009)

DDRs – delevering, deglobalization, and reregulation

... Well, the surprise is that there’s been a significant break in that growth pattern, because of delevering, deglobalization, and reregulation. All of those three in combination, to us at PIMCO, means that if you are a child of the bull market, it’s time to grow up and become a chastened adult; it’s time to recognize that things have changed and that they will continue to change for the next – yes, the next 10 years and maybe even the next 20 years. We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops and begins, as they do in Japan (to be a little ghoulish), starts saving to the grave.

This focus on the DDRs – delevering, deglobalization, and reregulation – may be conceptually understandable, but nevertheless still a little hard to get one’s arms around. Why would they necessarily lead to a new, slower growth normal? A little easier to grasp might be the following approach, which feeds off the same concept, but which extends it a little further by suggesting that DD and R lead to a number of broken business or economic models that may forever change the world we once knew and make even Barton Biggs a chastened adult. They are as follows:

1. American-style capitalism and the making of paper instead of things. Inherent in the “great moderation” of the past 25 years was the acceptance of a sort of reverse mercantilism. America would consume, then print paper assets and debt in order to pay for it. Developing (and many developed) countries would make things, and accept America’s securities in return. This game is over, and unless developing countries (China, Brazil) step up and generate a consumer ethic of their own, the world will grow at a slower pace.
   
2. Private vs. public-driven growth. The invisible hand of free enterprise is being replaced by the visible fist of government, a temporarily necessary, but (if permanent) damnable condition itself in terms of future growth and profits. The once successful “shadow banking system” is being regulated and delevered. Perhaps a fabled “110-pound weakling” may be an exaggeration of where our financial system is headed, but rest assured it will not be looking like Charles Atlas anytime soon. Prepare to have sand kicked in your face, if you believe you are a “child of the bull market!”
   
3. Global economic leadership. It’s premature to award the 21st century to the Chinese as opposed to the United States, but if the last six months have been any example, China is sort of lookin’ like Muhammad Ali standing over Sonny Liston in 1964 yelling, “Get up, you big ugly bear!” Not only has China spent three times the amount of money (relative to GDP) to revive its economy, but it has managed to grow at a “near normal” 8% pace vs. our “big R” recessionary numbers. Its equity market, while volatile and lightly regulated, has almost doubled in twelve months, making ours look like that ugly bear instead of a raging bull.
   
4. United States housing and employment. Old normal housing models in the U.S. encouraged home ownership, eventually peaking at 69% of households as shown in Chart 1. Subsidized and tax-deductible mortgage interest rates as well as a “see no evil – speak no evil” regulatory response to government Agencies FNMA and FHLMC promoted a long-term housing boom and now a significant housing bust. Housing cannot lead us out of this big R recession no matter what the recent Case-Shiller home price numbers may suggest. The model has been broken if only because homeownership is declining, not rising, sinking to perhaps a New Normal level of 65% as opposed to 69% of American households.
   
   Similarly, the financialization of assets via the shadow banking system led to an American era of consumerism because debt was available, interest rates were low, and the livin’ became easy. Savings rates plunged from 10% to -1%, as many (if not most) assumed there was no reason to save – the second mortgage would pay for everything. Now things have perhaps irreversibly changed. Savings rates are headed up, consumer spending growth rates moving down. Get ready for the New Normal.

I could go on, reintroducing the negatives of an aging boomer society not just in the U.S., but worldwide. Increased health care may be GDP positive, but it’s only a plus from a “broken window” point of view. Far better to have a younger, healthier society than to spend trillions fixing up an aging, increasingly overweight and diabetic one. Same thing goes for energy. Far easier and more profitable to pump oil out of the Yates Field in Texas or even Prudhoe Bay than to spend trillions on a new “green” society. Our world, and the world’s world, is changing significantly, leading to slower growth accompanied by a redefined public/private partnership.

The investment implications of this New Normal evolution cannot easily be modeled econometrically, quantitatively, or statistically. The applicable word in New Normal is, of course, “new.” The successful investor during this transition will be one with common sense and importantly the powers of intuition, observation, and the willingness to accept uncertain outcomes. As of now, PIMCO observes that the highest probabilities favor the following strategic conclusions:

1. Global policy rates will remain low for extended periods of time.
2. The extent and duration of quantitative easing, term financing and fiscal stimulation efforts are keys to future investment returns across a multitude of asset categories, both domestically and globally.
3. Investors should continue to anticipate and, if necessary, shake hands with government policies, utilizing leverage and/or guarantees to their benefit.
4. Asia and Asian-connected economies (Australia, Brazil) will dominate future global growth.
5. The dollar is vulnerable on a long-term basis.

Like playing in an Open Championship, future golfers/investors need to play conservatively and avoid critical mistakes.

(from September Investment Outlook by PIMCO's Bill Gross)

ZIRP, Deflation and Elevated Risk

Japan was the pioneer of a zero interest rate policy (ZIRP) after experiencing decade-long bouts with recession. Now, the rest of the developed world has followed.

Since late 2007, the U.S. has cut its benchmark overnight lending rate by 5 percentage points to 0.25 percent. The UK chopped its rate by 5.25 percentage points to 0.50 percent. Switzerland, Canada, Japan all sit at or near zero interest rates. And the Eurozone followed, slowly but surely, whittling rates down from 4.25 percent to 1 percent — and moving its key deposit rates down to near zero.

Even after aggressive rate cuts and other efforts by central banks to pump money into their economies and despite all of the chatter about the Fed’s plans to deal with future inflation … deflation remains the problem, not inflation.

Prices are falling in half of the twenty largest economies in the world!

For instance, as you can see in the chart below, year-over-year prices in the U.S. have fallen the most in 60 years.

Source: Bloomberg

In Germany, deflation has hit for the first time in 22 years. And it doesn’t stop there: Consumer prices in Japan, China, France, Spain, Canada, Switzerland, Ireland, Hong Kong and Singapore are falling.

And just this week: Italy joined the ranks, reporting its first drop in prices since 1959 … Japan reported a continued fall in prices … and the Eurozone recorded its biggest price drop on record.

Many think that the central banks, particularly the Fed, have done too much tinkering with the money supply spigot, consequently setting a date with runaway inflation.

The Fed’s job is not easy: Stimulate growth while keeping inflation in check.

But my question is this: Have central banks done enough with interest rates to stop prices from moving lower and to get economic growth back on track?

Contrary to all of the attention that has been placed on plans for removing monetary stimulus, the popular Taylor rule in economics suggests that interest rates in the U.S. should be much lower … well into negative territory. In fact, Goldman Sachs sees the appropriate level for short-term rates at minus 5.8 percent.

Since official interest rates are already near zero, does that mean the global printing presses will have to continue running? Does this rule imply that we can expect more severe deflation ahead?

During the Great Depression, prices fell for four straight years. For two of those years, prices were down 10 percent. But in the world of fiat currencies, central banks have the ammunition of the printing press to fend off such a nasty downward spiral.

However, with increasing global debt burdens, central banks are also scrutinized under a microscope and face massive political forces that may limit the firing of their ammunition.

This changing dynamic from inflation to deflation in a zero-interest-rate world creates interesting global yield comparisons when adjusted for prices. Of course nominal interest rates in major economies are virtually zero. But when normalized, to adjust for deflation (or inflation for some countries), the real yields paint a very different picture. In fact, in stark contrast to what most might expect, the U.S. and Japan join China and Brazil in having the highest real interest rates among the world’s largest countries.

Source: Bloomberg

And with global investors starved for yield, these countries with relative yield advantages, especially those bolstered with the additional advantage of liquidity and relative safety should attract capital.
Most importantly, their currencies should benefit!