Tuesday, April 05, 2005

Signs of the Economic Apocalypse 4-1-05

From Signs of the Times 4-5-05:

The euro closed at 1.2904 dollars last week which means the dollar is worth .7750 euros, a rise of 0.4% for the dollar compared to the previous week's close of .7716 euros to the dollar or 1.2960 dollars to the euro. Gold closed at 428.80 dollars an ounce, up 0.9% from the previous week's close of $425.00. Gold in euros closed at 332.30 per ounce, up 1.3% compared to the previous week's 327.93. Oil closed at $57.27 a barrel, up a full 4.4% for the week compared to March 25th's price of 54.84. Looking at the price of oil in euros (Bush's nightmare), oil closed at 44.38 euros a barrel, up 4.9% compared to the previous week's close of 42.31. As for the gold/oil comparison, last week saw oil gain ground, closing at 7.49 barrels for an ounce of gold, down 3.5% from the previous week's 7.75. In the United States' stock market, the Dow Jones Industrial Average closed at 10,404.30, down 0.37% from the previous week's close of 10,442.87, while the NASDAQ closed at 1984.81, down 0.31% from the previous week's 1991.06.
Now that we are one quarter of the way through 2005, let's look at the quarterly statistics. The big story was oil, which rose from $43.45 to $57.27 or 31.8% in the first quarter of 2005. That's after rising 33.6% in 2004. The euro lost ground against the dollar in Q1 2005, falling from 1.3540 to 1.2904 dollars (4.9%) after rising 8% in 2004. Gold went from $437.10 to $428.80 falling 1.9% in dollar terms. In euros, gold went from 332.32 euros an ounce to 332.30, virtually unchanged. The Dow fell in the first three months of 2005, going from 10,783 to 10,404, down 3.6%, wiping out all of its gains from 2004. Similarly, the NASDAQ went from 2175 to 1985, falling 9.6% after rising 8.6% in 2004.

The dollar has gained in 2005, due most likely to interest rate rises, which threaten to puncture the debt-driven bubble in the United States. For that reason, there is not much to celebrate in the recent rise of the dollar. And, if you look at the last five years, the dollar has still fallen sharply against the euro and other currencies. If, for example, we look at the price of gold in dollars for the past five years, we might think that the price of gold has been rising sharply, but gold has gone up only 13.8% in euros over the last five years while rising 53.3% in dollars. In fact, the average price of gold in 1999 dollars for the two hundred year period 1801-1999 was $435! That is very close to recent prices. Of course, for those two centuries, the dollar was a strong currency, which means that if the price of gold increases sharply, the dollar will be weakening - not that gold is increasing in value.

The big news last week was the release of March's job creation numbers for the United States. 110,000 new jobs were created, half of what most analysts expected.

Weak jobs report suggests cooler economy
- The US economy generated 110,000 jobs in March, the government said in a report sharply weaker than economists' forecasts and suggesting cooling economic momentum.

The Labor Department figure was half as strong as the 220,000 new jobs expected, on average, by Wall Street economists, and the weakest pace since July.

The unemployment rate fell to 5.2 percent in March from 5.4 percent in February, the agency said based on a separate survey that sometimes gives contradictory signals. The figure was better than the 5.3 percent expected on Wall Street.

New job creation is seen as one of the best indicators of economic momentum and the latest report was likely to shift views about the pace of growth of the world's largest economy.

John Lonski at Moody's Investors Service said the report "comes as a surprise and brings attention to above average risk aversion among businesses."

To make matters worse, the Labor Department revised downward its estimates for job growth in February to 243,000 (from 262,000) and in January to 124,000 (from 132,000). Service sector jobs were up 86,000 but manufacturing lost 8,000 jobs. Retail employment fell by 10,000 in March. Several industries added jobs in March, notably construction, health care and mining.

Economists say about 150,000 jobs are needed each
month to absorb new labor market entrants.

The analysts quoted in that article then go on say that if you average the job creation numbers for the past six months you get about 175,000 new jobs a month, more than needed to accommodate new entries. The U.S. economy, then, is on a steady growth pace of about 3.5 to 4.0% annually, which is a stable, sustainable number. Why is it so hard to feel confident, then? Part of it is the rapid rise in oil prices. Of course, there's also the dire fiscal situation of the United States, which is running half-trillion budget deficits. The real wild card, though, is the question of whether or not the United States is going to invade two or three more countries, after having botched the last two invasions. Things don't look good for Iran, Syria and Venezuela, but they also don't look good for the United States either, if that country tries to push its military advantage from such a weak economic position.

What all these things have in common, though, is the increasing potential for catastrophic changes in direction, changes that conventional economics is incapable of foreseeing. Martin Hutchinson makes the point that the inability of conventional neo-classical economists to incorporate non-linear dynamics prevents them from predicting the economic future with any accuracy:

The Bear's Lair: Beware of singularities
By Martin Hutchinson
Washington, DC, Mar. 28 (UPI) -- As the Fed raises interest rates quarter point by quarter point, the financial environment may seem to be changing little, but in reality it is becoming increasingly at risk of singularities, financial tornadoes that appear from a clear sky and produce economic devastation.

Conventional economics deals primarily with equations that are linear or exponential. Relationships between the different components of the economy are held to be linear, economic growth is held to be exponential, with the economy increasing in size each year by a constant or even an increasing rate, depending on productivity growth, which is supposed to be constant in the short run albeit possibly increasing in the long run. Linear and exponential equations have the great virtue of being relatively easy for economists to solve; they also tend to behave in smooth ways, so that if an economy behaves in one way in one year it will behave in a similar way in the following year; change is always gradual, and there are no point "singularities" at which sudden changes occur.

It's an attractive if somewhat sterile picture, no doubt useful when teaching economics to the less academically gifted students. It allows simple folk such as the George W. Bush economic team to make confident predictions of continued economic progress, halving of the Federal budget deficit within five years etc., without more than the usual barrage of politically motivated criticism. However, it doesn't bear a great deal of resemblance to reality, and nor should we expect it to.

The reality is more complex, and the complexities are not simply errors of detail in the standard economic model, but fundamental flaws in its underlying mathematics. You only have to read a standard economic textbook to realize that many of the relationships described in it, such as the demand curve, the interaction by which comparative advantage takes effect, and the interaction between marginal tax rates and economic output are neither linear nor exponential, but some quite different relationship -- the standard demand curve, for example, is fairly close to a hyperbola.

Equations were simplified to linear and exponential forms by the early econometricians, who were not particularly good mathematicians and wished to construct computer models of the economy using equations they thought they understood. Even then they got it wrong: the notorious MIT/Club of Rome model of the world economy constructed in 1971, which purported to prove that whatever policies were pursued, the world was due for an exploding ecological crisis within no more than a few decades, wasn't wrong because of its details, it was wrong through technical error. The model extrapolated exponential equations for 30 or 40 years into the future without taking account of the fact that if you extrapolate exponentials on a finite digital computer, the errors caused by rounding to a finite number of digits also increase exponentially, and after a few dozen iterations explode the graph off the screen in some random direction no matter what the underlying reality.

In reality, a significant number of economic equations appear to be determined not by linear or exponential equations, but by power series equations, mostly of the quadratic, cubic or quartic order. This fits economics in well with physics, chemistry and other "hard" sciences where such relationships are relatively common. Although simple quadratic equations are easily solvable, complex systems with such equations intermingled are not. The principal difference between such systems and linear/exponential systems is the existence of singularities, where a small change in conditions or a small interval of time produces a large and discontinuous change in the output, a discontinuity in the "phase space."

Modern mathematics, in particular "catastrophe theory" and "chaos theory" have examined these types of systems in much more detail than was possible 30 years ago. Discontinuities in the system do not occur randomly; over large areas of the system there are no discontinuities, while in other areas where the equation set is "critical" there are many discontinuities or even an infinite number of them.

Turning with relief back to the real world, we can see that economic crises follow this
pattern quite closely. During some lengthy periods, there are no crises, and obvious areas of unsoundness in the system have very little effect, continuing or even intensifying themselves for years, without causing the damage that is predicted for them. During other periods, crises occur with bewildering rapidity, while institutions that have appeared entirely stable and well managed suddenly spiral into bankruptcy with very little warning. Areas of unsoundness that have persisted for years or even decades, without apparently leading to any ill effects, suddenly cause a major financial collapse with large adverse economic consequences, and often further collapses in areas only distantly related to the first.

... The "landscape" of the economy thus correlates pretty closely with the cost and availability of capital. When capital is cheap, with a bubbly stock market and low interest rates, frauds almost certainly proliferate but they do little damage; individual bankruptcies and exposed frauds do not lead to adverse economic consequences and the economic ship continues to sail ahead without difficulty. When real interest rates are high, on the other hand, the stock market is low, and capital is expensive, frauds are much less likely, but unexpected bankruptcies caused by the high cost of capital happen quite often, and the adverse effect on investor confidence and the economy in general from such events is severe.

This is why investors today should beware of singularities. Short term interest rates are increasing steadily, and may have to increase faster because even at 2.75 percent the Federal Funds rate remains significantly below the steadily rising rate of inflation. Banks, which have covered up an almost infinite quantity of insane consumer and corporate lending by the profits from the "carry trade" of borrowing short term and lending long, are looking at a bleak future. Either short term rates will overtake long term rates, in which case the "carry trade" will go into reverse, wiping out a huge source of profits, or long term rates will increase enough to prevent this, in which case banks are looking at huge losses on their mostly unhedged bond portfolios, particularly corporate bonds (whose yields can be expected to rise more that Treasuries) second quality consumer debt (whose default rates will soar in a period of tighter money) and mortgage backed securities, whose refinancing rate will drop to zero, defaults rise and maturity extend to infinity, as homeowners can no longer refinance and get into financial difficulty.

These non-linear singularities in our world are much more likely to be catastrophically bad than to lead to a greater and more prosperous order. Why is that? Why does there seem to be nowhere to go but down? To answer questions like these it may be more useful to turn away from mainstream economists and analysts and to consider the analysis of someone normal society would consider crazy, a poor man in Tennessee suffering from severe pesticide poisoning who corresponds with the writer Joe Bageant. Bageant published some emails from the guy in Counterpunch including this that seems to speak to the deep karmic fear that most of us try not to acknowledge:
Meanwhile, the sheer carnage of our terrible national enterprise is staggering! Yet no one mentions the back rooms of research facilities filled with mutilated tortured beings kept alive for study or force-fed Drano to see how long it takes fifty-percent of them to die. I am always astonished at how very few people know what goes on in medical and corporate research labs, not to mention the meat industry. "For every action... " It's the nature of reality. It's physics. There will be a reckoning for the culture that creates a holocaust of that magnitude. The fact that there is something terribly wrong with anyone who does such a thing, and that this same "lack" will therefore affect EVERYTHING he/she does, eventually creating magnificently awful problems. Elevating carnage to cultural protocol is very dangerous. And official rationalization of it is disastrous. Why isn't someone talking about these things? We have no examples. We have no ideals. We have only corruption and self-justifying silliness in service of capitalism as it runs further and more terribly amok.


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