Sunday, October 31, 2010

99 Weeks: When Unemployment Benefits Run Out

¹²99 Weeks: When Unemployment Benefits Run Out
Report On The Growing Number of Americans Who Are Exhausting Their Benefits

By Scott Pelley | 31 October 2010

Video: Unemployment Benefits: The 99ers
Even after an extension of unemployment benefits to 99 weeks, many of those about to go off the program are in a quandary. Scott Pelley talks to some of them in Silicon Valley.

Video Extra: Wiping Out Savings
Long-term unemployment is wrecking years of saving and planning by people like Lisa and Doug Francone. They tell Scott Pelley they have had to tap into the 401(k) and their kids' college funds.

Video Extra: San Jose and the Recession
San Jose Mayor Chuck Reed explains to Scott Pelley how not one but two recessions have hit his city, destroying thousands of jobs.

Link: Job Connections
Link: Second Harvest Food Bank
Link: Martha's Soup Kitchen

Scott Pelley, meeting people attending a workshop called "Job Connections." (CBS)

(CBS) The economic jam we're in has topped even the Great Depression in one respect: never have we had a recession this deep with a recovery this flat. Unemployment has been at nine and a half percent or above for 14 months. And congress did something that it has never done before— it extended unemployment benefits to 99 weeks. That cost more than $100 billion, a huge expense for a government in debt.

But now, for many Americans 99 weeks have passed and there's still no job in sight. Some have taken to calling themselves the "99ers". "60 Minutes" and correspondent Scott Pelley went to several communities in search of the 99ers, but we didn't expect to find such a crisis in Silicon Valley, the high tech capital that many people hoped would be creating jobs.

If you want to understand why the economy is stalled, come to San Jose, Calif., and talk with 99ers like Marianne Rose. "I remember it coming close to like six months. I was saying, 'I can't believe I'm out of work this long.' Then the year mark hit. And I just started just panicking seriously. Now that it's over two years I can't believe it. I just, I can't believe it," she told Pelley.

Rose was a financial analyst at a real estate firm. Age 54, she's single with a grown daughter. After being laid off with about 100 co-workers, she spent her savings, lost her home and finally found herself sitting in a truck with her dog and all of her possessions. She made a desperate call to a friend and found refuge upstairs in the home of strangers, her friend's brother and sister-in-law.

"How long did you think you would be in here?" Pelley asked. "Two weeks really. That's all I thought," she replied. But she told Pelley it has been six months. "And not really an end in sight, yet."

"What sort of things would you be willing to do at this point?" Pelley asked. "Well, I can say that probably the lowest level position for me has been now to apply for a clerk, a county clerk. And I just realized the competition is pretty stiff out there," she replied.

Asked what she meant by stiff competition, Rose explained. "There's a lot of people, speaking of the county. I had applied to those clerk positions. There's actually four positions that were open. I found there were over 2,000 people that applied for those four positions."

Rose is one of at least a million and a half Americans who've exhausted their unemployment checks. Now, Silicon Valley, the capital of American innovation has a new creation: revival meetings for the unemployed. On weekends, they come by the hundreds.

"60 Minutes" joined a gathering called "Job Connections," held inside a local church. It's part how-to-find-a-job workshop, part networking opportunity with the feel of a 12-step program. The people in the group are the faces of unemployment in Silicon Valley, people in their 40s, 50s and 60s who thought they had done everything right: earned a degree, stayed with their company, saved for retirement.

"I'm curious. How many PhDs in this room?" Pelley asked. "One, two, three, four several. Now leave your hands up. How many master's degrees? Oh boy. And how many of you went to college. Everybody keep your hands up if you have a college degree, a master's degree or a PhD."

Many in the room had their hands up. "How many of you expected to retire from the company where you were working"? he then asked. "More than half the room," he noted.

(CBS) "How many of you have cashed out your 401ks? IRAs? Savings accounts?" Pelley asked. Again, many hands went up. A lot of them are too young to retire and, maybe, too old to rehire. The longer they're out, the tougher it gets.

Judy Thompson was marking the time before she loses her home. "Three months maybe, and I've been in that house since 1982. I don't want to move," she said. Asked where she is going to go, Thompson told Pelley, "I don't know. I'm trying' not to think that far ahead. But anyway, didn't mean to get emotional. Sorry."

Sara Huber may lose her family business of 23 years. "Everything's gone and we can't survive 'cause these people can't survive," she explained. "Because these people don't have jobs, they're not coming to your business"? Pelley asked. "The equity lines are frozen, Right. People don't have credit. There's nothing there," she replied.

When asked how long her business can go on, Huber said, "We're going month to month, literally. I'm praying for more work." Jim Wild has been applying for jobs two years. "I've gone through the tier one companies. I've gone through the tier two companies and now I'm down to Target. I just got a job offer from Target to work a part-time job at 9.50 or 9.25 an hour," he explained.

The Target job is floor sales; previously, Wild was a fiber optics engineering manager. He's taking the job at Target and he's glad to get it. These folks aren't that unusual: today, nearly 20 percent of the unemployed in America have college degrees. Silicon Valley lost its jobs in construction, manufacturing and in high-tech engineering that went overseas. San Jose looks the same, but it shrank by 75,000 jobs. Many buildings there stand empty.

The national unemployment rate of about nine and a half percent sounds incredibly high and of course it is. But it doesn't nearly capture the depth of the trouble. It doesn't count the people who've seen their hours cut to part time. It doesn't count the people who have quit looking for work.

If you add all of that together, the unemployed and the underemployed, it's not nine and a half percent, it's 17 percent; and in California it's 22 percent. And what makes it so much worse is that, nationwide, one third of the unemployed have been out of work more than a year. That hasn't happened since the Depression.

(CBS) "60 Minutes" stopped by the soup kitchen in San Jose. Many folks used to think that they could see all the way to retirement. But now long-term unemployment is wrecking years of saving and planning by people like Lisa and Doug Francone. Doug was a $200,000-a-year personnel executive.

"You must have thought that you'd get another job pretty quickly," Pelley remarked. "Yeah. It really didn't cross my mind that I wouldn't find something. The question was trying to take the time to find the right job," he replied.

"You'd have a job in six months, a job that you liked in six months, and how long has it been?" Pelley asked Lisa Francone. "Two years and three months," she replied. They had saved for retirement and college for their son and daughter. But most of that is gone. "The unemployment checks were tiny, I can't remember what they were but…," Francone said.

"$475," his wife said. "Lisa, what were you doing with $475 a week"? Pelley asked. "Well, by the time we paid benefits, we had enough to pay a bill or two but certainly not meet the mortgage or property taxes or groceries," she replied. Now their son is going to the military instead of college; selling the house will be next.

Doug Francone took matters into his own hands: he created jobs for him and his son, buying a franchise that cleans air ducts. He spent his 401(k) on this. But, there hasn't been enough business to make money. "I don't wanna come off like 'Oh you know, woe is us.' There's other people struggling a lot worse than we are. But it's certainly very different for us," he told Pelley.

"You're surprised to be in this place?" Pelley asked. "Oh, absolutely. Yeah. Shocked really," Francone replied. Like the Francones, four and a half million Americans have taken hardship withdrawals from their 401(k)s. With savings gone, unemployment checks exhausted, many are coming to charities including the CALL Primrose Center, a pantry of free food.

Mary Watts has run CALL Primrose for 11 years. "Before the Great Recession began, you were sending out how many bags of groceries in a year"? Pelley asked. "When I started in '99 it was 4,000 bags a year," she replied. "It's going to be 32 to 35,000 bags this year."

"You know these people coming into the pantry now, they must look like professionals," Pelley remarked. "Oh absolutely, yes, absolutely professionals. Career professionals, people that never, ever would have thought they would be coming in our door other than perhaps as a donor," Watts said.

(CBS) We met Claudia Bruce at the center. She was an office manager making $70,000 a year when she was laid off. Now her 99 weeks of unemployment checks are running out. She never imagined she'd need free food. But then, she never imagined she would be picking out trash to sell to the recycler.

"You do what you have to do. I'm not delighted, but I'm happy to have the money that it provides," she told Pelley. "The day before you were laid off, what was your lifestyle"? Pelley asked. "I was a shop-a-holic. Yeah. I was trying to reform myself, but there's nothing like losing your job for a long period of time to completely reform a shop-a-holic," she replied.

Her car has turned into a garbage truck, filled with recyclables. She's learned a lot. Glass pays more than cans, and she has to be quick to beat the neighborhood homeless guy to the good stuff. She estimated her haul would bring in $28; instead, she got $33.81.

"Personal record," she told Pelley. "Did you ever think that $33 would mean so much"? he asked. "No. But then, I never thought $5 would mean so much either," Bruce replied. She has applied for hundreds of jobs, from office manager to clerical work. She's had four interviews in two years. She has kept a small apartment with help to pay the rent.

"I do get some help from my mom," Bruce said. Her mother is 83. "And so, she's helping you out even now," Pelley remarked. "Yeah, I'm her baby still, you know," Bruce said.

"You didn't expect to be her baby at this point in your life?" Pelley asked. "Absolutely not. I thought I'd be helping her now, that she wouldn't be helping me," she replied. Her benefits will end when she hits 99 weeks soon. No one is expecting Congress to vote another extension of unemployment checks given our historic budget deficits.

As government benefits run out, a lot of people are depending on kindness to take their place. Marianne Rose lived with her friend's brother for seven months, insisting on cooking and cleaning to earn her keep. In recent days she found a job in a public school. It'll pay about one third what she used to make. It's the best thing to happen in two years, but it's little and late.

"Do you imagine getting your lifestyle back?" Pelley asked. "No," Rose replied. "Not to the same point now because now I would have to worry about, you know, my old age, in my old age you know its rebuild a nest egg, pay off my debts that I have. That has to happen so now, my lifestyle will not be the same ever, ever again."

The Elephant In The Room: Debt Grows Exponentially

¹²The Elephant In The Room: Debt Grows Exponentially, While Economies Only Grow In An S-Curve

By George Washington | 31 October 2010

Michael Hudson is a highly-regarded economist. He is a Distinguished Research Professor at the University of Missouri, Kansas City, who has advised the U.S., Canadian, Mexican and Latvian governments as well as the United Nations Institute for Training and Research. He is a former Wall Street economist at Chase Manhattan Bank who also helped establish the world's first sovereign debt fund.

Hudson says that— in every country and throughout history— debt always grows exponentially, while the economy always grows as an S-curve. Moreover, Hudson says that the ancient Sumerians, Babylonians, and Hebrews knew that debts had to be periodically forgiven, because the amount of debts will always surpass the size of the real economy in time.

For example, Hudson noted in 2004:

Mesopotamian economic thought c. 2000 BC rested on a more realistic mathematical foundation than does today's orthodoxy. At least the Babylonians appear to have recognized that over time the debt overhead became more and more intrusive as it tended to exceed the ability to pay, culminating in a concentration of property ownership in the hands of creditors.


Babylonians recognized that while debts grew exponentially, the rest of the economy (what today is called the
"real" economy) grows less rapidly. Today's economists have not come to terms with this problem with such clarity. Instead of a conceptual view that calls for a strong ruler or state to maintain equity and to restore economic balance when it is disturbed, today's general equilibrium models reflect the play of supply and demand in debt-free economies that do not tend to polarize or to generate other structural problems.
And Hudson wrote last year:

Every economist who has looked at the mathematics of compound interest has pointed out that in the end, debts cannot be paid. Every rate of interest can be viewed in terms of the time that it takes for a debt to double. At 5%, a debt doubles in 14½ years; at 7 percent, in 10 years; at 10 percent, in 7 years. As early as 2000 BC in Babylonia, scribal accountants were trained to calculate how loans principal doubled in five years at the then-current equivalent of 20% annually (1/60th per month for 60 months). "How long does it take a debt to multiply 64 times"? a student exercise asked. The answer is, 30 years— 6 doubling times.

No economy ever has been able to keep on doubling on a steady basis. Debts grow by purely mathematical principles, but
"real" economies taper off in S-curves. This too was known in Babylonia, whose economic models calculated the growth of herds, which normally taper off. A major reason why national economic growth slows in today's economies is that more and more income must be paid to carry the debt burden that mounts up.

By leaving less revenue available for direct investment in capital formation and to fuel rising living standards, interest payments end up plunging economies into recession. For the past century or so, it usually has taken 18 years for the typical real estate cycle to run its course.
Hudson calls for a debt jubilee, and points out that periodic debt jubilees were a normal part of the Sumerian, Babylonian and ancient Jewish cultures. [[In ancient Israel, all slaves and indentured debtors had to be freed at the end of each seven year period— so a seventh or 'Sabatical' year was a 'special' time; the Jubilee year was a seventh seventh year, ie, every 49 years— an 'extra'-special time.: normxxx]] Economist Steve Keen and economic writer Ambrose Evans-Pritchard also call for a debt jubilee. If a debt jubilee is not voluntarily granted, people may very well repudiate their debts.

And as I have previously pointed out, our modern fractional reserve banking system is really a debt-creation system, which is guaranteed to create more and more debts. As then-Chairman of the Federal Reserve (Mariner S. Eccles) told the House Committee on Banking and Currency on September 30, 1941:
That is what our money system is. If there were no debts in our money system, there wouldn't be any money.
The modern banking system is therefore really a debt-creation system. See this for details. One thing is for sure. The exponential growth of debt is a structural problem which— unless directly addressed— will swallow all economies which try to ignore it.

Angela Merkel Consigns Ireland, Portugal And Spain To Their Fate

¹²Angela Merkel Consigns Ireland, Portugal And Spain To Their Fate

Germany has had enough. Any eurozone state that spends its way into a debt crisis or cannot adapt to a monetary union set for Northern rhythms will face "orderly" bankruptcy.
By Ambrose Evans-Pritchard | 31 October 2010

Angela Merkel needs a treaty change to prevent the German constitutional court from blocking the bail-out fund as a breach of the EU law

Bondholders will discover burden-sharing. Debt relief will be enforced, either by 'interest holidays' or 'haircuts' on the value of the bonds. Investors will pay the price for failing to grasp the mechanical and obvious point that currency unions do not eliminate risk: they switch it from exchange risk to default risk.

What were investors thinking when they bought Greek 10-year bonds at 26 basis points over Bunds in 2007, below the spread between British Columbia and Quebec? "We must keep in mind the feelings of our people, who have a justified desire to see that private investors are also on the hook, and not just taxpayers," said German Chancellor Angela Merkel. Or in the words of Bundesbank chief Axel Weber: "Next time there is a problem, (bondholders) should be part of the solution rather than part of the problem. So far the only ones who have paid for the solution are the taxpayers."

These were the terms imposed by Germany at Friday's EU summit as the Quid Pro Quo for the creation of a 'permanent' rescue fund in 2013. A treaty change will be rammed through under Article 48 of the Lisbon Treaty, a trick that circumvents the need for full ratification. Eurosceptics can feel vindicated in warning that this "escalator" clause would quickly be exploited for 'unchecked treaty-creep'.

Mrs Merkel needs a treaty change to prevent the German constitutional court from blocking the bail-out fund as a breach of the EU law, and a treaty change is what she will get. "This will strengthen my position with the Karlsruhe court," she admitted openly. One might argue that bondholders should have been punished for their errors long ago.

The stench of moral hazard has been sickening, on both sides of the Atlantic. An orderly bankruptcy along lines routinely engineered by the International Monetary Fund is exactly what Greece needs. It makes no sense to push Greece further into a debt compound spiral by raising public debt from 115% of GDP at the outset of the "rescue" to 150% at the end of the ordeal. If you strip out the humbug, the Greek package allows banks and funds to shift roughly €150bn of liabilities onto EU governments, or the European Central Bank, or the IMF. Greek citizens are being subjected to the full pain of austerity under false pretences, without being offered the cure of debt relief.

It is in reality a bail-out for investors. There is a touch of cruelty in this. Needless to say, the Greek Left has noticed. A socialist dissident from the "anti-Memorandum" bloc (ie, anti EU-IMF) is likely to win the Athens region in coming elections.

Note too that the ruling socialists have fallen to 25% in the Portuguese polls, while the Communists and hard-left Bloco are together up to 18%. Ain't seen nothing, you might say. Yet opening the door to bondholder 'haircuts' at this delicate juncture— with spreads reaching fresh records in Ireland last week, and Portugal struggling to pass a budget— is to toss a hand-grenade into the eurozone periphery. We now know that that ECB's Jean-Claude Trichet warned EU leaders on Thursday night that it was dangerous to stir up this hornets' nest, and moreover that the politicians did not understand what they were unleashing. He was slammed down acrimoniously by French President Nicholas Sarkozy, who later denied that he lost his temper.

"Mr Trichet expressed a number of reserves. There was a debate, there is always a debate, but the European Council took its decision," he said. "It is wrong to say I was irritated. You can reproach heads of state for all kinds of things in a democracy, but I don't think you can reproach them for not being aware of 'the seriousness of the situation'," he snorted.

Mr Sarkozy was not going to let his Brussels 'triomphe' slip away after stitching up EU affairs once again in a pre-emptive deal with Germany and imposing his will. The notion that the Franco-German axis still runs Europe is potent politics in France, even if the decisions actually reached are often of little value or— as in this case— ill-advised. Such is the chemistry of EU summits, where mad things happen.

Spain's premier Jose-Luis Zapatero knew he had been mugged. "We need to listen carefully to what the head of the ECB says about the rescue mechanism. Great care is called for because this message is risky," he said.

Eurozone sovereign states must issue €915bn in new bonds next year, according to the UBS, either to roll over debt or to cover very big deficits— though it is hard to outdo Ireland's deficit of 32% of GDP in 2009. Yet investors have just been told in blunt terms to charge a hefty risk premium on any peripheral debt that expires after 2013, with great confusion over what happens even before that date. Can any investor be sure what the terms will be if Ireland or Portugal needs to access the EU's bail-out fund next week, or next month, or next year? Are haircuts already de rigueur?

A study by Giada Giani at Citigroup entitled "Bondholders Moving Back Home" said data from the second quarter reveals a sharp drop in foreign ownership of debt from Greece (-14%), Portugal (-12%), Spain (-8%), and Ireland (-5%). Local banks have stepped into the breach, borrowing cheaply from the ECB to buy their own state debt at higher yields in a 'carry trade' that concentrates risk. These four countries account for the lion's share of the €448bn in ECB funding for banks (Spain €98bn, Greece €94bn). Frankfurt is propping up this unstable edifice. Mr Trichet may well fret.

A strong case can be made that Spain has decoupled from the other PIIGS in pain, though the deficit will still be 6% next year, and the economy is at serious risk of a double-dip recession as wage cuts and higher taxes bite in earnest. But none are safe yet. An ominous pattern has emerged across much of the eurozone periphery: tax revenue keeps falling short of what was hoped for. Austerity measures are eating deeper into the economy than expected, forcing further fiscal cuts. It goes too far to call this a 'self-feeding spiral', but such policies test political patience to the snapping point.

There is little that these nations can do in the short-run as EMU members. They cannot offset fiscal tightening with full monetary stimulus or a weaker exchange rate— as Britain can. All they do can is 'soldier on', sell family silver to the Chinese and Gulf Arabs, beg the ECB to join the currency war to bring down the euro, and pray that the fragile global recover does not sputter out.

Chancellor Merkel is ultimately correct. A mechanism for sovereign defaults is entirely healthy. Had it been in place long ago, EMU would have been stronger. The proper timing for this was at the Maastricht Treaty, or Amsterdam, or at the latest Nice, but in those days the EU elites were still arrogantly dismissive about the full implications of a currency union. To wait until now borders on carelessness.


EU 'Haircut' Plans Rattle Bondholders

Investors face large potential losses on eurozone debt under German plans likely to win backing from EU leaders on Friday— risking a boycott of Greek, Irish, and Portuguese bonds.
By Ambrose Evans-Pritchard, and Bruno Waterfield In Brussels | 28 October 2010

Front row left to right, European Commission President Jose Manuel Barroso, French President Nicolas Sarkozy, and Lithuania's President Dalia Grybauskaite. Back row left to right, Portugal's Prime Minister Jose Socrates and German Chancellor Angela Merkel at the EU summit in Brussels Photo: AP

Germany has agreed to give the EU's €440bn (£383bn) bail-out fund permanent status rather than letting it expire in 2013 as planned, but only as part of a "Crisis Resolution Mechanism" that forces bondholders to share losses from any future bail-outs. The fund must be anchored in EU law through changes to the Treaties in order to head off legal challenges at Germany's constitutional court. A draft proposal from Berlin— now serving as a working text for the European Commission— calls for "orderly insolvency" by eurozone countries in trouble.

Details are sketchy, but this "Chapter 11" for sovereign states would include an extension of debt maturities, a "holiday" on interest payments for as long as needed to let debtors recover, and a suspension of bondholder rights. The blueprint is akin to debt-restucturing schemes used by the International Monetary Fund. Under a Finnish proposal, there are likely to be "Collective Action Clauses" in all new bond issues to prevent minority bondholders blocking a default deal.

European President Herman van Rompuy will be tasked to draw up a blueprint for the crisis mechanism. There may also be a Sovereign Debt Restructuring Mechanism (SDRM). Berlin is determined to avoid a repeat of the €110bn bailout for Greece when banks were shielded from losses, leaving eurozone taxpayers facing the full cost.

Silvio Peruzzo, Europe economist at RBS, said talk of "haircuts" for bondholder at this delicate juncture could backfire. "The debt crisis in the eurozone periphery has not been sorted out. These countries need markets to keep buying the bonds, but investors are going to stay away if you open the door to private sector pain," he said.

It is unclear whether the latest bond jitters in Greece, Ireland, and Portugal is linked to growing awareness of the German plans. Each country has its own troubles. Yields on Ireland's 10-year bonds briefly rose to a post-EMU high above 7% on Thursday, partly due to a stand-off between Dublin and angry funds facing losses on the junior debt of Anglo Irish Bank. However, EU officials fear that the proposals could make it harder for such high-debt states to tap debt markets, risking a self-fulfilling [[and ultimately intractable: normxxx]] crisis.

Germany is likely to win backing in principle at Friday's EU summit in Brussels since it has already struck a deal with France, and Britain has dropped its opposition to treaty changes. Brussels believes it is possible to invoke Article 48.6, which allows changes to the Lisbon Treaty without the political trauma of referenda or full ratification in all 27 states. This "simplified revision" can be used to cover matters in Part III of the Treaty, but the EU risks a political backlash if it tries to push through such a controversial plan by these means. Viviane Reding, the EU justice commissioner, said it was "suicidal" to tinker with the treaties so soon after the Lisbon storm.

German Chancellor Angela Merkel is also demanding EU powers to strip countries of their voting rights if they breach eurozone rules, but this has been dismissed by Brussels as "totally unacceptable" and will be blocked by other states. The summit was intended to endorse plans by an EU taskforce for a beefed-up Stability Pact but, as so often at EU meetings, France and Germany have run away with the agenda. The German proposals have a logic since they let struggling states claw their way out crisis by reducing debt. Greece's rescue risks failure because it will leave the country with public debt of 150% of GDP, near the 'Point Of No Return'.



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Fraud Caused The 1930s Depression And The Current Financial Crisis

¹²Fraud Caused The 1930s Depression And The Current Financial Crisis

By George Washington | 30 October 2010

Robert Shiller— one of the top housing experts in the United States— says that the mortgage fraud is a lot like the fraud which occurred during the Great Depression. As Fortune notes:
Shiller said the danger of foreclosuregate— the scandal in which it has come to light that the biggest banks have routinely mishandled homeownership documents, putting the legality of foreclosures and related sales in doubt— is a replay of the 1930s, when Americans lost faith that institutions such as business and government were dealing fairly.
The former chief accountant of the S.E.C., Lynn Turner, told the New York Times that fraud helped cause the Great Depression:
The amount of gimmickry and outright fraud dwarfs any period since the early 1970's, when major accounting scams like Equity Funding surfaced, and the 1920's, when rampant fraud helped cause the crash of 1929 and led to the creation of the S.E.C.
Economist Robert Kuttner writes:
In 1932 through 1934 the Senate Banking Committee, led by its Chief Counsel Ferdinand Pecora, ferreted out the deeper fraud and corruption that led to the Crash of 1929 and the Great Depression.
Similarly, Tom Borgers refers to:
The 1930s' Pecora Commission, which investigated the fraud that led to the Great Depression ….
Professor William K. Black writes:
The original Pecora investigation documented the causes of the economic collapse that led to the Great Depression. It … established that conflicts of interest and fraud were common among elite finance and government officials. The Pecora investigations provided the factual basis that produced a consensus that the financial system and political allies were corrupt.
Moreover, the Glass Steagall Act was passed because of the fraudulent use of normal bank deposits for speculative investments. As the Congressional Research Service notes:
In the Great Depression after 1929, Congress examined the mixing of the "commercial" and "investment" banking industries that occurred in the 1920s. Hearings revealed conflicts of interest and fraud in some banking institutions' securities activities. A formidable barrier to the mixing of these activities was then set up by the Glass Steagall Act.
Economist James K. Galbraith wrote in the introduction to his father, John Kenneth Galbraith's, definitive study of the Great Depression, The Great Crash, 1929:
The main relevance of The Great Crash, 1929 to the great crisis of 2008 is surely here. In both cases, the government knew what it should do. Both times, it declined to do it.

In the summer of 1929 a few stern words from on high, a rise in the discount rate, a tough investigation into the pyramid schemes of the day, and the house of cards on Wall Street would have tumbled before its fall destroyed the whole economy. In 2004, the FBI warned publicly of
"an epidemic of mortgage fraud".

But the government did nothing, and less than nothing, delivering instead low interest rates, deregulation and clear signals that laws would not be enforced. The signals were not subtle: on one occasion the director of the Office of Thrift Supervision came to a conference with copies of the Federal Register and a chainsaw. There followed every manner of scheme to fleece the unsuspecting….

This was fraud, perpetrated in the first instance by the government on the population, and by the rich on the poor.


The government that permits this to happen is complicit in a vast crime.
As the Great Crash, 1929 documents, there were many fraudulent schemes which occurred in the 1920s and which helped cause the Great Depression. Here's one example of a pyramid scheme in Florida real estate:
An enterprising Bostonian, Mr. Charles Ponzi, developed a subdivision "near Jacksonville". It was approximately sixty-five miles west of the city. (In other respects Ponzi believed in good, 'compact' neighborhoods; he sold twenty-three lots to the acre.) In instances where the subdivision was close to town, as in the case of Manhattan Estates, which were "not more than three fourths of a mile from the prosperous and fast-growing city of Nettie," the city, as was so of Nettie, did not exist.

The congestion of traffic into the state became so severe that in the autumn of 1925 the railroads were forced to proclaim an embargo on less essential freight, which included building materials for developing the subdivisions. Values rose wonderfully. Within forty miles of Miami
"inside" lots sold at from
$8,000 to $20,000; waterfront lots brought from $15,000 to $25,000, and more or less bona fide seashore sites brought $20,000 to $75,000."
As DoctorHousingBubble notes [2009]:
This Mr. Ponzi of course is the man who gave name to the "Ponzi scheme" that many use today. He laid the groundwork for many of the criminals today in the housing industry. Yet during the boom he wasn't seen as a criminal but as a "big" player in the Florida real estate bubble. Here's a nice picture of the gentleman:

James Galbraith recently said that
"at the root of the crisis we find the largest financial swindle in world history", where "counterfeit" mortgages were "laundered" by the banks.
As he has repeatedly noted, the economy will not recover until the perpetrators of the frauds which caused our current economic crisis are held accountable, so that trust can be restored. See this, this, and this. No wonder James Galbraith has said economists should move into the background, and "criminologists to the forefront."

Note 1: I asked Professor Black to comment on this essay, and he said the following:

The amount of fraud that drove the Wall Street bubble and its collapse and caused the Great Depression is contested [keep reading to see what Black means]. The Pecora investigation found widespread manipulation of earnings, conflicts of interest, and insider abuse by the nation's most elite financial leaders.

John Kenneth Galbraith's work documented these abuses. Theoclassical economic accounts, however, ignore or excuse these abuses. The Justice Department did not respond effectively to the crimes that helped spark the Great Depression so we have far fewer facts available to us.

The decisive role that
"accounting control frauds" played in driving the current crisis is clear. The FBI warned of an "epidemic" of mortgage fraud in 2004 and predicted that it would cause an economic crisis if it were not stopped. The mortgage lending industry's own experts reported that "liar's" loans were "an open invitation to fraudsters" and fully warranted their name— "liar's" loans— because fraud was endemic in such loans. Lenders and their agents led these lies.

They led the lies for an excellent reason— the strategy is a
"sure thing" (Akerlof & Romer 1993— Looting: the Economic Underworld of Bankruptcy for Profit). It guarantees record (albeit fictional) profits, which maximize the CEO's bonuses. The same strategy for maximizing fictional income maximizes real losses in the longer term
[[but only to the end 'investor' in those tainted derivatives based on those crappy mortgages, who are themselves merely another set of suckers in the "game": normxxx]]. When many lenders follow the same fraudulent strategy the result is a hyper-inflated bubble followed by a severe crisis.

Control fraud epidemics also produce
"echo" epidemics of fraud in other fields. For example, when lenders are control frauds, the CEO establishes perverse incentives ("Gresham's dynamics") that corrupt other industries and professions.

By rewarding professionals who are willing to inflate asset values, and refusing to hire honest professionals
[[and actively ridding themselves of honest professionals already on the payroll: normxxx]], control frauds cause the unethical to drive the ethical out of the markets. When one combines deregulation, desupervision, and the perverse incentives of modern executive and professional compensation the result is recurrent, intensifying crises.
Note 2: The Austrian economists point out that it is bubbles which cause crashes. I agree. But as Professor Black points out, fraud is one of the main causes of bubbles.

Note 3: Of course other factors, such as excess leverage and counterproductive actions by the Federal Reserve, also contributed to the 1930s Depression and the current crisis.

Saturday, October 30, 2010

As DoctorHousingBubble notes []:
This Mr. Ponzi of course is the man who gave name to the “Ponzi scheme” that many use today. He laid the groundwork for many of the criminals today in the housing industry. Yet during the boom he wasn’t seen as a criminal but a player in the Florida real estate bubble. Here’s a nice picture of the gentleman:

James Galbraith recently said that "at the root of the crisis we find the largest financial swindle in world history", where "counterfeit" mortgages were "laundered" by the banks.

Goldman Sachs: The Market Is At 7% Above The 55-DMA

Goldman Sachs: The Market Is At 7% Above The 55-Dma;
It Is More Overstretched Than Just Once In Its History

By Tyler Durden | 22 October 2010

John Noyce, Goldman's arguably best technician, in his weekly Charts that Matter, has released one (among many) interesting observation on just how overbought the market currently is. More specifically, just how desperate the velocity of the pick up in the stocks since August has been, in order for levered beta players such as hedge funds to make up as much of their year as possible before seeing redemptions. (As we predicted at the end of August and, even so, many such players will not survive into 2011 as the entire 2/20 model is now crumbling.) Specifically, by looking at where the S&P is relative to its 55 DMA, Noyce notes that every time the market has gotten to above 5% of its trailing average, it has always entered a period of consolidation (read: at least modest selling).

Click Here, or on the image, to see a larger, undistorted image.

Furthermore, compared to the recent trend extreme of 7% above 55 DMA, the market moved meaningfully above on just one occasion in the past: in January 2009— just before the crash to the decade lows of 666 on the S&P occurred. In the FX realm, Noyce appears to stand behind our FX team's recommendation of long EURUSD, with some technical back up.

Our EUR/Broad Index appears to have completed a similar size bear market from the December '08 highs to the September '10 low to that which it completed from the September '98 high to the May '00 low.
  • While the bounce here need not be in a straight line, it certainly looks as though the EUR has stabilised on a broad basis and further recovery seems quite likely over time.
  • This supports the idea that after a period of consolidation/correction to unwind extreme moving average setups on the daily chart, the EURUSD should again begin to move higher.
  • As a reminder, the EUR/Broad Index shows the performance of the EUR versus an equally weighted basket of the other "Old World G10" currencies, it's EUR-based, so higher indicates EUR-strength.

Click Here, or on the image, to see a larger, undistorted image.
And last, looking at the 10 Year, Noyce notes a comparable record overstretching relative to the 55 DMA:

U.S 10-year yields have now spent 126 consecutive trading sessions below their 55-day moving average on a close basis. This is beyond the prior extreme set in July '95 of 124 consecutive sessions below the 55-dma.
  • Given the concerns we've expressed on the prior slide this does seem to be a warning sign that the market is becoming increasingly susceptible to an upside correction in yields.
  • The pivot to watch is 2.58-2.61% where the downtrend from the April highs and the 55-dma are converged.
  • A break above that point would leave the 200-dma as a possible target a long way above at 3.23%.
  • Overall, it now appears very important to watch for any signs of a turn higher in yields.

Click Here, or on the image, to see a larger, undistorted image.
There is much more in Noyce's latest, but it all just goes to confirm the old maxim that the market can frontrun the Fed for far longer than the 55-DMA can stay solvent.

Thursday, October 28, 2010

Misconceptions About Gold

¹²Misconceptions About Gold

By "Trotsky", Edited By Mike "Mish" Shedlock. See Addendum. | 26 June 2007

Few markets are as widely misunderstood and subject to so many misconceptions as gold. Many of those misconceptions stem from gold's dual role as a commodity and as money. This post will attempt to clear up some of those misconception with a few facts. Let's start with one key fact.
Gold Is Money

How can I actually claim that 'gold is money'? After all, it is not used as official money anywhere and barring isolated instances of payments made from a digital gold account, it is unlikely that one will ever make a payment in gold these days.

In addition, central banks seem intent on 'demonetizing' gold, as the biggest CB holders of gold (except the US) continue to unload it, ostensibly to earn the higher returns provided by bonds. [[This has ceased to be true for at least the last two years or so; indeed, most recently, gold has been under accumulation by any number of CBs, most notably that of China.: normxxx]] Selling gold for 'returns' is actually a spurious argument, because reserves are just that: reserves. And the primary purpose of reserves is not to produce a return.

In spite of all this, we still know that gold is money, because it trades in the market as if it were money. Let's see if we can prove that thesis.

Gold Supply And Demand

If gold's price were determined by fabrication demand alone (jewelry and industrial uses), it could not possibly trade at a price of $650 oz. [[NB: Currently, over twice that figure!: normxxx]]

Many gold analysts, from the mainstream to fringe groups such as the Gold Anti-Trust Action Committee (GATA) claim that they can 'predict' what the gold price will do, eg, by adding up annual fabrication and investment demand (as well as dehedging demand by miners [[which has also ceased, snce no miner is hedging its gold output at present: normxxx]]) and contrasting the resulting total with annual supply (mine supply, central bank selling, disinvestment and scrap). In short, they 'analyze' the gold market in [much] the same manner as they would analyze the copper market.

It should be immediately obvious that this can't be correct. After all, nearly the entire supply of gold ever mined (approximately 150,000-160,000 tons) is still here. In short, the total potential supply of gold is some 97-98% greater than the gold produced every year (approximately 2,600 tons).

On that basis it makes no sense to apply traditional commodity supply/demand analysis based on annualized trends in the gold market. Simply put, there is a big difference between commodities that are effectively used up (aside from scrap residual returning to the market every year) and a commodity the indestructibility and durability of which [has] made gold the 'money commodity' in the first place.

Jewelry Demand Vs. Monetary Demand

One can further illustrate gold's unique nature as money with a study of gold prices vs. jewelry demand. If record fabrication demand for gold (jewelry) must be good for the price of gold, then a historic high in jewelry demand should in theory coincide with a high gold price. However, record high jewelry demand in 1999-2000 in actual fact coincided with a 20 year bear market low in the gold price— the exact opposite of what traditional commodity supply/demand analysis would suggest.

We can therefore conclude that there must be a source of gold demand that is of far greater importance than the jewelry and industrial demand components, and that that demand constitutes the 'true' driver of the price of gold in terms of fiat money. Indeed, there is. This demand component is called 'monetary demand'. Monetary demand and the supply of gold is actually best described as the 'degree of reluctance of the current owners of gold to part with their gold at current prices' since, as mentioned above, some 160,000 tons are owned by somebody already.

De facto gold acts in the markets as if it were another currency rather than a commodity. It often keys off other currency cross rates, such as dollar/euro , and has a strong tendency to ignore all the typical supply/demand analysis thrown at it by the mainstream (including the World Gold Council, which should know better). A rising gold price usually begets falling jewelry demand, which is exactly what the theory of price elasticity would suggest. But at the same time, rising prices actually tend to stoke investment demand, just as a developing uptrend in the stock market tends to invite more demand rather than less as this chart, courtesy of Sharelynx Gold shows.

The above chart shows that the record high in jewelry demand coincided with the 20-year bear market low in the gold price. So what was driving the price of gold higher? We know it was monetary demand driving the price because the total fabrication demand for gold has been basically flat since 1999. Ironically enough, the chart also shows the price of gold was falling for over 20 years even as fabrication demand was rising. This is proof that fabrication demand is not an important driver of the price of gold. Finally, it should also be noted that some 'jewelry' demand, especially in India, is really disguised monetary demand.

The sin of attaching importance to jewelry demand in gold price forecasts is engaged in by all the major brokerage houses. This leads even the best of money managers to making mistakes, as evidenced by the following. Legendary value investor Jean-Marie Eveillard recently stated the following in a Fortune interview:

"When we started our gold fund in 1993— which proved to be six or seven years too soon— I mistakenly thought that my downside was protected by the fact that jewelry demand was fairly vibrant. But I was wrong. I think gold moves up and down based on investment demand mostly."
The WGC (World Gold Council) meanwhile tries to gauge 'implied investment demand', respectively 'dehoarding' retroactively, by adding up known new annual supply (from mining, scrap, central bank selling and hedging) and contrasting it with known annual fabrication [and other] demand. The difference, it reckons, must represent 'implied investment demand' (presumably the demand from gold ETF's figures in these calculations as well these days).

However, as we noted, investment demand is also expressing itself by the reluctance of current gold holders to sell at a given price. This reluctance can not be measured [[except after the fact: normxxx]], and actual investment demand is therefore also not measurable [[in advance, but can and has changed abruptly based largely on psychology driven by financial and fiscal events: normxxx]].

Gold Mine Production Vs. Total Demand

The above chart depicts another peculiarity of the gold market's supply/demand situation: As the price of gold rises, mine production actually flattens out and falls. There are two reasons for this unusual response to higher prices.

During low gold price environments, mines are forced to 'high grade' (i.e., to mine the higher grade portions of their orebodies). Once the price rises, they shift their mining activities to the lower grade portions of their orebodies, that hadn't been economic to mine previously. During periods of low gold prices, exploration spending falls, so that once prices rise, very few new mines are set to open and take up the slack from depleted mines. It can take up to 7— 10 years from the discovery of an economic orebody to the point when mining can begin.

What Motivates Monetary Demand For Gold?

To answer this question one must look back at how gold evolved to become money in the first place. First of all, it always was a commodity with a demand based on its usefulness for creating ornamentation and jewelry, so there was a prior demand for gold that made it useful in barter. In addition to that, its non-corrosiveness, divisibility, fungibility and easy portability weighed in its favor for use as money. Lastly, its scarcity and the fact that its supply is unlikely to suffer sudden increases, regardless of the wishes of the money issuing authorities, made it a prime candidate to act as a store of value.

There is a single historical exception to this gold supply dogma— when Spain imported (stole) [huge amounts of] gold from the New World in the 17th century it led to inflation throughout Europe [[ie, the value of gold in Europe dropped with respect to the value of the things it could purchase: normxxx]]. Nowadays, mine supply is around 2% of the total stock of gold per annum and it's highly unlikely there will be much deviation from this percentage. Thus a similar gold-based inflation today would be extremely unlikely [[unless everyone— but especially the U.S.— throughout the world were to suddenly embark on the 'austerity cure' espoused by the EC: normxxx]].

This latter point— that the 'State' [[nor anyone else: normxxx]] can't create gold out of thin air— is what lies at the heart of the monetary demand for gold.

In our modern day fiat money system with its fractional reserve banking systems and free-floating paper currencies, gold is the only form of money 'safe' from the depredations of central bankers [[well, relatively so; they can always sell off their individual hoards of gold— as they did until the last few years— to depress the value of gold in the CB's currency: normxxx]]. It therefore serves in the widest sense as a barometer of confidence in this central bank administered system.

Considering that the US dollar has lost about 97% of its value against gold since the Federal Reserve has been in business [[more like 98.5% today: normxxx]], one can conclude that confidence in fiat money has been waning rather precipitously [since the most recent abandonment of the gold standard]. This trend is certain to remain a one-way street over the long term, with occasional fluctuations as confidence in paper (or digital) money waxes and wanes. Unfortunately, this sad state of affairs doesn't seem to worry the engineers of inflation.

They only get worried when it happens too quickly (ie, so fast that everybody takes notice). One should add here that in the back of the mind of the typical monetary bureaucrat there is this little voice that says: "If push comes to shove, we can always take [that gold] back by force". After all, it wouldn't be the first time.

Time Preferences

In the shorter term, the motives of gold holders who refuse to sell (possibly even adding to their position) often depend on immediate concerns such as real interest rates, inflation expectations, the spread between short and long term interest rates as a proxy for the likely bias of monetary policy, and the exchange value of the US dollar. Typically gold is a counter-cyclical asset that does best in real terms when liquidity evaporates. At times however [[such as at present: normxxx]], there can be pro-cyclical demand when equity, commodity, and gold prices are all rising strongly, and liquidity is more than abundant [[indeed, overabundant: normxxx]].

In the end, such price fluctuations in gold are a bit like Warren Buffet's famous remark about the stock market being a 'voting machine in the short term and a weighing machine in the long term'. In the short term, all sorts of considerations can be used to 'explain' movements in the gold price, but in the long term, gold acts as the aforementioned barometer of confidence in central bank issued fiat money [[or, rather, as a barometer of the relative scarcity of gold versus that of a given fiat currency: normxxx]].

Addendum: Mish asked me if I would consider writing a series of posts on his blog about gold. I was pleased to take advantage of his offer. Together we came up with the topics, I did the writing, and Mish did the editing. A question came up as to what name to make these posts under. The name "Trotsky" had its origins as a joke handle I started using a long ways back on Kitco. I'm as anti-Leon Trotsky as one can possibly be. I'm not particularly fond of the handle anymore, but it's now the name I am associated with and we decided not to change it on short notice.

Tax Shortfalls Spur New Fear On Europe’s Recovery Bid

¹²Tax Shortfalls Spur New Fear On Europe’s Recovery Bid

Debt Rising in Europe: Greece is not the only country in Europe with problems with credit and debt.

The Austerity Zone: Life in the New Europe

A Setback for Greece as Europe Says Deficit Is Larger Than Thought

By Landon Thomas Jr. | 28 October 2010

LONDON— The mathematics of austerity are getting harder. With economic conditions weaker than expected, tax revenue is coming up short of projections in parts of Europe. As a result, countries struggling with high deficits are now confronting the prospect that they will miss the budget deficit targets forced upon them this year by impatient bond investors.

Greece, for one, looks as if it will run a budget deficit for 2010 greater than the 8.1 percent of gross domestic product it agreed to as part of a rescue package from the International Monetary Fund and the European Union that amounted to more than $150 billion, according to a person briefed on the matter but not authorized to speak about it. The adjustment, at worst, would result in a deficit of 8.9 percent of Greece's output, this person said. Normally, such a small difference would not be cause for alarm.

But after the latest upward revision in Greece's 2009 deficit— to about 15.5 percent from 13.5 percent of output— the miss has spurred investor fears that the Greek government will be unable to close the gap and that Greece may ultimately be forced to 'restructure' its mountain of debt with foreign investors. [[That is, it will force its creditors to take a payback 'haircut' with respect to the principal sums borrowed. : normxxx]] As word seeped into the market on Wednesday, Greek 10-year bond yields jumped to 10.3 percent, from 9.3 percent.

That more or less reversed what had been an impressive bond market rally, when yields fell from more than 11 percent to just under 9 percent over the last month. The cost of insuring Greek bonds against a possible default also rose. A spokesman for the Greek finance ministry declined to comment. There has not been any suggestion from the I.M.F. or the European Union that this slip represents a lack of resolve by Prime Minister George A. Papandreou to maintain the harsh spending cuts, structural reforms and tax increases that lie at the heart of the Greek reform effort.

But it does highlight just how difficult it is for stagnating economies with rising unemployment rates to make fiscal adjustments exceeding 10 percent of their economic output in just a couple of years. In Ireland, which is expecting its third consecutive year of economic contraction this year, the government says it will need an additional 15 billion euros in budget cuts to reduce its deficit from 32 percent of gross domestic product to 3 percent by 2014. And in Portugal, the government is struggling to meet its deficit target of 9 percent of output as the economy continues to weaken.

Spain also faces a difficult task in slicing its deficit to 6 percent next year, from 11 percent last year, in the face of a slumping economy. "All the leading indicators for the peripheral economies are negative, so it is logical that these countries will fall short of their projections," said Jonathan Tepper, an analyst at Variant Perception, a London-based research boutique. "People tend to forget that when you are in a deflationary dynamic, your tax take will be going down."

In Ireland, the deficit has been swollen by the cost of bailing out the country's failed banks. But because there have been so many upward revisions in the deficit, investors are growing more doubtful that the government will be able to meet its target in the years ahead. The deficit misses by Europe's weaker economies also provide fodder for the critics of the I.M.F.-inspired programs who fear that these dire menus of spending cuts and tax increases will send economies into prolonged recessions from which they will be unable to recover.

Eurostat, the statistical agency for the European Commission, has had a team in Athens for a few weeks, digging through the Greek budget figures, and is expected to announce the [latest] 'final' revision of the country's 2009 deficit in mid-November— a change that could expose debt as more than its current level of 133 percent of G.D.P. Eurostat's investigation has the full support of the Greek government, which has said many times that it wants to put the nightmare of the ever-increasing 2009 deficit— initially estimated by the previous government at 5 percent— behind it.

So far, Greece has made solid progress in its austerity program, cutting expenditures by 11 percent through September from the comparable period last year. But revenue, always difficult to spur in an economy with a poor record of tax collection, has been hurt by this year's 4 percent economic contraction and is up just 3 percent. Government officials, while acknowledging that July and August were off target, are banking on increased taxes and measures to curb tax evasion to kick in during the second half.

Still, Greek officials are contemplating changes in their spending targets to reflect the lower revenue. This year, spending cuts will make up two-thirds of the deficit-cutting plan, with tax increases the remainder. In 2011, the plan was for tax increases to constitute 60 percent of the fiscal adjustment, with spending cuts the rest.

Now there is talk within the Greek finance ministry of reversing this ratio. The view is growing that it will be easier and quicker to cut expenditures rather than raise taxes— an approach that has been accepted by many economists and lies at the heart of the British government's deficit-cutting strategy. Though such an approach may look good on paper and produce quicker results, the political and social consequences of further cuts in wages and public sector services could be severe not just for Greece but Europe as a whole.



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Wednesday, October 27, 2010

The Great Deflation

¹²The Great Deflation
Japan Goes From Dynamic to Disheartened

Dispirited Akiko Oka has worked part time in an Osaka clothing shop since her store closed in 2002. She said she lamented Japan's loss of vigor.

OSAKA, Japan— Like many members of Japan's middle class, Masato Y. enjoyed a level of affluence two decades ago that was the envy of the world. Masato, a small-business owner, bought a $500,000 condominium, vacationed in Hawaii and drove a late-model Mercedes. But his living standards slowly crumbled along with Japan's overall economy.

First, he was forced to reduce trips abroad and then eliminate them. Then he traded the Mercedes for a cheaper domestic model. Last year, he sold his condo— for a third of what he paid for it, and for less than what he still owed on the mortgage he took out 17 years ago.

"Japan used to be so flashy and upbeat, but now everyone must live in a dark and subdued way," said Masato, 49, who asked that his full name not be used because he still cannot repay the $110,000 that he owes on the mortgage. Few nations in recent history have seen such a striking reversal of economic fortune as Japan. The original Asian success story, Japan rode one of the great speculative stock and property bubbles of all time in the 1980s to become the first Asian country to challenge the long dominance of the West.

But the bubbles popped around 1989, and Japan fell into a slow but relentless decline that neither enormous budget deficits nor a flood of easy money has reversed. For about a generation now, the nation has been trapped in low to negative growth and a corrosive downward spiral of prices known as deflation. In the process, it shriveled from an economic Godzilla to little more than an afterthought in the global economy.

Now, as the United States and other Western nations struggle to recover from a debt and property bubble of their own, a growing number of economists are pointing to Japan as a dark vision of the future. Even as the Federal Reserve chairman, Ben S. Bernanke, prepares a fresh round of 'unconventional' measures to 'stimulate' the economy, there are growing fears that the United States and many European economies could face a prolonged period of slow growth or even, in the worst case, deflation, something not seen on a sustained basis outside Japan since the Great Depression. Many economists remain confident that the United States will avoid the stagnation of Japan, largely because of the greater responsiveness of the American political system and Americans' greater tolerance for capitalism's creative destruction.

Japanese leaders at first denied the severity of their nation's problems and then spent heavily on 'job-creating' public works projects that only postponed painful but necessary structural changes, economists say. "We're not Japan," said Robert E. Hall, a professor of economics at Stanford. "In America, the bet is still that we will somehow find ways to get people spending and investing again."

Still, as political pressure builds to reduce federal spending and budget deficits, other economists are now warning of "Japanification"— of falling into the same deflationary trap of collapsed demand that occurs when consumers refuse to consume, corporations hold back on investments and banks sit on cash. It becomes a vicious, self-reinforcing cycle: as prices fall further and jobs disappear, consumers tighten their purse strings even more and companies cut back on spending and delay expansion plans. "The U.S., the U.K., Spain, Ireland, they all are going through what Japan went through a decade or so ago," said Richard Koo, chief economist at Nomura Securities who recently wrote a book about Japan's lessons for the world.

"Millions of individuals and companies see their balance sheets going underwater, so they are using their cash to pay down debt instead of borrowing and spending." Just as inflation scarred a generation of Americans, deflation has left a deep imprint on the Japanese, breeding generational tensions and a culture of pessimism, fatalism and reduced expectations. While Japan remains in many ways a prosperous society, it faces an increasingly grim situation [[especially demographically: normxxx]], particularly outside the relative economic vibrancy of Tokyo, and its situation provides a possible glimpse into the future for the United States and Europe, should the most dire forecasts come to pass.

Scaled-Back Ambitions

The downsizing of Japan's ambitions can be seen on the streets of Tokyo, where concrete "microhouses" have become popular among younger Japanese who cannot afford even the famously cramped housing of their parents, or lack the job security with which to take out a traditional multidecade loan. These matchbox-size homes stand on plots of land barely large enough to park a sport utility vehicle, yet have three stories of closet-size bedrooms, suitcase-size closets and a tiny kitchen that properly belongs on a submarine. "This is how to own a house even when you are uneasy about the future," said Kimiyo Kondo, general manager at Zaus, a Tokyo-based company that builds microhouses.

For many people under 40, it is hard to grasp just how far this is from the 1980s, when a mighty— and threatening— "Japan Inc". seemed ready to obliterate whole American industries, from automakers to supercomputers. With the Japanese stock market quadrupling and the yen rising to unimagined heights, Japan's companies dominated global business, gobbling up trophy properties like Hollywood movie studios (Universal Studios and Columbia Pictures), famous golf courses (Pebble Beach), and iconic real estate (Rockefeller Center).

In 1991, economists were predicting that Japan would overtake the United States as the world's largest economy by 2010. In fact, Japan's economy remains the same size it was then: a gross domestic product of $5.7 trillion at current exchange rates. During the same period, the United States economy has doubled in size to $14.7 trillion, and this year China overtook Japan to become the world's No. 2 economy.

Hiro Komae for The New York Times. Over the past 15 years, the number of fancy clubs has declined sharply in Kitashinchi, Osaka's main entertainment district.

China has so thoroughly eclipsed Japan that few American intellectuals seem to bother with Japan now, and once crowded Japanese-language classes at American universities have emptied. Even Clyde V. Prestowitz, a former Reagan administration trade negotiator whose writings in the 1980s about Japan's threat to the United States once stirred alarm in Washington, said he was now studying Chinese. "I hardly go to Japan anymore," Mr. Prestowitz said.

The decline has been painful for the Japanese, with companies and individuals like Masato having lost the equivalent of trillions of dollars in the stock market, which is now just a quarter of its value in 1989, and in real estate, where the average price of a home is the same as it was in 1983. The future looks even bleaker, as Japan faces the world's largest government debt— around 200 percent of gross domestic product— a shrinking population and rising rates of poverty and suicide. But perhaps the most noticeable impact here has been Japan's crisis of confidence.

Just two decades ago, this was a vibrant nation filled with energy and ambition, proud to the point of arrogance and eager to create 'a new economic order' in Asia based on the yen. Today, those high-flying ambitions have been shelved, replaced by weariness and fear of the future, and an almost stifling air of resignation. Japan seems to have pulled into a shell, content to accept its slow fade from the global stage.

Its once voracious manufacturers now seem prepared to surrender industry after industry to hungry South Korean and Chinese rivals. Japanese consumers, who once flew by the planeload on flashy shopping trips to Manhattan and Paris, stay home more often now, saving their money for an uncertain future or setting new trends in frugality with discount brands like Uniqlo. As living standards in this still wealthy nation slowly erode, a new frugality is apparent among a generation of young Japanese, who have known nothing but economic stagnation and deflation.

They refuse to buy big-ticket items like cars or televisions, and fewer choose to study abroad in America. Japan's loss of gumption is most visible among its young men, who are widely derided as "herbivores" for lacking their elders' willingness to toil for endless hours at the office, or even to succeed in romance, which many here blame, only half jokingly, for their country's shrinking birthrate. "The Japanese used to be called economic animals," said Mitsuo Ohashi, former chief executive officer of the chemicals giant Showa Denko. "But somewhere along the way, Japan lost its animal spirits."

When asked in dozens of interviews about their nation's decline, Japanese, from policy makers and corporate chieftains to shoppers on the street, repeatedly mention this startling loss of vitality. While Japan suffers from many problems, most prominently the rapid graying of its society, it is this decline of a once wealthy and dynamic nation into a deep psychological, socialogical, and cultural rut that is perhaps Japan's most ominous lesson for the world today. The classic explanation of the evils of deflation is that it makes individuals and businesses less willing to use money, because the 'rational' way to act when prices are falling is to hold onto cash, which gains in value.

But in Japan, nearly a generation of deflation has had a much deeper effect, subconsciously coloring how the Japanese view the world. It has bred a deep pessimism about the future and a fear of taking risks that make people reflexively reluctant to spend or invest, driving down demand— and prices— even further. "A new common sense appears, in which consumers see it as irrational or even foolish to buy or borrow," said Kazuhisa Takemura, a professor at Waseda University in Tokyo who has studied the psychology of deflation.

A Deflated City

While the effects are felt across Japan's economy, they are more apparent in regions like Osaka, the third-largest city, than in still relatively prosperous Tokyo. In this proudly commercial city, merchants have gone to extremes to coax shell-shocked shoppers into spending again. But this often takes the shape of price wars that only end up feeding Japan's deflationary spiral.

There are vending machines that sell canned drinks for 10 yen, or 12 cents; restaurants with 50 yen beer; apartments with the first month's rent of just 100 yen, about $1.22. Even marriage ceremonies are on sale, with discount 'wedding halls' offering weddings for $600— less than a tenth of what such ceremonies typically cost here just a decade ago. On Senbayashi, an Osaka shopping street, merchants recently held a 100 yen day, offering much of their merchandise for that price. Even then, they said, the results were disappointing.

"It's like Japanese have even lost the desire to look good," said Akiko Oka, 63, who works part time in a small apparel shop, a job she has held since her own clothing store went bankrupt in 2002. This loss of vigor is sometimes felt in unusual places. Kitashinchi is Osaka's premier entertainment district, a three-centuries-old playground where the night is filled with neon signs and hostesses in tight dresses, where just taking a seat at a top club can cost $500.

But in the past 15 years, the number of fashionable clubs and lounges has shrunk to 480 from 1,200, replaced by discount bars and chain restaurants. Bartenders say the clientele these days is too cost-conscious to show the studied disregard for money that was long considered the height of refinement. "A special culture might be vanishing," said Takao Oda, who mixes perfectly crafted cocktails behind the glittering gold countertop at his Bar Oda.

After years of complacency, Japan appears to be waking up to its problems, as seen last year when disgruntled voters ended the virtual postwar monopoly on power of the Liberal Democratic Party. However, for many Japanese, it may be too late. Japan has already created an entire generation of young people who say they have given up on believing that they can ever enjoy the job stability or rising living standards that were once considered a birthright here.

Yukari Higaki, 24, said the only economic conditions she had ever known were ones in which prices and salaries seemed to be in permanent decline. She saves as much money as she can by buying her clothes at discount stores, making her own lunches and forgoing travel abroad. She said that while her generation still lived comfortably, she and her peers were always in a defensive crouch, ready for the worst.

"We are the survival generation," said Ms. Higaki, who works part time at a furniture store. Hisakazu Matsuda, president of Japan Consumer Marketing Research Institute, who has written several books on Japanese consumers, has a different name for Japanese in their 20s; he calls them the 'consumption-haters'. He estimates that by the time this generation hits their 60s, their habits of frugality will have cost the Japanese economy $420 billion in lost consumption.

"There is no other generation like this in the world," Mr. Matsuda said. "These guys think it's stupid to spend". Deflation has also affected businesspeople by forcing them to invent new ways to survive in an economy where prices and profits only go down, not up.

Yoshinori Kaiami was a real estate agent in Osaka, where, like the rest of Japan, land prices have been falling for most of the past 19 years. Mr. Kaiami said business was tough. There were few buyers in a market that was virtually guaranteed to produce losses, and few sellers, because most homeowners were saddled with loans that were worth more than their homes.

Some years ago, he came up with an idea to break the gridlock. He created a company that guides homeowners through an elaborate legal subterfuge in which they erase the original loan by declaring personal bankruptcy, but continue to live in their home by "selling" it to a relative, who takes out a smaller loan to pay its greatly reduced price. "If we only had inflation again, this sort of business would not be necessary," said Mr. Kaiami, referring to the rising prices that are the opposite of deflation. "I feel like I've been waiting for 20 years for inflation to come back."

One of his customers was Masato, the small-business owner, who sold his four-bedroom condo to a relative for about $185,000, 15 years after buying it for a bit more than $500,000. He said he was still deliberating about whether to expunge the $110,000 he still owed his bank by declaring personal bankruptcy. Economists said one reason deflation became self-perpetuating was that it pushed companies and people like Masato to survive by sharply cutting costs and selling what they already owned, instead of buying new goods or investing. "Deflation destroys the risk-taking that capitalist economies need in order to grow," said Shumpei Takemori, an economist at Keio University in Tokyo. "Creative destruction is replaced with what is just destructive destruction."



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