Monday, May 30, 2005

Signs of the Economic Apocalypse 5-30-05

From Signs of the Times 5-30-05:

The euro closed at 1.2542 dollars on Friday, down 0.17% from last week's 1.2563 dollars, with traders reacting in advance to France's rejection of the proposed EU constitution. That put the dollar at .7973 euros compared to .7960 the previous Friday. In U.S. stock markets, the Dow Jones Industrial Average closed at 10,542.55 on Friday, up 0.67% from 10,471.91 a week earlier. The NASDAQ closed at 2075.73 up 1.4% from 2,046.42 the week before. The yield on the ten-year U.S. Treasury bond was 4.07% at Friday's close, down five basis points from 4.12 the previous Friday, continuing a trend of falling long-term interest rates recently in the United States at a time when short-term rates are rising. Gold closed at $422.70 an ounce up 1.2% from 417.60 on the previous Friday. Gold in euros would be 337.03 euros an ounce, up 1.4% from 332.40 a week earlier. Oil closed at 51.85 dollars a barrel, up sharply (9.2%) from last week's $47.50. In euros, a barrel of oil would cost 41.34 euros, up 9.3% from 37.81 at the previous week's close. An ounce of gold would buy 8.15 barrels of oil down 7.9% compared to 8.79 on the previous Friday.

The vote on Sunday the 29th in France to reject the proposed EU constitution, which polls had predicted during the past week, led to some continuing weakness in the euro and to some soul-searching in Europe.

Euro Drops Versus Dollar, Yen; France Rejects EU Constitution

May 30 (Bloomberg) -- The euro fell against the dollar and yen in Asia after France rejected the European Union constitution in a referendum, hindering integration of the region's economies.

The legislation was aimed at streamlining decision-making after the EU's expansion last year to 25 members from 15. The euro has dropped 2.8 percent this month as opinion polls showed ebbing support for the constitution and reports indicated the region's economy is struggling to grow.

"This is pretty bad news," said Luke Waddington, head of currency trading in Tokyo at Royal Bank of Scotland Group Plc. "It's quite straight-forward: sell the euro. It's going to go lower."

Against the dollar, the euro fell to $1.2540 as of 10:27 a.m. in Tokyo, from $1.2584 late on May 27 in New York, according to electronic currency-dealing system EBS. The currency was headed for its worst decline in four months against the dollar. It also fell to 135.33 yen from 135.82.

Waddington, who came in at 4 a.m. to monitor the results, said the euro may fall below $1.25 today.

Fifty-five percent of French voters cast their ballots against the constitution compared with 45 percent in favor, the Interior Ministry said.

The French "no" vote means "we're entering a period of high uncertainty, and investors don't like uncertainty," French Finance Minister Thierry Breton said on France 2 television.

Declines in the euro may be limited because many investors probably sold the currency in the weeks before the vote as opinion polls suggested a rejection of the treaty, said John Horner, a currency strategist at Deutsche Bank AG in Sydney.

"Widely Expected"

"It was widely expected we'd get a result like this," Horner said. "It's pretty closed to priced in. The euro may fall to about $1.2450 and that would pretty much do it."

...The French referendum result kills the EU constitution and may cast doubt on closer ties with members of the bloc that haven't adopted the euro, and set back plans by countries including Turkey and Croatia to join.

"A Problem"

Rejection by France, one of the EU's founding members, gives investors already disappointed by the region's faltering economy one more reason to sell the euro, said Guy Stern, who oversees $17.8 billion in assets as chief investment officer of Credit Suisse Asset Management's German business in Frankfurt. The currency is down 8 percent from a record $1.3666 on Dec. 30.

"We will have a problem with the euro," Stern said. "It could depreciate 5 percent to 10 percent."

The poor growth numbers for the euro-zone countries has even led to some questioning as to whether the euro is a good thing for Europe or not. The OECD (Organization for Economic Cooperation and Development) released its semi-annual report last week, pointing to the slow growth in Europe and to the massive deficits in the United States as contributors to a possible "doomsday." Here's Nick Beams:

A summary of the report presented by OECD chief economist Jean-Philippe Cotis made clear that the continued lack of growth in Europe is causing increased concern. "The smooth scenario where the recovery was expected to spread more evenly across the OECD has not materialised. While some elements of this scenario, such as a relatively successful 'soft landing' in the United States and a rebound of activity in Japan may be in place, what is badly lacking is sustained momentum in the euro zone."

Cotis said that "circumstantial arguments" used to explain the lack of growth in Europe, such as the Iraq war, oil and commodity price shocks as well as currency fluctuations, were "not sufficient to explain the string of aborted recoveries in Europe."

..."These continuing divergences in domestic demand between Europe and some Asian countries on the one hand, and the United States on the other, cannot be treated with benign neglect," he said. Given the unsustainable US current account position, the pressure to correct the imbalances would grow, possibly taking the form of "an abrupt weakening of the dollar with adverse consequences for the OECD area as a whole."

Cotis told the Financial Times (FT): "Were not saying there will be doomsday tomorrow morning ... but because the adjustments (to global imbalances) are relatively slow, we are running the risk an accident will happen. That's where we are. Time is running out. The numbers are getting big, big, big."

What might be causing lack of growth in Europe?

For some years the prevailing mantra has been that Europe must undergo "structural reforms" - the adoption of "free market" measures, cuts in social welfare and a more "flexible" workforce - in order to boost growth. But, according to a member of the European Central Bank (ECB), these measures do not seem to be working.

Erkki Liikanen, governor of the Bank of Finland, told the Financial Times this week that reforms that allowed for increased competition had not overcome poor economic performance. The issue had been discussed in the ECB but "we don't have an answer. Perhaps the reforms first increase uncertainty." Liikanen said he was unsure whether the eurozone economy would pick up this year.

One reason for the sluggish domestic demand can be seen in the figures on real wages for the euro area prepared by the OECD. These show that, on average, real hourly rates across the region are falling at the rate of 1 percent, with the largest declines experienced in Italy and Germany. With falling wages putting a dampener on consumption demand, the OECD has called on the ECB to make a significant cut in interest rates, saying that in the context of low underlying inflation and weak aggregate demand, the case for an easing of monetary policy looked "rather compelling."

Could it be the euro itself that is hampering national economies in Europe? From Business Week:

Squeezed By The Euro

By Jack Ewing in Frankfurt, with Carol Matlack in Paris, Stanley Reed in London, Maureen Kline in Milan, Carlta Vitzthum in Madrid, and bureau reports

Fri May 27, 8:07 AM ET
Were the skeptics right? In early 1998, University of Bonn Professor Manfred J.M. Neumann mobilized 155 fellow economists to protest the coming introduction of the European common currency. The euro was dangerously premature, they argued in open letters published in major newspapers. Big countries such as Germany and France lacked the flexible labor markets they needed to compensate for losing control over monetary policy as a tool to promote growth. Needless to say, the protests had little effect. The euro blasted off on Jan. 1, 1999, as planned.

Six years later, Neumann's warning seems ominously prescient. Far from becoming a powerhouse to compete with the U.S. and Asia, Europe in the past four years has been nearly stagnant, with average annual growth in the euro zone of of 1.2% since 2002. Meanwhile, it's hard to overlook the superior economic performance of European Union members that stayed clear of the common currency. Britain and Sweden have enjoyed healthy expansions and lower unemployment. Britain's jobless rate is 4.7%, compared with 8.9% for the euro zone.

Even common currency champions such as European Central Bank President Jean-Claude Trichet see little chance of a euroland boom anytime soon. Just as Neumann predicted, overregulated labor markets in much of the euro zone prevent pay scales from reacting fast enough to competitive pressure from abroad. And individual countries can no longer compensate for these rigidities by devaluing their currencies to boost exports, usually through the swift downward movement of interest rates. "Unfortunately," says Professor Neumann ruefully, "we were right."

That raises a larger question: Was the euro a mistake? Not even euro-skeptics such as Neumann argue that the currency should be scrapped now that euro coins and notes have become a fact of life from Finland to Greece. "It would be insane to give up the euro. We have to make the most of it," Neumann says.

Impatience On The Rise

Still, the question hangs in the air, especially amid evidence of growing popular discontent over core Europe's dreadful economic performance. A dramatic expression of that discontent came on May 22 when German Chancellor Gerhard Schroder's Social Democratic Party [SPD] was booted from power in North Rhine-Westphalia, an economically battered industrial state that had been ruled by the party for four decades. Schroder, in what amounts to an admission that his tepid economic reforms have failed, has called for national elections in September, a year early. In addition, French and Dutch voters may reject the proposed European constitution in referendums May 29 and June 1. If so, the votes will surely be interpreted as protests against a European system that seems ever more powerful yet ever more unable to deliver jobs and prosperity. The euro is integral to that system.

Stagnation and political upheaval were obviously not part of the plan when the currency was launched six years ago. At the time, euro-optimism was running high. The idea was this: Before they could adopt the currency, countries like France, Germany, Italy, and others would rein in their budget deficits, and afterwards keep public spending in check to support monetary union. The existence of one currency, backed by fiscal discipline across the board, would then turn the half-fiction of a common market into reality. As Europe's various economies melded together into one, internal barriers to competition would tumble and the best-managed countries and companies would pull ahead. Countries that lagged would respond by loosening labor rules and cutting taxes to boost competitiveness. Like the Bundesbank, which had made Germany a beacon of monetary stability, the ECB would squash any hint of inflation with a rate hike. If countries wanted to grow, they would have to deregulate their economies and keep wage hikes in line with productivity.

Of course, for Business Week, it is the fault of Europeans for not being "flexible" enough, but Europeans are smart enough to know that "flexibility" usually means that the rich get richer and everyone else gets poorer and less secure. And, sure enough, the article calls for those countries in the euro-zone which are lagging in "reform" (neo-liberal, low-wage, low-benefit, low-social spending reform) to get with the program in order to save the euro.

ECB President Trichet was at pains to point out the euro's benefits to an Italian business audience recently. But in a sign of growing nervousness within the bank, he also warned political leaders to step up the pace of reform. "Many countries have not adapted their economic, social, and legal frameworks in order to face the new challenges," Trichet said.

Some governments have pulled off those changes, cutting taxes, rolling back job regulations, and eliminating barriers to competition. That's true of countries in the euro, like Ireland, and outside it, like Britain, Denmark, and Sweden, which focused on deep structural reforms after experiencing wrenching economic crises. Now, Germany may get a reformist government in September led by Christian Democrat Angela Merkel.

In past weeks we have looked at the problem of outsourcing in Europe as well as the neoliberal attack on European social democracy. Clearly, global capital wants to reduce social safety net spending in Europe and to reduce wages there as well. Both of these things (falling wages and the real probability of falling benefits) will tend to reduce consumer spending. The only reason they haven't in the United States is the insane level of consumer debt there. In Europe, in contrast to the United States, long, often-painful, national histories provide the antidote to the temptation to live in a rosy illusion (American exceptionalism, and optimism). Consumer capitalism thrives on illusion, however, so it will entice suckers into the hall of mirrors whenever it can, and we in the United States like our illusions. As the American Al Martin ( put it:

The Norwegians, unlike the British, have wisely subordinated all of their North Sea oil income for the first 30 years into a national trust fund, for the benefit of the Norwegian people.

Why can't we have that? Because we have Bushonomics. Norway is not plagued with Bushes. Norway is a Western European country; i.e., a country where citizens are more adroit, more educated, more aware of economics than Americans, and the fiscal practices practiced in the United States under Bushonian regimes would not be allowed. There is no other nation on earth that it would be allowed. It is only the naivete of the American people on all things economic which allows the fiscally destructive practice of Bushonomics to be maintained. Because the American people don't know the difference.

This then bespeaks of the growing schism between Washington and the rest of the planet.

Martin says that the rest of the world is starting to pull the plug on the United States economy:

T]he US Treasury Department announced on May 16 that foreign investments in U.S. securities fell from $84.1 billion in February 2005 to $45.7 billion in March 2005.

This is a monthly statistic known as "net foreign flow of funds." It did raise some eyebrows since the net foreign inflows into the United States by about half of the number of the previous month. The Street was looking for a number of about $70 billion. Another interesting thing about this number is that foreign accounts were net sellers of U.S. Treasury securities in April for the first time in 18 months.

... This is being accomplished the way that the South Korean central bank is doing it, which announced that they are actually allowing some of their 2-year U.S. Treasury notes to go into redemption without rolling them over.

In other words, the foreign central banks aren't actually selling U.S. Treasury securities outright. They are simply taking short term 2- and 3-year U.S. Treasury notes that they hold and simply not rolling them over. In essence, they are allowing them to go into redemption, as a way to withdraw funds from the United States.

As the South Korean bank, interestingly enough, points out, they were concerned about becoming direct sellers of U.S. Treasury instruments in a market which is increasingly uncertain. The South Korean bank was saying -- Who would be the potential buyers?

...However, if the central banks began selling, remember, this is what Paul O'Neill called 'The Bushonian Nightmare Scenario.' If the central banks begin selling, and they constitute 2/3 of the buyers, there is no market for them.

As former Treasury Secretary Paul O'Neill pointed out, the U.S. Treasury no longer has the ability to step into the markets, acting either on its own behalf or through the Federal Reserve, to purchase U.S. Treasury instruments on an emergency basis in order to stabilize the market. Why? Because the Bush Cheney regime has bled out from the U.S. Treasury and the Federal Reserve all of its operating surplus accounts as well as the Federal Reserve's $20 billion emergency currency stabilization account.

Yet the housing bubble continues in the United States, with "McMansions" going up everywhere you look. According to Business Week, this housing-driven boom is distorting the U.S. economy by sending spending to the lower-tech sectors.

The Cost of All Those McMansions

By Michael Mandel

It's like living in a parallel universe. Surprising most economists, mortgage rates have gone down in recent weeks rather than up. The housing market, instead of cooling, has stayed hot, with record sales of existing homes in April. And prices are up 15% over a year ago. Even Federal Reserve Chairman Alan Greenspan, who has regularly dismissed the possibility of a housing bubble, is worrying that current trends are "unsustainable."

But whether prices level out, crash, or even keep going up, the housing boom is already having pernicious economic effects. The real problem: the incredible amount of resources -- workers, materials, and money -- being sucked into home construction and renovation.

EVER UPWARD. Residential investment has become a black hole, absorbing a staggering 5.8% of gross domestic product. That's the highest level since the late 1940s and early '50s, when an entire generation of returning soldiers was setting up families and expanding into newly built suburbs. This time, Americans are building second homes and enlarging current ones at a record pace.

By comparison, the tech boom of the '90s was at worst a baby bubble. Starting in 1991, business investment in information technology and communications gear began a steady climb, going from 3.1% to a peak of 4.8% in 2000 before collapsing.

Without much fanfare, residential construction basically followed the same path in the 1990s. Starting at 3.4% of GDP in 1991, it rose to 4.6% in 2000. But rather than turn down, as tech did, spending on housing just kept climbing, fueled by low interest rates. Measured by the increase in its share of GDP, the housing boom so far is about 40% larger than the tech boom.

LOW-TECH. Is the housing boom a bubble? As Greenspan has said, it's hard to tell. But what's certain is that housing-driven growth, while creating jobs and lifting wealth, is also distorting the economy, benefiting low-tech commodity sectors rather than the high-tech industries at the heart of America's competitive strength.

New homes are built mainly out of materials, such as wood for the frame and floors, plasterboard for the walls, and fabricated metal parts for plumbing fixtures. High-tech equipment plays a very small role. Even when new homes include cable for broadband -- so-called structured wiring -- the high-tech component accounts for at most 1% or 2% of the entire cost of the home.

Calculations by BusinessWeek show that construction is among the least info-tech-intensive of all industries. In 2003, the latest data available, only 1.6 cents of every construction dollar was used for info-related products and services, such as computer gear, data-processing services, and telecom services. This includes both the tech-related products used in the building process and tech investment by construction companies. Most other industries -- including retailing, manufacturing, education, and health care -- are much heavier users of info tech.

Here again, we see the bourgeois, neo-liberal bias of Business Week in their unexamined assumptions. They seem to look down their noses at real substances ("New homes are built mainly out of materials..." no kidding! ). The problem is not where the money is going it's where it came from (debt). And the lack of investment in high-tech jobs (not companies) in the United States. The fact that the housing industry is not "high tech" is meaningless in this regard, since high-tech consumer spending goes towards electronics, which are not produced in the United States. The computer software industry, once a dominant strength of the United States, is offshoring its jobs as fast as it can to India. Construction trades cannot be offshored, someone has to come to your site and pound nails, connect wires and install the plumbing. And, not surprisingly, formerly rural townspeople in the exurbs (the far reaches of suburbia) have seen great increases in wealth during the housing boom of the last ten years (that, and the fact that most of the recipients of those jobs and that wealth were white male, small business owners provided a lot of votes for Bush in the last two elections). The class bias of the editors of Business Week is clear, the money should go to educated "innovators" not skilled craftspeople. After an economic crash, however, it may be the craftspeople who will have skills that still mean something.

Business Week concludes with this:

What happens when the housing boom finally slows? The share of GDP going into housing construction will fall sharply, hurting construction workers, architects, and homebuilders. Homeowners will no longer be able to draw on rising home equity. And what about Americans who borrowed heavily to buy properties for investment, expecting prices to keep climbing? Much like the companies who built miles of now-unused fiber-optic cable during the 1990s, they will be in deep trouble.

Yet even if there are temporary disruptions, the end of the housing boom may be good news for the overall economy. The U.S. doesn't need to drive growth with ornate new homes and elaborate kitchens with expensive marble counters. Instead, a shift away from housing could free up hundreds of billions of dollars for other, more productive investments.

That "deep trouble" will probably extend a lot farther than they are letting on in that article if the U.S. housing bubble pops. But articles like the one above do make it seem like they are setting the stage to pop the bubble soon. When the lumbering New York Times jumps on the bandwagon, the pop is well overdue. In contrast to Business Week, however, they do manage to understand the consequences:

Hear a Pop? Watch Out

NOW that even Alan Greenspan is talking about "froth" in real estate markets, how concerned should people be - not just about the value of their own homes, but about the entire country?

After all, we just had a big stock market bust and it barely dented the economy. Outside of brokers, speculators, and a few unlucky sellers, would a real estate crash really matter to the country as a whole?

In a word, yes. To understand why, first look at how pervasive the effects of real estate are throughout the economy.

Start with the so-called wealth effect. If people tend to spend more when their net worth increases, they'll spend less when it decreases. Economists use this rule of thumb: a $1 change in household wealth leads to a roughly 5-cent change in consumer spending. By that measure, a 10 percent decline in real estate prices would knock about half a percent off the gross domestic product.

Even more significant for the economy, though, would be a collapse in home equity lending. The industry has been booming as housing prices have soared. But if prices stop rising, new borrowing against home equity will drop, and may disappear.

That is important, because home equity lending amounted to more than $200 billion last year - or nearly 2 percent of the economy, according to, a research group based outside Philadelphia. If all that borrowing - which freed up cash that was spent on new furniture, appliances, vacations, cars and the like - simply vanished, the effect could be large enough all by itself to send the economy into recession.

But that's not all. The housing sector has even broader effects on the economy, by some estimates accounting for 25 percent of all activity. A decline in property values would most likely lead to declines in other industries, like construction, brokerage, banking and insurance. And these are important for future growth. Construction, for example, amounts to 4 percent to 5 percent of the economy, according to the Bureau of Economic Analysis.

Then there's banking. Because of the leverage associated with real estate, a fall in values would affect banks and other lenders. It would probably lead to tightened credit standards, less lending and higher interest rates. If lenders begin to suffer steep losses, there is always the danger of financial contagion, in which problems at one institution ripple out to others it does business with.

And there's a new wild card for the economy. In 2004, adjustable-rate mortgages made up a third of new mortgage originations. No one knows what the effect of the widespread use of A.R.M.'s would be in a down market. A climb in interest rates, of course, would put downward pressure on real estate prices, but A.R.M. borrowers would feel the pinch rapidly. If those borrowers started to default, lenders would be hurt.

Adding it all up, it's easy to see how a drop in real estate prices would spell trouble for the economy. To put that in perspective, the International Monetary Fund conducted a detailed study in 2003 that assessed the potential economic impact of a property slump. Reviewing the experience in the United States and 13 other industrialized countries, the I.M.F. found that a real estate bust is far more dangerous to the economy than a stock market bust.


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