Monday, August 28, 2006

Signs of the Economic Apocalypse, 8-28-06

From Signs of the Times, 8-28-06:

Gold closed at 631.60 dollars an ounce on Friday, up 3.2% from $612.00 at the previous Friday’s close. The dollar closed at 0.7841 euros Friday, up 0.6% from 0.7797 for the week. The euro closed at 1.2753 dollars, compared to 1.2825 at the end of the previous week. Gold in euros, then, would be 495.37 euros an ounce, up 3.8% from 477.19 for the week. Oil closed at 72.51 dollars a barrel Friday, up 1.9% from $71.14 at the close of the previous Friday. Oil in euros would be 56.86 euros a barrel, up 2.5% from 55.47 for the week. The gold/oil ratio closed at 8.71 up 1.3% from 8.60 at the close of the previous week. In U.S. stocks, the Dow Jones Industrial Average closed at 11,284.05 Friday, down 0.9% from 11,381.47 at the end of the week before, and the NASDAQ closed at 2140.29, down 1.1% from 2163.95 for the week. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.79 on Friday, down six basis points from 4.85 at the end of the week before.

The downturn in the U.S. housing market has become undeniable recently, raising fears of a recession.

Housing weighs on the economy
by Chad Hudson

August 23, 2006

There was little surprise that the housing market remained weak in July. Existing homes sales fell 4% from June to an annual rate of 6.33 million in July. This was 12.5% lower than last year. This was the slowest rate of home sales since January 2004. The median price gained 0.9% from last year, the South was the only region to experience a year-over-year gain. The West had its second consecutive month of lower year-over-year prices. Sales in the West were 18% lower than last July. This was the seventh month of double-digit yearly decline for the West. Not only are fewer homes selling, but more are coming on the market. In July, the number of homes for sales jumped 118,000 to 3.856 million. Combined with slower sales, the number of months supply jumped to 7.3. This is two months longer than in January.

On Tuesday, Toll Brothers reported third quarter earnings of $1.07. This was slightly ahead of analysts estimates, but was 16% lower than a year ago. Similar to other homebuilders, Toll Brothers wrote off $23 million related to land. Excluding this charge earnings were down 9%. The homebuilder also revised its guidance for the full year to $4.41 to $4.63 from previous guidance of $4.69 to $5.16. Wall Street had already reduced its estimates to $4.40. The company didn’t provide earnings guidance for 2007, but said that revenue would fall due to a 10-19% drop in deliveries and a 7% drop in the average selling price. Part of the drop in average selling price will be due to a shift to smaller homes. In response to a question whether or not the company felt the market was starting to bottom, it said, “but I don’t see a turnaround in any of the markets specifically

Last week, Home Depot reported that the slowing housing market has adversely affected its outlook. On Monday, Lowe’s echoed similar comments. Lowe’s reported an 11% gain in second quarter earnings, which was inline with analysts’ estimates. Same stores sales increased 3.3%, driven by a 4% gain in the average ticket. It also mentioned that promotional activity increased during the quarter. It was interesting that Lowe’s noted that even as it saw evidence that customers cutback discretionary spending, it still had strong sales of high end items in some product lines. Similar to Home Depot last week, the home improvement retailer lowered its guidance for the second half of the year. Same store sales are expected to be flat to up 2% during the third quarter as “near-term pressures on the U.S. consumer have led to a more cautious outlook for the balance of the year.”

Also playing a role in the housing market is a shift in psychology Just a year ago the media was hyping the housing boom highlighting investors that had switched from investing in the stock market to investing in residential housing. Today, there are an abundance of stories highlighting the bursting bubble. This week, the Wall Street Journal ran two such stories. The first highlighted the problems of “stated income” loans. The article mentioned a study done for the Mortgage Bankers Association by the Mortgage Asset Research Institute found that 60% of a sampling of 100 loans from one lender had income overstated by more than 50%. On Wednesday, the Wall Street Journal highlighted one homeowner that placed her house on the market for its 2005 appraised values of $1.1 million. Long story short, she ended up selling it for $530,000. Over the weekend, Barron’s noted that only 1% of WaMu’s option ARMS were in negative amortization at the end of 2003. In 2004, it moved up to 21% and has jumped to 47% at the end of last year.

Yet, in spite of the recessionary signs, analysts still worry about inflation due to higher energy costs: a classic 1970s-style stagflation, a central bankers nightmare:

Global economic braintrust divided on Fed policy

Tim Ahmann and Ros Krasny
August 27, 2006

Central bankers and top academics departed here on Sunday after two days of discussions on how the global economic landscape is shifting.

But they said goodbye still divided on what is perhaps the biggest question hanging over the outlook -- whether an unfolding slowdown in the U.S. economy will curb U.S. inflation without further interest-rate rises from the Federal Reserve.

While Fed policy was not a primary focus of the formal discussions at the Kansas City Federal Reserve Bank's annual Jackson Hole retreat, it was a hot topic on the sidelines.

"I think this is a time of a fair amount of uncertainty, because certainly there seems to be a shifting in the United States," IMF chief economist Raghuram Rajan said. "We're not quite sure if inflationary pressures are contained ... and we are also not sure how far and how quickly housing will slow."

After two years of steadily pushing benchmark borrowing costs higher, the U.S. central bank stepped to the sidelines at its last meeting on August 8, preferring to wait for more data shedding light on the outlook for growth and inflation.

A downturn in the U.S. housing market is seen cutting the wherewithal of U.S. consumers, who have been able to tap the equity fast rising home prices had provided to maintain their free-spending ways.

Former Brazilian central bank chief Arminio Fraga fretted that a slowdown in the United States, for years an engine supporting growth around the globe, could exact a big toll on economies elsewhere.

"Can the world make up for what is likely to be a slowdown in (U.S.) growth, maybe even a bigger slowdown than one expects at this point -- certainly a deeper slowdown than markets are pricing in?" Fraga asked conference participants.


Financial markets are largely convinced the Fed is finished raising interest rates and look for U.S. policy-makers to lower credit costs next year.

Former White House economic adviser Glenn Hubbard, dean of Columbia University's Graduate School of Business, suggested it might be wiser for the Fed to resume its credit-tightening course.

"It is a very difficult moment for the Fed to achieve both the desired fall in inflation and the soft landing in the real economy at the same time. It's easy to do one or the other; it's a little more difficult to do both," he said.

A similar debate appears to be unfolding at the Fed.

Richmond Federal Reserve Bank President Jeffrey Lacker voted against the majority of policy-makers at the central bank's August meeting, preferring to bump borrowing costs up another notch.

Analysts are keenly awaiting minutes of that session, which will be released on Tuesday, to see if his concerns were more widely shared.


While oil prices have given a big boost to overall U.S. inflation, the Fed has kept its sights firmly set on ensuring other prices stay under wraps.

If they do, the energy-led rise in inflation should prove a one-off phenomenon.

"When your faced with a terms of trade shock, such as an oil shock, there's logic to allow inflation to rise above target," Harvard University professor and and former IMF chief economists Kenneth Rogoff said in what amounted to a defense of the Fed strategy.

In response, Bank of England chief economist Charles Bean said such an approach risked denting the central bank's inflation-fighting credibility, and urged erring on the side of caution.

"To me, the most important issue is not whether there is a theoretical case for such accommodation. Rather it is whether there are likely to be any adverse effects on inflation expectations and credibility from doing so," he said.former IMF chief economists Kenneth Rogoff said in what amounted to a defense of the Fed strategy.

The experts are uncertain, but more data will be on the way this week:

Wall Street preps for more economic data
By Joe Bel Bruno, AP Business Writer

Wall Street will finally get the data it has craved to help get a better handle on the economy and whether it has pulled back further than policy-makers wanted. In the next five days, some two dozen economic reports will be released — including consumer confidence, job growth and manufacturing figures. Investors might even get a better clue about what Federal Reserve Chairman Ben Bernanke thinks of interest rates when minutes from the last Fed meeting are released.

These readings might help give Wall Street the guidance it has been clamoring for, especially after last week's lackluster performance. But the real question is, how many people will be around to trade on the news — this is, after all, the last week of August.

"I looked up the word doldrums in the dictionary, and there's no coincidence it comes from the word dull," David Darst, chief investment strategist of Morgan Stanley's global wealth management group, said Friday. "You might see some kind of fluctuation next week with these reports, but people will come back to work after Labor Day and sort through everything that's gone on. That's when you'll see volume go up."

Indeed, this past week's volume was lethargic, and traders say expect to see more of the same in the coming days. Looking back to last August, the NYSE reported consolidated volume for the month of 43.33 billion shares — while it popped up to 46.37 billion in September and 51.37 billion in October.

Last week, the Dow ended down 0.86 percent, Nasdaq fell 1.09 percent, and the S&P 500 dropped 0.55 percent.

Stocks fell on concerns that the Fed might have gone too far by raising rates 17 straight times before pausing at its August meeting. While this means Bernanke is unlikely to initiate another hike, it also troubles Wall Street that the economy might have moderated too quickly.

The biggest fear is that consumer spending is eroding, and that could translate into lower corporate profits. Oil prices, which rose steadily last week, also are a major contributor to how much people spend.


On Tuesday, investors hope to get some clues as the direction of consumer spending from the Conference Board's August consumer confidence index, and analysts are calling for a modest decline. The Federal Reserve minutes also come out that day.

On Wednesday, Wall Street will be reading the preliminary second-quarter gross domestic product numbers with interest to see if personal spending has slowed, and how business investment and government spending fared.
Consumers will also be in focus Wednesday, when the Commerce Department releases its personal income and personal spending reports for July. Also that day, the department will release its factory orders report for last month.

Perhaps the most important report this week comes out Friday, when the Labor Department releases its nonfarm payroll data for August. In July, the report showed slowing momentum and volatility in payroll growth, which is expected to continue.

The pace of business spending will also be measured on Friday when the Institute for Supply Management releases its survey of activity in the manufacturing sector, covering new orders, production, employment and inventories.


Wall Street will have to get most of its direction from economic data since there is little in the way of corporate earnings reports. On Wednesday, TiVo Inc. kicks off the week with its second-quarter results, which are expected to come in at a 14 cent per share loss. It has traded between $4.56 and $9.49 over the past 52 weeks, closing Friday up 17 cents, or 2.2 percent, at $7.85.

On Thursday, tax preparation company H&R Block Inc. is expected to report a loss of 19 cents per share. It has traded between $19.80 and $27.94 over the past 52 weeks, closing Friday down $1.98, or 8.7 percent, at $20.81.

Also Thursday, food company H.J. Heinz Co. reports its results. Heinz closed up Friday 5 cents at $41.35, and has traded within a 52-week range of $33.35 and $44.15. And luxury jeweler Tiffany & Co., reports the same day, giving an inkling of how the well-heeled consumer is holding up. Shares were unchanged Friday at $30.80, near the bottom of its 52-week range of $29.63 and $43.80.

Last week we wrote about the strange dominance of neo-classical economics and its dependence on an impoverished model of human beings. We also pointed to Andrew Lobaczewski’s work, Political Ponerology, in which he argues that systems based on impoverished views of human nature become more susceptible to takeover by psychopaths. In a similar vein, a movement in economics, begun in France at the turn of the millennium, has referred to neo-classical economics as “autistic economics.” Like Lobaczewski, they choose to focus on the psychopathology of modes of thought that we take for granted, yet which contribute to the bad situation the world is in. These economists have argued for a ‘post-autistic economics’, one with a more fuller and more accurate view of human beings:

A Brief History of the Post-Autistic Economics Movement

Theories, scientific and otherwise, do not represent the world as it is but rather by highlighting certain aspects of it while leaving others in the dark. It may be the case that two theories highlight the same aspects of some corner of reality but offer different conclusions. In the last century, this type of situation preoccupied the philosophy of science. Post-Autistic Economics, however, addresses a different kind of situation: one where one theory, that illuminates a few facets of its domain rather well, wants to suppress other theories that would illuminate some of the many facets that it leaves in the dark. This theory is neoclassical economics. Because it has been so successful at sidelining other approaches, it also is called “mainstream economics”.

From the 1960s onward, neoclassical economists have increasingly managed to block the employment of non-neoclassical economists in university economics departments and to deny them opportunities to publish in professional journals.

Note: this is what Lobaczewski would call the process of ponerization (a systematic yet subtle takover of an institution by evil forces).

They also have narrowed the economics curriculum that universities offer students. At the same time they have increasingly formalized their theory, making it progressively irrelevant to understanding economic reality. And now they are even banishing economic history and the history of economic thought from the curriculum, these being places where the student might be exposed to non-neoclassical ideas. Why has this tragedy happened?

Many factors have contributed, but three especially. First, neoclassical economists have as a group deluded themselves into believing that all you need for an exact science is mathematics, and never mind about whether the symbols used refer quantitatively to the real world. What began as an indulgence became an addiction, leading to a collective fantasy of scientific achievement where in most cases none exists. To preserve their illusions, neoclassical economists have found it increasingly necessary to isolate themselves from non-believers.

Second, as Joseph Stiglitz has observed, economics has suffered “a triumph of ideology over science”. Instead of regarding their theory as a tool in the pursuit of knowledge, neoclassical economists have made it the required viewpoint from which, at all times and in all places, to look at all economic phenomena. This is the position of neoliberalism.

Third, today’s economies, including the societies in which they are embedded, are very different from those of the 19th century for which neoclassical economics was invented to describe. These differences become more pronounced every decade as new aspects of economic reality emerge, for example, consumer societies, corporate globalization, economic induced environmental disasters and impending ecological ones, the accelerating gap between the rich and poor, and the movement for equal-opportunity economies. Consequently neoclassical economics sheds light on an ever-smaller proportion of economic reality, leaving more and more of it in the dark for students permitted only the neoclassical viewpoint. This makes the neoclassical monopoly more outrageous and costly every year, requiring of it ever more desperate measures of defense, like eliminating economic history and history of economics from the curriculum.

But eventually reality overtakes time-warp worlds like mainstream economics and the Soviet Union. The moment and place of the tipping point, however, nearly always takes people by surprise. In June 2000, a few economics students in Paris circulated a petition calling for the reform of their economics curriculum. One doubts that any of those students in their wildest dreams anticipated the effect their initiative would have. Their petition was short, modest and restrained. Its first part, “We wish to escape from imaginary worlds”, summarizes what they were protesting against.

Most of us have chosen to study economics so as to acquire a deep understanding of the economic phenomena with which the citizens of today are confronted. But the teaching that is offered, that is to say for the most part neoclassical theory or approaches derived from it, does not generally answer this expectation. Indeed, even when the theory legitimately detaches itself from contingencies in the first instance, it rarely carries out the necessary return to the facts. The empirical side (historical facts, functioning of institutions, study of the behaviors and strategies of the agents . . .) is almost nonexistent. Furthermore, this gap in the teaching, this disregard for concrete realities, poses an enormous problem for those who would like to render themselves useful to economic and social actors.

The students asked instead for a broad spectrum of analytical viewpoints.

Too often the lectures leave no place for reflection. Out of all the approaches to economic questions that exist, generally only one is presented to us. This approach is supposed to explain everything by means of a purely axiomatic process, as if this were THE economic truth. We do not accept this dogmatism. We want a pluralism of approaches, adapted to the complexity of the objects and to the uncertainty surrounding most of the big questions in economics (unemployment, inequalities, the place of financial markets, the advantages and disadvantages of free-trade, globalization, economic development, etc.)

The Parisian students’ complaint about the narrowness of their economics education and their desire for a broadband approach to economics teaching that would enable them to connect constructively and comprehensively with the complex economic realities of their time hit a chord with French news media. Major newspapers and magazines gave extensive coverage to the students’ struggle against the “autistic science”. Economics students from all over France rushed to sign the petition. Meanwhile a growing number of French economists dared to speak out in support and even to launch a parallel petition of their own. Finally the French government stepped in. The Minister of Education set up a high level commission to investigate the students’ complaints.

News of these events in France spread quickly via the Web and email around the world. The distinction drawn by the French students between what can be called narrowband and broadband approaches to economics, and their plea for the latter, found support from large numbers of economics students and economists in many countries. In June 2001, almost exactly a year after the French students had released their petition, 27 PhD candidates at Cambridge University in the UK launched their own, titled “Opening Up Economics”. Besides reiterating the French students’ call for a broadband approach to economics teaching, the Cambridge students also champion its application to economic research.

This debate is important because in our view the status quo is harmful in at least four respects. Firstly, it is harmful to students who are taught the 'tools' of mainstream economics without learning their domain of applicability. The source and evolution of these ideas is ignored, as is the existence and status of competing theories. Secondly, it disadvantages a society that ought to be benefiting from what economists can tell us about the world. Economics is a social science with enormous potential for making a difference through its impact on policy debates. In its present form its effectiveness in this arena is limited by the uncritical application of mainstream methods. Thirdly, progress towards a deeper understanding of many important aspects of economic life is being held back. By restricting research done in economics to that based on one approach only, the development of competing research programs is seriously hampered or prevented altogether. Fourth and finally, in the current situation an economist who does not do economics in the prescribed way finds it very difficult to get recognition for her research.

In August of the same year economics students from 17 countries who had gathered in the USA in Kansas City, released their International Open Letter to all economics departments calling on them to reform economics education and research by adopting the broadband approach. Their letter includes the following seven points.

1. A broader conception of human behavior. The definition of economic man as an autonomous rational optimizer is too narrow and does not allow for the roles of other determinants such as instinct, habit formation and gender, class and other social factors in shaping the economic psychology of social agents.

2. Recognition of culture. Economic activities, like all social phenomena, are necessarily embedded in culture, which includes all kinds of social, political and moral value-systems and institutions. These profoundly shape and guide human behavior by imposing obligations, enabling and disabling particular choices, and creating social or communal identities, all of which may impact on economic behavior.

3. Consideration of history. Economic reality is dynamic rather than static – and as economists we must investigate how and why things change over time and space. Realistic economic inquiry should focus on process rather than simply on ends.

4. A new theory of knowledge. The positive-vs.-normative dichotomy which has traditionally been used in the social sciences is problematic. The fact-value distinction can be transcended by the recognition that the investigator’s values are inescapably involved in scientific inquiry and in making scientific statements, whether consciously or not. This acknowledgement enables a more sophisticated assessment of knowledge claims.

5. Empirical grounding. More effort must be made to substantiate theoretical claims with empirical evidence. The tendency to privilege theoretical tenets in the teaching of economics without reference to empirical observation cultivates doubt about the realism
of such explanations.

6. Expanded methods. Procedures such as participant observation, case studies and discourse analysis should be recognized as legitimate means of acquiring and analyzing data alongside econometrics and formal modelling. Observation of phenomena from different vantage points using various data-gathering techniques may offer new insights into phenomena and enhance our understanding of them.

7. Interdisciplinary dialogue. Economists should be aware of diverse schools of thought within economics, and should be aware of developments in other disciplines, particularly the social sciences.
In March 2003 economics students at Harvard launched their own petition, demanding from its economics department an introductory course that would have “better balance and coverage of a broader spectrum of views” and that would “not only teach students the accepted modes of thinking, but also challenge students to think critically and deeply about conventional truths.”

Students have not been alone in mounting increasing pressure on the status quo. Thousands of economists from scores of countries have also in various forms taken up the cause for broadband economics under the banner “Post-Autistic Economics” and the slogan “sanity, humanity and science” The PAE movement is not about trying to replace neoclassical economics with another partial truth, but rather about reopening economics for free scientific inquiry, making it a pursuit where empiricism outranks a priorism and where critical thinking rules instead of ideology.
How does such a movement work in practice? Here’s a good example:

Neoclassical economics regards competition as a state rather than as a process. It defines perfect competition as a market with a large number of firms with identical products, costs structures, production techniques and market information. But in real life competition is a process by which firms continually seek to re-establish the conditions of their own profitability. To compete in a market requires firms to seek out and exploit differences between them in production, technology, distribution, access to information and awareness of trends in consumption. These differences are the essential dimensions in which competition takes place. Once the neoclassical conception of competition becomes imbedded in the student’s mind, appreciation of real-world competition, and hence the policies that might enhance it, becomes logically impossible.

Neoclassical economists love to talk about freedom of choice. But this is pure rhetoric, because they define rationality in a way that eliminates free choice from their conceptual space. By rationality they mean that an agent’s choices are in conformity with an ordering or scale of preferences. The “rational” agent chooses among the alternatives available that one which is highest on his ranking. Rational behaviour simply means behaviour in accordance with some ordering of alternatives in terms of relative desirability. In order for this approach to have any predictive power, it must be assumed that the preferences do not change over some period of time. So the basic condition of neoclassical rationality is that individuals must forego choice in favour of some past reckoning, thereafter acting as automata. This conceptual elimination of freedom of choice, in both its everyday and philosophical meanings, gives neoclassical theory the hypothetical determinacy that its Newtonian inspired metaphysics require. No indeterminacy; no choice. No determinacy; no neoclassical model. This is far from just an academic matter, because society needs an economics that is able to address questions regarding freedom of choice.

No terms in neoclassical economics are more sacrosanct than rational choice and rationality. Everyone identities with these words, because everyone wants to think of themselves as rational. But few people realize that economists give these words an ultra eccentric meaning.

Lobaczewski would call this a “conversive meaning.”

Neoclassical economics begins with an a priori conception of markets and economies as determinate systems that by the action of individual agents alone tend toward an efficient and market-clearing equilibrium. This requires that the individual agents, like the bodies in Newton’s system, behave in a prescribed manner. Neoclassicalists have deduced the particular pattern of behaviour that would make their imagined world logically possible, then named it “rational choice” or “rationality” and then declared that that is the way real people behave. But thankfully they don’t. Everyday economic actors do many things that by the neoclassical meaning of “rational” are “irrational”. Looking to the choices of other consumers as guides to what one might buy; buying a stock because you believe other people will be buying it and so increase its value, spending your money in a spirit of spontaneity rather than stopping to calculate the consequences and alternatives up to the limits of your cognitive powers; a taste for change, that is, buying something because you did not previously prefer it; these common consumer behaviours are all prohibited under the neoclassical notions of rational choice and rationality and so outside its scope of analysis.

These failings connect with another. Neoclassical economics is by its own axioms incapable of offering a coherent conceptualisation of the individual or economic agent. From where do the preferences that supposedly dictate the individual’s choice come from? Not from interpersonal relations, because if individual demands were interdependent, they would not be additive and thus the market demand function – neoclassicalism’s key analytical tool – would be undefined. And not from society, because neoclassicalism’s Newtonian atomism translates as methodological individualism, meaning that society is to be explained in terms of individuals and never the other way around.

This leaves an awful lot in the dark. In the main, despite the neoclassical axioms, we all categorise and classify according to prevailing cultural norms. Likewise our tastes and preferences for this and that reflect the social conventions and institutions with which we interact. Consequently individual choice is unavoidably and inextricably bound up with historically and geographically given social worlds. An economics that has nothing to say about the formation of economic tastes and preferences is silly and irresponsible, especially in an age of consumer societies and in a world now threatened with climate-change or worse.

Once the pathological system of thought, such as neoclassical economics, is seen for what it is, and the conversive terms interpreted correctly, new horizons open:

Mainstream economics, and in consequence most policy dialogue, conflates two very different meanings of economic growth that are in common usage and with GNP mistakenly taken to be a measure of both. There is quantitative growth meaning an increase in the quantity of production and consumption, and there is qualitative growth meaning an improvement in well-being. For example, an epidemic may lead to growth of medical expenditure and hence increase GNP but not well-being. Pollution and congestion lead to huge expenditures to escape them (e.g., commuting from the suburbs, double glazing, air filters, security measures), the creation of new industries and an ever larger GNP but they also decrease well-being. Quantitative growth that causes negative qualitative growth is also called uneconomic growth. It is both a reality and a concept with which policy makers must come to terms, the sooner the better.

Closely related to these new anti-neoclassical concepts is another one, sustainable development. This refers to the physical scale of the economy relative to the ecosystem. Ecological economists view the economy as an open subsystem of the larger ecosystem which is finite, non-growing and, except for solar energy, materially closed. This point of view compels asking questions regarding scale. How large is the economic subsystem relative to the earth’s ecosystem? What is its maximum possible size? What is its most desirable size in terms of human welfare? These questions, around which policy decisions will and must increasingly be made, are not found in standard economics textbooks. Neoclassical economics can not accommodate the concept of sustainable development because if adopted as a goal it requires that goods be valued in part by their contribution to that goal and not solely on their contribution to individual utility maximisation.
A look at the recent history of neoclassical economics and of the mathematical modes of analysis that underpin it, suggest that its hegemony today is no accident:
Following WWII, the United States increasingly came to determine (one might say dictate) the shape of economics worldwide, while within the United States the sources of influence became concentrated and circumscribed to an absurd degree. This state of affairs, which persists to the present day, was engineered in significant part by the US Department of Defense, especially its Navy and Air Force.3 Beginning in the 1950s it lavishly funded university research in mathematical economics. Military planners believed that game theory and linear programming had potential use for national defense. And although now it seems ridiculous, they held out the same hope for mathematical solutions of “general equilibrium”, the theoretical core of Neoclassical economics. In 1954 Kenneth Arrow and Gerard Debreu achieved for this mathematical puzzle a solution of sorts that has been the central show piece of academic economics ever since. Arrow’s early research had been partly, in his words, “carried on at the RAND Corporation, a project of the United States Air Force.”4 In the 1960s, official publications of the Department of Defense praised the Arrow-Debreu project for its “modeling of conflict and cooperation whether if be [for] combat or procurement contracts or exchange of information among dispersed decision nodes.” In 1965, RAND created a fellowship program for economics graduate students at the Universities of California, Harvard, Stanford, Yale, Chicago, Columbia and Princeton, and in addition provided postdoctoral funds for those who best fitted the mold. These seven economics departments along with MIT’s, an institution long regarded by many as a branch of the Pentagon, have come to dominate economics globally to an astonishing extent. Two examples will show what I mean.

The American Economic Review (AER), the Quarterly Journal of Economics (QJE), and the Journal of Political Economy (JPE), have long been regarded as the world’s three most prestigious economics journals, the ones in which a publication adds the most value to an economist’s CV and most helps an economics department’s ranking and research funding.

A study has been made of the affiliation of the authors of full-length articles appearing in these journals from 1973 through 1978.5 For the QJE it found that the eight departments with the most articles were the seven favoured through RAND by the US Department of Defense plus MIT, and that this Big Eight accounted for 77.3 percent of the articles published. In the JPE all of the RAND Seven were in the top ten and together with MIT accounted for 63.1 percent of the articles published. In the AER the top eight contributing departments were again the RAND Seven plus MIT, which together accounted for 59.3 percent of the articles published. Even within this Big Eight there was an astonishing concentration of success. In the QJE, which is controlled by Harvard, 33.3 percent of the articles were by Harvard-affiliated authors. In the JPE, controlled by Chicago, 20.7 percent of the articles were by Chicago-affiliated authors. In the AER, nearly half of whose editorial board during these years was from, in rank order, Chicago, MIT and Harvard, 14.0, 10.7 and 7.1 percent of the articles were by authors from these departments respectively. About 70% of the board members were from the Big Eight and nearly 60 percent of the members of the nominating committees for officers.

Neoclassical economics is ideal for the pathocrats, it gives us “consumers” the illusion of freedom while convincing us to behave in ways that make our behavior easier to model. It also reduces our awareness of political alternatives, as the following account by Deborah Campbell of a rebellion at Harvard against the introductory economics class there taught by Martin Feldstein shows:
Sitting in an overcrowded café near Harvard Square, talking over the din of full-volume Fleetwood Mac and espresso fueled chatter, Gabe Katsh describes his disillusionment with economics teaching at Harvard University. The red-haired 21-year-old makes it clear that not all of Harvard’s elite student body, who pay close to $40,000 a year, are the “rationally” self-interested beings that Harvard’s most influential economics course pegs them as.

“I was disgusted with the way ideas were being presented in this class and I saw it as hypocritical – given that Harvard values critical thinking and the free marketplace of ideas – that they were then having this course which was extremely doctrinaire,” says Katsh. “It only presented one side of the story when there are obviously others to be presented.”

For two decades, Harvard’s introductory economics class has been dominated by one man: Martin Feldstein. It was a New York Times article on Feldstein titled “Scholarly Mentor To Bush’s Team,” that lit the fire under the Harvard activist. Calling the Bush economic team a “Feldstein alumni club,” the article declared that he had “built an empire of influence that is probably unmatched in his field.” Not only that, but thousands of Harvard students “who have taken his, and only his, economics class during their Harvard years have gone on to become policy-makers and corporate executives,” the article noted. “I really like it; I’ve been doing it for 18 years,” Feldstein told the Times. “I think it changes the way they see the world.”

That’s exactly Katsh’s problem. As a freshman, he’d taken Ec 10, Feldstein’s course. “I don’t think I’m alone in thinking that Ec 10 presents itself as politically neutral, presents itself as a science, but really espouses a conservative political agenda and the ideas of this professor, who is a former Reagan advisor, and who is unabashedly Republican,” he says. “I don’t think I’m alone in wanting a class that presents a balanced viewpoint and is not trying to cover up its conservative political bias with economic jargon.”

In his first year at Harvard, Katsh joined a student campaign to bring a living wage to Harvard support staff. Fellow students were sympathetic, but many said they couldn’t support the campaign because, as they’d learned in Ec 10, raising wages would increase unemployment and hurt those it was designed to help. During a three-week sit-in at the Harvard president’s office, students succeeded in raising workers’ wages, though not to “living wage” standards.

After the living wage “victory,” Harvard activists from Students for a Humane and Responsible Economics (SHARE) decided to stage an intervention. This time, they went after the source, leafleting Ec 10 classes with alternative readings. For a lecture on corporations, they handed out articles on corporate fraud. For a free trade lecture, they dispensed critiques of the WTO and IMF. Later, they issued a manifesto reminiscent of the French post-autistic revolt, and petitioned for an alternative class. Armed with 800 signatures, they appealed for a critical alternative to Ec 10. Turned down flat, they succeeded in introducing the course outside the economics department.

Harvard President Lawrence Summers illustrates the kind of thinking that emerges from neoclassical economics. Summers is the same former chief economist of the World Bank who sparked international outrage after his infamous memo advocating pollution trading was leaked in the early 1990s. “Just between you and me, shouldn’t the World Bank be encouraging MORE migration of the dirty industries to the LDCS [Less Developed Countries]?” the memo inquired. “I think the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable and we should face up to that.... I’ve always thought that under-populated countries in Africa are vastly UNDER-polluted....”

Brazil’s then-Secretary of the Environment, José Lutzenburger, replied: “Your reasoning is perfectly logical but totally insane.... Your thoughts [provide] a concrete example of the unbelievable alienation, reductionist thinking, social ruthlessness and the arrogant ignorance of many conventional ‘economists’ concerning the nature of the world we live in.”

Summers later claimed the memo was intended ironically, while reports suggested it was written by an aide. In any case, Summers devoted his 2003/2004 prayer address at Harvard to a “moral” defense of sweatshop labor, calling it the “best alternative” for workers in low-wage countries.

Monday, August 21, 2006

Signs of the Economic Apocalypse, 8-21-06

From Signs of the Times, 8-22-06:

Gold closed at 612.00 dollars an ounce on Friday, down 5.0% from $642.40 at the close of the previous week. The dollar closed at 0.7797 euros Friday, down 0.7% from 0.7855 for the week. The euro closed at 1.2825 euros, up from 1.2732 at the close of the previous Friday. Gold in euros would be 477.19 euros an ounce, down 5.7% from 504.56 for the week. Oil closed at 71.14 dollars a barrel Friday, down 4.4% from $74.30 at the close of the Friday before. Oil in euros would be 55.47 euros a barrel, down 5.2% from 58.36 for the week. The gold/oil ratio closed at 8.60 Friday, down 0.5% from 8.64 at the close of the previous Friday. In the U.S. stock market, the Dow closed at 11,381.47 last week, up 2.6% from 11,088.03 for the week. The NASDAQ closed at 2163.95 Friday, up 5.2% from 2,057.71 at the close of the previous Friday. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.85%, down 12 basis points from 4.97 for the week.

With gold and oil down and U.S. stocks up, the mainstream media last week credited a mood of optmism. About all they could point to was the cease fire between Israel and Lebanon, which lowered oil prices and the lower than expected inflation numbers in the U.S.
Dow closes up 47 on investor optimism

By Joe Bel Bruno, AP Business Writer

Fri Aug 18, 4:53 PM ET

Investors eked out Wall Street's fifth-straight day of gains Friday, bucking concerns about lagging consumer sentiment and disappointing second-quarter results from Dell Inc.

Trading got off to a shaky start after the University of Michigan released its preliminary consumer sentiment index, which fell to 78.7 in August, down from 84.7 a month earlier. Wall Street had been looking for the index to slide to 83.8, and the greater-than-expected drop was viewed as a signal the economy may weaken too much.

The poor sentiment index threatened to stall the market's rally this week, which came on evidence of lower inflation risk and a gently slowing economy. Yet the market's recovery from its session lows — aided by a $36 billion stock buyback announced by Microsoft Corp. — shows investors remain optimistic that the Federal Reserve will keep the economy strong enough to withstand recession while keeping inflation contained.

"If this rally continues on bad economic news, that's saying that investors have already made a decision we're going to have a soft landing in this economy," said Alexander Paris, economist and market analyst for Chicago-based Barrington Research.

Technology stocks nevertheless saw pressure after Dell reported second-quarter profit fell 51 percent, with sales growth slowing to the lowest rate in three years. The world's largest computer maker — already reeling from a massive laptop battery recall earlier in the week — also disclosed the Securities and Exchange Commission has been investigating its accounting for the past year.

The Dow Jones industrial average rose 46.51, or 0.41 percent, to 11,381.47.
Broader stock indicators also made modest gains. The Standard & Poor's 500 index added 4.82, or 0.37 percent, to 1,302.30, and the Nasdaq composite index gained 6.34, or 0.29 percent, to 2,163.95.

For the week, the Dow jumped 2.65 percent, the S&P 500 gained 2.81 percent and the Nasdaq surged 5.16 percent.

Bonds pushed toward gains for a fourth straight session, with the yield on the benchmark 10-year Treasury note falling to 4.84 percent from 4.86 percent late Thursday. The dollar was mixed against other major currencies, while gold prices fell.

Oil prices moved higher in trading after tumbling a day earlier on cooling of Middle East tensions. A barrel of light, sweet crude for September delivery settled at $71.14, up $1.08 from Thursday's close, in electronic trading on the New York Mercantile Exchange. On Thursday, oil fell as low as $69.60 a barrel — a level not seen since June 21.

The optimistic story had to ignore the plainly temporary lull in the aggressive actions of the United States and Isreal as well as both countries’ recent abysmal failures in their wars. The media also had to downplay a bad housing market and low consumer confidence numbers in the United States.
Home sales decline in 28 states, D.C.

By Martin Crutsinger, AP Economics Writer

The slowdown in the once-sizzling housing market is spreading, with 28 states and the District of Columbia reporting spring sales declines, led by big drops in former boom areas of Arizona, Florida and California.

Nationally, sales were down 7 percent in the April-June quarter this year compared with the same period in 2005, the National Association of Realtors said Tuesday in its latest state-by-state look at housing conditions around the country.

The Realtors survey showed that the biggest declines occurred in states that had been enjoying red-hot sales during the five-year housing boom.

The five biggest declines this spring compared to the April-June period of 2005 were Arizona, down 26.9 percent; Florida, down 26.7 percent; California, down 25.3 percent; Virginia, down 23.9 percent, and Nevada, down 23.5 percent.
The Realtors report depicted a tale of two housing markets, with former boom areas experiencing declines and other areas of moderate sales gains during the boom years experiencing strong growth.

In all, 20 states had sales gains in the spring, led by Alaska, which enjoyed a 48.6 percent jump in sales; followed by Arkansas, up 17.9 percent; Texas, up 11.3 percent; North Carolina, up 11 percent, and Vermont, up 9.1 percent compared to the spring of 2005.

Now the optimists can say that 20 states had housing sales gains, and that the 28 states that had declines were those which saw the greatest gains in the bubble. The problem, as always, is that the process of decline will not be linear. Here is the Billmon blogger:
Home is Where the Sink Hole Is

…Here in paradise, the housing boom is over:

Southern California home sales fell to their lowest level in nine years last month as price appreciation continued to decelerate, data released Tuesday showed . . . .

The figures could rev up the debate over whether the Southland's housing market will be able to navigate a "soft landing" that produces only moderate price declines, or face a brutal correction.

…[T]alk of a "soft landing" is one of the normal steps in a bubble addict's recovery program.

It goes something like this:

1.) We're not in a bubble. Prices are just recovering from years of underappreciation.

2.) It's a bubble, but it's a sustainable bubble because the fundamentals of the market have changed in the past decade. People need to recognize this. (Note: this stage is usually recognizable by an explosion in popularity of increasingly desperate and bizarre financing options.)

3.) Yes, growth is slowing, but we think we'll navigate a soft landing. It's absurd to think that housing in [fill in area where you live] will actually lose value.

4.) This is a disaster! Somebody better step in and do something! People are losing their life savings!

5.) Buyers have learned a permanent lesson this time. Homeowners need to accept the reality that the bubble of the past five years was a one-time fluke and we'll never see it happen again.

Rise and (eventually) repeat.

These are actually the residential real estate versions of the more generic speculative cycle described by economist (and wise old man of the academic hills) Charles Kindleberger in his classic text Manias, Panics and Crashes.

Working from a schematic first developed by the late financial economist Hyman Minsky, Kindleberger described the idealized bubble thusly:

· Displacement: Some sort of exogenous shock -- such as the huge drop in interest rates in the early '00s -- gets the speculative juices flowing.

· Credit expansion: Lenders hustle to get in on the action, feeding more liquidity into the market, creating a self-sustaining loop of price increases, which leads to:
· Euphoria: (Minsky, following Adam Smith, called it "overtrading.") Since expectations are adaptive, not rational, a prolonged period of rising prices creates a growing consensus that the boom will never end. Clever writers and hack economists like Jim Glassman and Kevin Hassett,
hustle to develop new wave theories showing why this must be true.

· Distress: As price gains slow or plateau (there are only so many fools in the world with money to wager) it begins to dawn on the crowd -- always slowly, never at once -- that the boom will NOT last forever.

· Revulsion: (Minsky also used the term "discredit") The conviction sets in that the one thing you do not want to own, under any circumstances, is the asset in question -- the same one the Glassmans and Hassets of the world were recently predicting would grow to the sky.

It appears that Southern California (which originally was the product of an 1880s real estate bubble deliberately engineered by the Southern Pacific railroad) has arrived at the stage of "distress" and is quickly moving on to "revulsion."

In the stock market, the revulsion stage typically ends in massive panic-driven price declines, as everybody and their broker tries to crowd through the same small door. However, because real estate markets are less liquid and have higher transaction costs, and since houses are a consumption item as well as an asset, what traditionally happens when the bubble bursts is that sales just dry up. Nobody wants to buy at quoted prices (usually based on previous, overinflated appraisals) but sellers aren't willing -- and often aren't able -- to sell for less. So the market can't clear, as Southern California markets aren't clearing now.

This tends to make housing busts the economic equivalent of Chinese water torture: they generally begin slowly but last a long time, as home "owners" gradually capitulate to reality and lenders (or in the S&L industry's case, the federal government) slowly write off all that bad debt and dispose of all those foreclosed homes.

That's one reason why the collapse in real estate values that accompanied the Great Depression didn't bottom out until the late 1940s. It's also why it took almost ten years for the last home price boom/bust cycle in California to come around again. According to the Office of Federal Housing Enterprise Oversight, the reg agency that tracks these things, home prices in the greater Los Angeles metro area didn't return to their 1990 peak until the spring of 2000.

But what makes things different -- and potentially more exciting -- this time around are the gaudy new financing gimmicks Kevin mentions: no money down loans, interest-only mortgages, ARMs that reset to truly usurious rates, etc. If and when these loans blow up, and they will, it could leave many home "owners" with no alternative but to sell and sell quickly -- or simply mail the keys back to the bank.

Combine that with the fact that this housing bubble, far more than past bubbles, appears to have been driven by the speculative investment demand of people who have no intention of living in the houses they've bought, and the finale could be much more spectacular, and play out a lot faster, at least in some markets.

How fast and how spectacular depends in part on Chairman Ben and the boys and girls at the Fed. Although short-term interest rates have now jumped 425 basis points since the trough in the summer of 2004 (a whopper of a move by past standards, particularly in real, after-inflation terms) long-term mortgage rates have increased much more modestly, thanks in large part to our good friends at the People's Bank of China. This is the main reason anyone can still talk about a "soft landing" for Southern California home prices.

However, now that the downward wave of the cycle is well-entrenched, the Fed is going to have to move relatively fast to keep the "soft landing" scenario from smashing into the runway. But experience teaches that the Fed rarely shifts from tightening to easing fast enough to head these kind of things off -- the fall of 1990 and the summer and fall of 2000 being two case studies in point.

My guess is that the Southern California market (along with the New York metro market and the South Florida market and a few other places where the bubble got well out of hand) are going to "auger in," as the test pilots used to call it. They've soared too high, and the Fed isn't going to be able to move quickly enough to catch them because national growth and inflation conditions aren't going to let it.
But whether the bust is national, as opposed to just regional, may depend as much or more on our Chinese benefactors as on the Fed.

The chain of causation is somewhat perverse: The Fed's recent decision to at least pause in its tightening campaign has put downward pressure on the dollar, which is forcing the People's Bank to buy dollars to protect the "crawling peg" with the renminbi, said dollars then being reinvested in the Treasury market, which drives long-term yields down, which pulls mortage yields down, too.

As long as that particular windfall lasts, the prospects for a soft landing to the national real estate bubble look reasonably good -- that is, as long as the regional real estate busts, plus the overextended state of the American consumer and the mysterious reluctance of U.S. firms to funnel their bloated profits into capital spending, don't tip the national economy over into a recession.

You'd need a Cray supercomputer hooked up to a crystal ball to figure out the odds on that latter scenario, and I have neither. What I do have is a conventional 30-year mortgage at 6.12%, and a house with lots of equity located in one of the country's more stable real estate markets. So I'm personally not sweating the housing bubble too much. Yet.

Last week we wrote about the longer-term issues of imperial competition for resources and cheap labor. We should not think that these competitions between different power centers are exclusively economic. In Political Ponerology, Andrzej Lobaczewski wrote in 1984:
Upbeat economists point out that humanity has gained a powerful slave in the form of electric energy and that war, conquest, and subjugation of other countries is becoming increasingly unprofitable in the long run. Unfortunately… nations can be pushed into economically irrational desires and actions by other motives whose character is meta-economic (Politcal Ponerology, p. 93)
In fact, reducing all motivations to economic ones is precisely the kind of oversimplification that plays right into the hands of the pathocrats. Lobaczewski argues that, to the extent that a society’s working model of human nature is inadequate, that society’s institutions are more vulnerable to ponerization, or takeover by psychopaths. What Lobaczewski writes about western European legal psychology in the Middle Ages can be applied to the homo oeconomicus of classical economics, the rational calculator of economic advantage:
A “Western civilization” thus arose hampered by a serious deficiency in an area which both can and does play a creative role, and which is supposed to protect societies from various kinds of evil. This civilization developed formulations in the area of law, whether national, civil, for finally canon, which were conceived for invented and simplified beings. These formulations gave short shrift to the total contents of the species Homo sapiens. For many centuries any understanding of certain psychological anomalies found among some individuals was out of the question, even though these anomalies repeatedly caused disasters.

This civilization was insufficiently resistant to evil, which originates beyond the easily accessible areas of human consciousness and takes advantage of the enormous gap between formal or legal thought and psychological reality. (Politcal Ponerology, p. 48)

Such models have just enough truth in them to seem plausible while concealing dangerous simplifications. The neoclassical economic model of human psychology, a model with deepest roots in the Anglo-American world, cannot adequately reflect the complexity of motivations in most humans. Its psychology is plainly inadequate to all but psychopaths. It should be no surprise, then, that our culture is wide open to ponerizing forces. Furthermore, late capitalism’s preferred institution, the modern business corporation, provides an ideal vehicle for ponerization. The recent boom in the study of psychopathy has led many to see the corporation as a psychopath, that is, someone without a conscience. Given legal personhood under the Constitution by the U.S. Supreme Court, the psychopath that pretends to have empathy when it has absolutely none. It’s rules are the same as an individual psychopath’s.

Neoliberals have pushed the privatization of just about everything. Even roads are now beginning to be privatized in the United States. However, we clearly cannot depend on corporations to fund infrastructure investment—usually only government can do that—but in the United States, with a neoliberal economic policy and a neoconservative foreign policy, the government is only good for destroying other countries’ infrastructure and for funnelling money to cronies in the military-industrial complex.

Alice Friedemann compares multinational corporations to “out of control robots.” The economic rationality of these psychopathic actors are placing the world in increasing danger. Friedemann, a proponent of peak oil, marshals some startling facts about the lesser-known aspects of our energy dependence. Supply chains, made more efficient with just-in-time supply, and the offshoring of jobs to low-wage, low regulation countries, have increased the vulnerability of developed economies to transportation interruptions due to natural disasters or high energy costs:

The fragility of global trade and infrastructure
By Alice Friedemann

Science fiction movies used to scare us with out-of-control robots bent on world destruction. If there’s a runaway robot now, it’s global corporations doing what’s best for the shareholder rather than the citizens and nations of the world. Pensions have been looted, health care benefits taken away, taxes avoided, and regulations ignored.

Risks are being taken that could bring down the global financial system.

One of the risks to global trade is due large computer and electronic companies using the same outsourcers for similar components from the same region -- even the same place – such as an industrial park in Hsinchu, Taiwan. The risk is a single source of failure.

Microprocessors are essential to the modern world.

Billions of chips are created every year for a myriad of applications: in autos, airplanes, ATMs, air conditioners, calculators, cameras, cell phones, clocks, DVDs, machine tools, medical equipment, microwave ovens, office and industrial equipment, routers, security systems, thermostats, TVs, VCRs, washing machines – nearly all electrical devices.

So when an earthquake struck Taiwan in 1999, world markets were shaken. Willem Roelandts of Xilinx immediately knew this had the possibility of hurting the world economy. “There is not an electronic product in the world that does not contain a Taiwanese component”, he said.

Even though the factories were fine, electrical and transportation systems weren’t, so production and delivery of components stopped, which caused assembly lines in the United States to halt as well. Wall Street traders sold off electronic firms, especially Dell, HP, and Apple.

You wouldn’t think the United States would build microchip factories offshore in industries that were essential to its national and economic security. But low wages are irresistible to corporations. Also, many foreign countries are closer to sources of natural gas, which is declining at an alarming rate in North America.

According to Jack Gerard, president and CEO of the American Chemistry Council, “Natural gas is a raw material for compounds used in thousands of consumer products — from agriculture, telecommunications and automobiles to pharmaceuticals…and food packaging. More than 96 percent of all manufactured goods are directly touched by chemistry. The industries that rely on chemistry together represent more than a quarter of the nation's entire workforce." Unaffordable natural gas is driving away investment, crippling our manufacturing base, and reducing job opportunities. It is transferring to foreign countries the advanced research and technology desperately needed in order to compete on the world stage. In effect, our nation's energy policy has become its de facto manufacturing and national-security policies as well.26

Industries also like to locate factories where environmental regulations are less stringent.

The chemicals used to create computer parts have resulted in 29 superfund sites in Silicon Valley, the most concentrated number of superfund spots in America. At the Advanced Micro Devices superfund site in Sunnyvale, California, chemicals are in the groundwater and soil that can cause death, cancer, brain and central nervous system damage, leukemia, anemia, convulsions, nausea, unconsciousness. The zinc and copper at this site are toxic to plants, ruining what were once some of the best orchards in the world.

The need to go where costs are lowest is driven by the enormous amount of money it takes to build a mega-size wafer fabrication plants -- nearly ten billion dollars.27

Part of this amount is due to very high insurance costs. In 1997, an Hsinchu Taiwan fabrication plant had a fire that caused $421 million dollars in smoke and water damage.

Business interruptions can cost a fabrication plant 20-30 million dollars in lost revenue. For instance, a plant that had a four-hour long electricity outage had to spend the next four days recalibrating their equipment, resulting in a $5 million dollar loss. Insurance companies have responded with huge deductibles and capped the loss amounts.28

As unexpected energy shortages and outages grow more common in the future, this will wreak havoc on microprocessor production.

Outsourced products are delivered just-in-time to the factory assembly. According to Barry C. Lynn, “Our corporations have built a global production system that is so complex, geared so tightly, and leveraged so finely, that a breakdown anywhere increasingly means a breakdown everywhere, much in the way that a small perturbation in the electricity grid in Ohio tripped the great North American blackout of August 2003”.29

Less major blows to assembly lines have come from strikes, SARS, fires, explosions, and manufacturing mistakes, such as the ones that resulted in Chiron’s failure to deliver half of the American flu vaccine. Fortunately, the impacts so far have been temporary and regional. But it’s not hard to imagine events that could result in worldwide disruptions leading to a global depression.

United States Infrastructure

While the EROI of oil was high, we built a vast infrastructure to deliver clean water, treat sewage, built roads, bridges, dams, and so on. Any non-fossil fuel type of energy will have a great deal of work just maintaining the existing infrastructure.

…Consider just the drinking water infrastructure, the main reason our life spans have increased so much.23 In this century, all of the 600,000 miles of pipes delivering clean water to homes will need to be replaced. Every component of the water system is aging. The energy required to replace or maintain thousands of treatment plants, pumping stations, reservoirs and dams over the next century is staggering.24

...And consider the energy required to deliver the water. According to Allan Hoffman, “Energy is required to lift water from depth in aquifers, pump water through canals and pipes, control water flow and treat waste water, and desalinate brackish or sea water. Globally, commercial energy consumed for delivering water is more than 26 Quads, 7% of total world consumption”.25

Energy shortages for instance. Already many businesses in the chemical, agricultural, steel, glass, and other industries have failed or are in pain from high natural gas prices in America.30 31 32 When enough key suppliers of infrastructure components fail, this will stop the downstream assembly line. Suppliers might also go out of business because of economic failure in the manufacturing country, civil or regional wars, and extreme weather.

Despite the risk, single-sourcing occurs because cutting costs is how you stay in business, so the cheapest supplier wins the race to the bottom. Corporations have gone cuckoo with outsourcing; letting suppliers located in potentially shaky political and economic countries hatch their nest eggs.

When the fledglings hatch they often fly on Fed Ex, which is so reliable it seems as if the supplier were on the other side of town instead of across the world. But the airline industry is reeling from higher energy prices, so it’s possible that the intricate, just-in-time, high-speed aircraft delivery of electronic gear will shift to ships, a much slower, less predictable way to deliver cargo “just-in-time”.

Most products traded globally travel by sea. Over 50,000 large ships carry 80 percent of the worlds’ cargo. Shipping faces critical challenges in the future.

Oil and LNG tankers are increasingly failing from corrosion. Over 2400 tankers split up or nearly did so from 1995 to 2001 according to the International Association of Independent Tanker Owners.33

…Continued global trade at current levels cannot be sustained as energy declines. At some point global trade will lessen due to a combination of declining fossil fuels, piracy, terrorism, energy shocks, pandemics, natural disasters, political turmoil, global depression, and a shortage of large, non-oil based vessels.

Global trade will not disappear, since moving freight over water is very efficient, but there will be several discontinuities as declining energy forces us to roll backwards though history.

Most cargo is shipped on enormous container vessels that can be over 1100 feet long with ten thousand containers stacked many stories high.

The first discontinuity will come when we have to retrofit ships to run on coal, and set up coal stations and tenders all over the world.

The second discontinuity will occur when coal gets scarce and container ships are moved by wind power (if this is even possible), with liquid fossil fuel only used when entering and leaving ports. A further step down will happen when it’s too energy-intensive to keep harbors dredged deep enough accommodate large container ships. It’s already very tricky getting these large ships into port, a local pilot is brought in and complex computer systems are used to delicately park these gargantuan ships along the wharf.43 These huge ships would have to remain offshore and unloaded to smaller ships, if that is possible, since they weren’t designed for this.

The third discontinuity will come when containerization can no longer be supported due to lack of fuel and/or electricity for cranes, trucks, and trains. Containerization revolutionized the amount of cargo and the swiftness with which it could be loaded and delivered from origin to destination by orders of magnitude over earlier forms of transportation.

The final discontinuity will come when ships need to be built from wood, because the remaining mineral ore is too low quality and energy-intensive to process, and when we can no longer recycle the rusted and dispersed iron and steel.

Whether “Peak Oil” reflects actual short-sighted over-exploitation of a limited resource or a deliberate strategy of elites without conscience creating shortages to establish control and increase the suffering of others, our society is frighteningly vulnerable to its effects.

Monday, August 14, 2006

Signs of the Economic Apocalypse, 8-14-06

From Signs of the Times, 8-14-06:

Gold closed at 642.40 dollars an ounce on Friday, down 2.4% from $658.10 at the close of the previous Friday. The dollar closed at 0.7855 euros last week, up 1.2% from 0.7765 euros at the end of the previous week. That puts the euro at 1.2732 dollars compared to 1.2878 at the close of the Friday before. Gold in euros, then, would be 504.56, down 1.3% from 511.03 for the week. Oil closed at 74.30 dollars a barrel Friday, down 0.4% from $74.57 at the close of the previous Friday. Oil in euros would be 58.36 euros a barrel, up 0.8% from 57.90 for the week. The gold/oil ratio closed at 8.64 Friday, down 2.5% from 8.43 at the close of the previous week. In the U.S. stock market, the Dow closed at 11,088.03 Friday, down 1.4% from 11,240.35 at the close of the Friday before. The NASDAQ closed at 2,057.71 Friday, down 1.3% from 2,085.05 for the week. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.97%, up eight basis points from 4.89 for the week.

The markets were fairly steady again last week, when the world situation was anything but steady:
Financial markets weather global turmoil
by Ben Perry
Sun Aug 13, 4:25 AM ET

AFP - Global financial markets are seeing limited reactions to geopolitical jitters as investors become used to events such as the alleged plot to destroy US-bound passenger planes, analysts say.

Markets recovered Friday after being rattled by news that police had foiled a scheme to blow up jets flying from Britain to the United States.

Investor sentiment also recovered quickly this year following sharp price movements caused by Iran's nuclear programme and violence in the Middle East.

"Financial markets are aware of the risk associated with geopolitical tension," said Jeremy Batstone, director of private client research at Charles Stanley stockbrokers, in the wake of the latest scare.

The thwarted bomb plot "wasn't an attack on the financial system, it was a commercial target. The financial market's behaviour was appropriate".

Batstone added, however, that had planes been destroyed, the consequences would have been "horrific" for trading sentiment.

World oil prices tumbled more than two dollars a barrel Thursday on forecasts that air traffic could suffer.

"I think that was a knee-jerk reaction of the market," said Victor Shum, a Singapore-based analyst with energy consultancy Purvin and Gertz.

Crude futures recovered Friday in New York and London and the International Energy Agency (IEA) said fresh geopolitical tension could send oil prices even higher.

Oil prices which hit a record high 78.64 dollars per barrel in London on Monday are widely regarded as a key barometer of the global economy because they impact equity, foreign exchange and commodity markets.

In its latest monthly report, the IEA said Friday that disruptions to oil supplies, the threat of platform damage from hurricanes, turmoil in the Middle East and concern over Iran presented a tight picture for the crude market.

But "scratch below the surface ... and these geopolitical and supply issues are less defining for the oil market than they appear", it added.

European stock markets tumbled Thursday as well, hammering share prices across the airline sector.

British Airways closed down 5.0 percent as the airline cancelled most short-haul flights departing from its hub at London's Heathrow airport.

Air France-KLM and German carrier Lufthansa both finished more than three percent lower on Thursday, but Air France-KLM recovered slightly on Friday.

"It's worth remembering that markets tend to be pretty resilient," said Henk Potts, equity strategist at Barclays Stockbrokers.

"When we have seen events in the past, such as the London attacks (on July 7, 2005), stocks have bounced back."

Wall Street shares actually gained ground on Thursday even though US airline stocks came in for a rocky ride.

On currency markets, the pound dropped on news of the Britain-US bomb scare but the dollar climbed on better-than-expected US trade data for June.

"The markets anticipate terrorist threats these days," said Steven Saywell, a currency analyst with US group Citibank.

"The initial September 11 attack was the first of its kind and the market did not know what the outcome would be," he said in reference to the 2001 strikes on the United States.

"But now there is now a much more muted response to these attacks."

The price of gold, which traditionally benefits from safe-haven status in times in geopolitical instability, steadied as police updated media on the latest terror probe.

Contained wars can be “good” for the markets, stimulating profits in corporations located far from the fighting. It is hard to see how an uncontained, global conflagration can be any good, though. But the “cease fire” announced (but not implemented) late last week gave hope to the markets that the Middle East wars will remain contained.

But looking only at “markets” obscures the larger economic significance of the events. To see that, it can help to look at events in terms of imperial competition to secure natural resources and control over cheap labor. Among those who see the wars in the Middle East as essentially imperial wars, wars to secure power and wealth, there is some dispute as to whether the United States or Israel is in the driver’s seat. Bill Van Auken argues that the United States, as the leading power in world capitalism, is:
Bush’s “strategy” is to widen the wars for “regime change” in the Middle East that began with the toppling of Saddam Hussein in Iraq. When the American president—whose closest allies in the region are the police state regimes and absolutist monarchies of Egypt, Saudi Arabia and Jordan—uses the words “freedom” and “liberty,” he is talking about the freedom of American banks and corporations to exercise exclusive domination over Middle East and its oil wealth.

Facing a catastrophe in its occupation of Iraq (with thousands of US forces now being sent back into Baghdad to resecure the capital and confront its restive Shiite population), the Bush administration has decided that the solution is not to withdraw, but rather to launch new wars, not only in Lebanon, but ultimately against Syria and Iran.

There is undoubtedly an element of madness in this strategy of escalating militarism, but this is not merely the lunacy of America’s dim-witted president and his advisors. Rather, it reflects an irrational social system based on private ownership of the planet’s productive forces and vital resources and the division of a globally integrated world economy into rival nation states.

US policy is essentially to utilize its military power to assert domination over the oil resources of the Middle East and Central Asia, and thereby assure American capitalism both a secure energy supply and the ability to dictate terms to its economic rivals.

The turn to escalating militarism is also driven by the profound internal contradictions of American society, dominated by an unprecedented polarization between a wealthy elite and the masses of working people, and faced with a growing prospect of economic slump combined with rising inflation—a recipe for social explosions.

A military attack on Syria and Iran has the gravest implications. With US military forces already stretched to the limit by the failing imperialist adventure in Iraq, a new war will inevitably bring with it the reinstitution of the draft, forcing American young people to serve as cannon fodder for the conquest of Iranian oil fields.

Moreover, a war against Iran has the most deadly implications. A US attack would provoke an Iranian response against Israel, and, in turn, a possible nuclear retaliation by Israel. The path now being taken by US imperialism leads to the death of millions.

The carnage in Lebanon has demonstrated that there exists no genuine political opposition to this turn towards global warfare within the US political establishment, with the ostensible opposition party, the Democrats, seeking to outdo the Republicans in their support for Israel. At the same time, the draft resolution produced by the US and France makes it clear, once again, that the European bourgeoisie is incapable of mounting any opposition to US militarism, and that the UN itself serves only as a tool for imperialist policy.

Mike Whitney, on the other hand, sees the Israeli aggression against Lebanon as an attempt to establish Israel as at least an imperial equal to the United States:

Israel, oil and the "planned demolition" of Lebanon
Mike Whitney

Online Journal Contributing Writer

Aug 8, 2006

…The media portrayal of the current conflict is blatantly absurd. It has nothing to due with “captured soldiers” or Israel’s “right to defend itself.” This is a traditional war with clear territorial and political objectives. The border controversy is nonsense. Israel is trying to seize more land to realize its vision of “Greater Israel,” while reducing an adjacent Arab country to a “permanent state of colonial dependency.”

This explains the vast and deliberate destruction to Lebanon’s civilian infrastructure. Israel’s dominance requires that its neighbors endure abject poverty and oppression. By destroying the infrastructure and life-support systems, Israel hopes to eliminate the rise of a potential rival as well as to diminish the ability of the Lebanese resistance to wage war against the Jewish state. Once Lebanon is decimated, it will be delivered to Zionists at the World Bank (Paul Wolfowitz) who will apply the shackle of reconstruction loans and structural readjustment, which will keep Lebanon as an indentured servant to the global banking establishment. This model of economic servitude has been used throughout the developing world with varying degrees of success. It anticipates Israel’s regional ascendancy while ensuring that Lebanon’s sovereignty will be compromised for decades to come.

The United States has played a unique role in Israel’s war on Lebanon. In its 230-year history, the US has never deliberately assisted in an attack on an ally. That record will end with Lebanon.

Lebanon's was a demonstrably “pro-American” government on friendly terms with Washington. In fact, American NGOs and intelligence organizations helped to activate the “Cedar Revolution,” which gave rise to the Fouad Siniora government and the eventual expulsion of Syrian troops. To a large extent, Washington and Tel Aviv had achieved what they wanted to by meddling in Lebanon’s political affairs. The country was singled out as a shining example of Bush’s “global democratic revolution,” which was the stated goal of American intervention in the Middle East.

Lebanon has since been rewarded for its cooperation by the total obliteration of its economy and infrastructure. The Bush administration has abandoned any pretense of being an “honest broker” and is now providing Israel with precision-guided missiles to prosecute a war against a (mainly) civilian population. They are also actively collaborating with the Olmert regime to foil all plans for an immediate cease-fire. The United States is a fully engaged partner in the premeditated destruction of a democratic country. It is as much a part of the Israeli aggression as any IDF tank commander rumbling towards Beirut.

The United Nations has been sidelined by the administration’s obstructionism at the Security Council. The efforts of the Bolton-Rice team are tantamount to a “declaration of war.” So far, the Israeli offensive has uprooted nearly 1 million people in the south; making refugees of approximately 25 percent of Lebanon’s total population. The UN has done nothing to respond to this calamity. Its ineffectiveness casts doubt on whether it will survive the present crisis. Security in the new century will ultimately depend on alliances between the individual countries. The UN model of one, monolithic international institution trying to "preserve the peace” has proved to be a wretched failure.

The scene in the south of Lebanon is hauntingly similar to the ethnic cleansing of Palestinians in 1948; the Nakba. Once again, Israel is seen driving Muslims from their homes in an attempt to expand its territory. The “deliberate” attack on Qana, which killed 57 civilians, as well as the bombing of clearly marked ambulances and “white flag-waving” mini-buses chock-full of fleeing villagers, shows that the Israeli high-command still understands the importance of using terror as a means of controlling behavior. Israel’s carefully calculated atrocities have had the desired effect; triggering the mass-exodus of hundreds of thousands of frightened civilians and leaving Hezbollah guerillas to fight it out with the IDF.

The Bush administration is now attempting to pacify its critics by pushing a resolution that calls for a “full cessation of hostilities.” The resolution does not demand that Israel stop attacking Hezbollah nor does it require the IDF to leave Lebanon. It is Munich all over again; a miserable “sell-out” by the Security Council that guarantees a steady increase in the violence as well as an intensification of the rage that is sweeping across the Muslim world. The UN has unwittingly endorsed Israeli occupation of southern Lebanon and created the foundation for another generation of terrorists. The resolution shows that the UN is nothing more than a “cat’s paw” for US/Israeli geopolitical ambitions and that the “post-colonial” European allies are willing to succumb to the neocon plan for a “New Middle East…”

What does Israel want?

The only way that Israel can maintain its dominance in the region is by becoming a main-player in the oil-trade. Otherwise it will continue to be dependent on the United States to strengthen its military and defend its interests. Israel’s determination to “stand on its own two feet” is outlined in the neocon plan for “rebuilding Zionism” in the 21st century; “A Clean Break: A New Strategy for Securing the Realm.” The document is the blueprint for redrawing the map of the Middle East and eliminating rivals to Israeli power. Most of the attention has been focused on the parts of the paper which presage the attacks on Iraq, Lebanon and Syria; including this ominous passage:

Securing the Northern Border:

Syria challenges Israel on Lebanese soil. An effective approach, and one with which America can sympathize, would be if Israel seized the strategic initiative along its northern borders by engaging Hezbollah, Syria, and Iran, as the principle agents of aggression in Lebanon, including by:

· paralleling Syria’s behavior by establishing the precedent that Syria is not immune to attacks emanating from Lebanon by Israeli proxy forces.

· striking Syrian military targets in Lebanon, and should that prove to be insufficient, string at select targets in Syria proper.” (“A Clean Break”; Richard Perle, Douglas Feith, David Wurmser)

Clearly, this is the basic schema for US/Israeli aggression in the region. What has been overlooked, however, is Israel’s determination to “break away” from its traditional dependence on American support.

As stated in the text: (Israel intends to) “forge a new basis for relations with the US -- stressing self-reliance, maturity, strategic cooperation on areas of mutual concern, and furthering values inherent to the West. This can only be done if Israel takes serious steps to terminate aid, which prevents economic reform. Israel can make a clean-break from the past and establish a new vision for the US-Israeli partnership based on self-reliance, maturity, and mutuality -- not one narrowly focused on territorial disputes. (Israel) does not need US troops in any capacity to defend it . . . and can manage its own affairs. Such self-reliance will grant Israel greater freedom of action and remove a significant lever of pressure used against it in the past. . . . No amount of weapons or victories will grant Israel the peace it seeks. When Israel is on sound footing, and is free, powerful, and healthy internally, it will no longer simply manage the Arab-Israeli conflict; it will transcend it.”

Israel’s “economic freedom” depends in large part on its ability to become a central petroleum-depot for the global oil trade. In Michel Chossudovsky’s recent article “Triple Alliance: US, Turkey, Israel and the War on Lebanon,” the author provides a detailed account of the alliances and agreements which underscore the current war. As Chossudovsky says, “We are not dealing with a limited conflict between the Israeli Armed Forces and Hezbollah as conveyed by the Western media. The Lebanese War Theater is part of a broader US military agenda, which encompasses a region extending from the Eastern Mediterranean into the heartland of Central Asia. The war on Lebanon must be viewed as ‘a stage’ in this broader ‘military road map.’”

Chossudovsky shows how the recently completed Baku-Tblisi-Ceyhan pipeline has strengthened the Israel-Turkey alliance and foreshadows an attempt to establish “military control over a coastal corridor extending from the Israeli-Lebanese border to the East Mediterranean border between Syria and Turkey.”
Lebanese sovereignty is one of the unfortunate casualties of this Israel-Turkey strategy.

Most of the oil from the Baku-Tblisi-Ceyhan pipeline will be transported to western markets but, what is less well-known, is that a percentage of the oil will be diverted through a “proposed” Ceyhan-Ashkelon pipeline which will connect Israel directly to rich deposits in the Caspian. This will allow Israel to supply markets in the Far East from its port at Eilat on the Red Sea. It is an ambitious plan that ensures that Israel will be a critical part of the global energy distribution system. (See Michel Chossudovsky, The war on Lebanon and the Battle for Oil, July 2006)

Oil is also a major factor in the calls for “regime change” in Syria. An article in the UK Observer “Israel Seeks Pipeline for Iraqi Oil” notes that Washington and Tel Aviv are hammering out the details for a pipeline that will run through Syria and “create and endless and easily accessible source of cheap oil for the US guaranteed by reliable allies other than Saudi Arabia.” The pipeline “would transform economic power in the region, bringing revenue to the new US-dominated Iraq, cutting out Syria, and solving Israel’s energy crisis at a stroke.”

The Israeli Mossad is already operating in northern Iraq where the pipeline will originate and have developed good relations with the Kurds. The only remaining obstacle is the current Syrian regime which has already entered the US/Israeli crosshairs. The Observer quotes a CIA official who said, “It has long been a dream of a powerful section of the people now driving this administration and the war in Iraq to safeguard Israel’s energy supply as well as that of the US. The Haifa pipeline was something that existed, was resurrected as a dream, and is now a viable project -- albeit with a lot of building to do.”

Former US Ambassador James Atkins added, “This is a new world order now. This is what things look like particularly if we wipe out Syria. It just goes to show that it is all about oil, for the United States and its ally.”

The Middle East is being reshaped according to the ideological aspirations of Zionists and the exigencies of a viciously-competitive energy market. Behind the bombed-out ruins of Qana and the endless sorties laying Lebanon to waste, are the tireless machinations of the energy giants, the corporate media, the banking establishment and Israel.

Don’t expect a quick return to peace. This war is just beginning.

Regardless of who is driving, especially since it is essentially the same group controlling both Israel and the United States, the aggressive moves of both of these powers obscure the fact that both of them are losing wars. Losing wars is never a sign of a rising imperial power. Since Great Britain and the United States have dominated world financial system for two centuries, an end to that system will provide a test to see how truly “global” world markets really are. Does it still matter to the multinational corporations which currency dominates the world? Does it even matter to the wealthy in any country? We shall see.

In the meantime, the weaknesses of the U.S. economy become more apparent. The economist Nouriel Roubini sees a bad recession in the United States in 2007:
The Next Move by the Fed Will be a Cut, Not a Hike, as the US Slips into a Recession...

Nouriel Roubini
Aug 09, 2006

As I pointed out in my previous blog, markets and investors are behind the curve in terms of their views of what the Fed will do next. The debate and commentary among markets, bloggers and investors – based on yesterday’s FOMC statement – is still on the question of whether the Fed will keep its pause in the fall or whether – given rising inflation – it will tighten again some time in 2006. The reality is that the next move of the Fed will be an easing - i.e. a cut in the Fed Funds rate - not a tightening, most likely in the fall or winter of this year.

My out-of-consensus call for the next Fed move to be an easing – rather than a hike - is based on a simple point: the U.S. economy is headed towards a sharp recession by early 2007 . Thus, while most commentators are still pondering and stressing the alleged “tightening bias” in yesterday’s FOMC statement, it is because they are still deluding themselves that the economy will face a soft landing; unfortunately the landing will be hard and ugly with a severe recession. Thus, unless core inflation sharply rises (as it could if oil goes sharply higher from here), there is only one choice and direction for the Fed ahead: to cut the Fed Funds rate as soon as there are strong signals that the economy is spinning into a recession. Such recession signals would – with one caveat – certainly lead to a cut in the Fed Funds rate as – unless stagflationary effects of higher oil become much larger – the inflation rate will tend to fall in the coming recession as demand falls, the unemployment rate goes up and wage growth slows down once workers lose jobs.

The only caveat to this easing call is a nightmare scenario where you have true stagflation, rather than stagflation-lite: i.e. a scenario where oil price keep on rising and get into core inflation via second and third round effects while the economy is spinning into a sharp recession. I.e. you need the anti-inflationary forces of lower demand and higher unemployment to be weaker than the inflationary forces of geopolitical shocks bringing oil prices higher (as non-energy commodity prices will start to fall sharply as soon as the U.S. recession trend is evident) for inflation to significantly rise in the coming recession.

Could this true stagflation (inflation sharply up while growth goes to zero and then negative) occur? It is possible only if geopolitics (tensions with Iran, a worsening security situation in Iraq, a wider Middle East conflict, a worsening civil war in Nigeria, a greater confrontation with Chavez) or “nature” (a major Katrina-style hurricane, even worse pipeline problems in Alaska or somewhere else, another workers’ strike in the North Sea) lead to sharply higher oil prices. During recessions, usually prices for energy and non-energy commodities sharply fall (as both demand and supply are price inelastic); but while a US recession and global slowdown will sharply hit non-energy commodity prices, energy prices may remain close to current levels – rather than sharply fall – if geopolitics or “nature” causes another supply shock.

But barring such a major oil supply shock, as the economy spins into a recession, inflationary pressures will dampen over time (with a possible lag given the inflation pressures in the pipeline) and the Fed will get into a panic mode of having realized that it overreacted - with excessive tightening until now - and will thus cut rates. This is the same pattern that we observed in 2000-2001. Then, the Fed expected a soft landing and paused in June 2000 six months before the onset of the recession. But the tech bust led to a growth slump and then recession – like the housing bust will now lead to a recession – and, once the Fed realized too late at Christmas in 2000, that the recession was coming it started to cut the Fed Funds rate – in between FOMC meetings – as early January 2001. This Fed Fund aggressive easing in 2001 did not prevent the mounting recession; and the Fed easing this fall or winter will – similarly - not prevent the coming US recession.

…So, leading Fed watcher John Berry – citing my recession call and that of DeLong – says today that no one at the Fed is yet worried about a recession. But Fed officials are much more worried about the recession risk than they are claiming or admitting in public. The simple proof: why would the Fed ever pause, as it did yesterday, when all inflationary signals and pressures are mounting (headline, every measure of core, wage growth, falling productivity growth, sharply rising unit labor cost, oil, commodities, you name it)?

Why? The only and simple answer is: they are starting to get scared of the coming recession. Their official argument or excuse for the pause is, of course, that the delayed effects of previous tightening that are in the pipeline and the slowing economy will lead to a slowdown in inflation. But investors should read more carefully the FOMC statement. I have been speaking for the last 8 months of the Three Ugly Bears of slumping housing, high oil prices and the delayed effects of rising interest rates triggering a recession. And yesterday the FOMC endorsed the Three Bears view by stating: “Economic growth has moderated from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.?” Three Bears! Is that plain English clear or what?

Then, the Fed also added: “inflation pressures seem likely to moderate over time, reflecting contained inflation expectations and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.” So, lagged monetary policy will slow down the economy by pushing demand down and unemployment up thus leading to lower inflation; and, on top of the “other factors restraining aggregate demand” will slow down inflation. What are those factors? In Q2 a fall in residential housing, a fall in consumption of durables, a fall in real investment in software and equipment, an increase in inventories as demand slows relative to output. And, as the Fed says, these forces will be stronger ahead: in fact, if these anti-inflationary forces did not prevent a rise in inflation in Q2, the Fed must believe that the fall in durables consumption, in housing, in non-residential investment and in other components of aggregate demand will be larger in H2 than in H1 to trigger the fall in investment. The Fed is telling you that it expects demand to slow further – regardless of the effects of past monetary tightening – and thus lead to lower inflation. Since any basic macro model – say the well respected model of Larry Meyer’s Macroeconomic Advisers that is closely followed by the Fed - tells you that only a significant increase in the unemployment rate will stabilize and then reduce core and headline inflation, if the Fed truly believes that inflation will peak and stabilize or fall in H2 or by early 2007 it must also believe that the growth slowdown will be much more severe than it is admitting it in public. So, there are only two options: either the Fed does not believe that inflation will stabilize in which case it is pausing now because it is already panicky about the recession; or, if it truly believes its own forecast of slowing inflation, it must be expecting a sharp economic slowdown, a much sharper one than the Bernanke forecast or the Fed forecast of a soft landing.

Indeed, Berry, after citing my views on the risks of a recession said: “Well, Fed officials recognize there are substantial risks ahead, particularly given the pressure of high energy prices on both inflation and consumer spending. None of them is expressing concern that a recession is likely.” So, while Fed officials may not believe that a recession is likely, they are not excluding - now in public via the mouthpiece of the only Fed watcher who is a true FOMC insider – that there are “substantial risks” to the growth outlook. Is that clear? Substantial risks…Also, as Berry put it: “Nevertheless, Fed officials are generally sticking by their collective forecasts of slower, but still solid, growth in the second half of the year, though they have to be somewhat troubled by the unexpected dip in business investment in new equipment and software in the second quarter.” So, again, Fed officials are troubled that non-residential investment that was supposed to pick up and sustain aggregate demand at the time when housing is falling and consumption growth is slowing, is instead headed south. This fall in non-residential investment is not a surprise, as I have argued before: corporations are flush with cash and profits but they do not see any good real investment opportunities as there is excess capacity and as demand is now slumping. Thus, the unprecedented share buyback bonanza – the biggest in US history - which we are now experiencing proves that firms do not have any good productive investment use for all the profits they have; and they are thus returning these profits to shareholders. Of all bearish signals in the economy, this investment slump and buyback bonanza is one of the strongest leading indicators of the coming recession.

It is true that the Fed has kept a formal tightening bias by suggesting that additional firming of the Fed Funds rate cannot be ruled out given current inflationary pressure; but it clearly stated that “extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.” So, the Fed is fully data dependent. And this means that if the economy slows down more than expected, there will be no firming and a pause that becomes a stop may end up being a cut. The risks are clearly balanced now in the Fed view: there are downward risks to growth and upward risks to inflation that, in the Fed view, will be moderated by the economic slowdown.

In conclusion: investors are still behind the curve debating whether the FOMC statement suggests a further hike sometime in the fall. The reality is different: the next move of the Fed will be easing, most likely in the fall when the signals of a recession become too self-evident for the Fed to ignore them. The only thing that could prevent a Fed Funds rate cut (and lead the Fed to keep a pause or even hike) or postpone the cut into 2007 is a sharp spike in core and actual inflation driven by a further oil shock or a build-up of domestic inflationary forces. But that would be a true nightmare scenario for the Fed and for the economy: a recession with a sharply rising inflation. Then, if the Fed lost control of the inflationary process, it may well be forced to hike even during an ongoing recession. But this scenario is, still, highly unlikely. The most likely scenarios is a slowdown and recession that cools down inflationary pressures (or, at least, does not stoke them further) and forces the Fed to cut the Fed Funds rate. But, as I have persistently argued, even such Fed ease will not prevent the coming recession. The recession boat has left the harbor and there is very little the Fed can do to prevent it. In 2000 the Fed failed to achieve a soft landing; this year we will get the same pattern as in 2000-2001 but a much harder landing than in the previous recession.

Roubini may be too optimistic about avoiding stagflation (the “true nightmare scenario”). What he wrote about it above seems only too likely:
Could this true stagflation (inflation sharply up while growth goes to zero and then negative) occur? It is possible only if geopolitics (tensions with Iran, a worsening security situation in Iraq, a wider Middle East conflict, a worsening civil war in Nigeria, a greater confrontation with Chavez) or “nature” (a major Katrina-style hurricane, even worse pipeline problems in Alaska or somewhere else, another workers’ strike in the North Sea) lead to sharply higher oil prices.

The following piece in the New York Times last week has a sample of views on the “soft landing” issue:
Economy Often Defies Soft Landing

By Edmund L. Andrews

WASHINGTON, Aug. 10 — In the cool and quiet marble corridors of the Federal Reserve, the strategy for taming inflation sounds painless, even soothing: a “soft landing” for the economy after several years of flying high.

As the central bank contended on Tuesday, when it decided to pause in its two-year effort to raise interest rates, inflation is “elevated” right now but will begin to decline because economic growth is poised for a modest slowdown.

Many economists, though, warn that the soft landing may seem anything but soft, and suggest that the Fed is either too rosy about the looming slowdown or naïve about the difficulty of reaching its goal for inflation.

In practice, the Fed has achieved only one true soft landing — in 1994-95, when, under the leadership of Alan Greenspan, it was able to slow the economy enough to cool spending and ease inflation pressure but not so much as to cause a big jump in unemployment. But even Mr. Greenspan, whose ability to fine-tune policy made him famous, presided over two formal recessions, in 1991 and in 2001.

This time, many analysts say that the Fed and its new chairman, Ben S. Bernanke, face considerably tougher challenges. Crude oil, at more than $70 a barrel, is selling at prices that would have been unthinkable in 1995. Productivity growth, which was accelerating in 1995, is slowing these days. The dollar, which was climbing against other major currencies in 1995, is declining against most of them now.

Analysts and other experts say that if Mr. Bernanke is serious about his goals for controlling inflation, at least two million more workers may have to lose their jobs over the next two years.

“The economic slowdown has to be much more substantial than anybody in the Federal Reserve or on Wall Street is expecting,” said Robert J. Gordon, a professor of economics at Northwestern University, who has analyzed the trade-off between inflation and unemployment for the last several decades.

Mr. Bernanke and other Fed officials say they want to keep core inflation, the main measure of retail prices excluding energy and food, below 2 percent a year. But core inflation is already 2.9 percent and almost certain to climb as the cost of oil pushes up prices for items as diverse as air fares and plastics.

Mr. Gordon said the last few decades had shown a grim but consistent trade-off: to reduce inflation by one percentage point, the unemployment rate has to rise by about two percentage points for a full year.

To reduce inflation to the upper limits of what Mr. Bernanke and other Fed officials consider acceptable, more than three million jobs would be lost, a bigger drop than in the recession of 2001.

And that is Mr. Gordon’s relatively upbeat hypothesis, which assumes no other shocks to the economy — no additional increases in energy prices, no collapse in the dollar’s value, no collapse in housing.

“I think the Fed is facing an absolutely classic case of stagflation,” Mr. Gordon said, “a situation in which they cannot win.”

He is not alone. Many other economists contend that inflation is more entrenched and will be more painful to reverse than the Fed thinks. Others predict that inflation will indeed subside, but only because the economy will weaken much more than the Fed is expecting.

The chief forecaster at Decision Economics, Allen Sinai, said unemployment would have to rise to at least 5.5 percent, from 4.8 percent today, putting a million more people out of work, before inflation begins to decline.

The chairman of Roubini Global Economics Monitor, Nouriel Roubini, predicted that the economy would fall into a recession early in 2007 as a result of high energy prices, higher interest rates and a housing collapse.

“Either the Fed does not believe its own inflation forecast, which I don’t think is the case,” Mr. Roubini said, “or the slowdown is going to be greater than what they have been saying. They can’t have it both ways.”

To be sure, economists differ on how weak the economy already is or how severe inflation pressure is. And skepticism abounds on the chances of achieving a true soft landing.

The very idea of such a thing is only about a decade old. It was conceived by Mr. Greenspan, then the Fed chairman, as a way to attack inflation before it started, by shrewdly using the levers of monetary policy to slow the economy just enough to keep it from overheating.

Mr. Greenspan’s greatest success was in the mid-1990’s, when the economy had been expanding for nearly four years. Though inflation was declining and was lower than it is today, the Fed doubled short-term interest rates, to 6 percent from 3 percent, in just over a year.

At the time, the result seemed neither soft nor smooth. Several financial institutions, caught by surprise, found themselves in big trouble. The economy slowed for a while, and unemployment edged up.

But by 1996, the economy was rapidly growing again and the nation enjoyed several years of booming stock markets, falling unemployment and relatively low inflation.

The success, along with Mr. Greenspan’s growing aura as a wizard of monetary nimbleness, prompted the Fed to step in and help soften the blows of the Asian financial crisis of 1997-98, the stock market collapse of 2000, the recession of 2001 and the surge of unemployment that followed.

He failed in preventing the 2001 recession, but the Fed cut interest rates so deeply that this started a boom in housing prices and home refinancing that kept consumers spending even as incomes stagnated and unemployment moved higher.

Laurence H. Meyer, a former Fed governor and now a chief forecaster at Macroeconomic Advisers, said Mr. Bernanke needed to do more than simply duplicate Mr. Greenspan’s one soft landing.

Mr. Greenspan was not trying to reduce inflation, but merely to keep it from going up. Mr. Bernanke, by contrast, is trying to reduce it substantially.

…“Soft landings are much more frequent in forecasts than in real life,” Mr. Meyer said. “With a computer, I can give you a soft landing if you give me 10 or 20 runs. But in real life, you only have one run.”

Uncertainties and disagreement among experts about the economy’s direction are now unusually high.
A big uncertainty is whether the nation is near full employment.

Many economists contend that the country is essentially at full employment, meaning that additional demand for workers will tend to push up wages. Because wages account for more than three-quarters of total production costs, Fed officials view them as inflationary if they rise significantly faster than productivity.

Specialists like Mr. Gordon at Northwestern and Mr. Meyer maintain that the labor market is already very tight and predict that wages will soon start to push up inflation.

But others disagree, arguing that wages over the last five years have lagged behind increases in productivity and have barely kept up with inflation. The bigger risk, according to that school of thought, is to make the situation worse by driving up unemployment.

“We have no clue about labor market tightness right now,” said J. Bradford De Long, a professor of economics at the University of California, Berkeley, who argues that workers still have little bargaining power.

Depending on one’s perspective, Mr. De Long said, the Fed’s attempt at a soft landing is either a display of cool-headed technocracy or murky witchcraft.
Right now, he said, “this is on the witchcraft side.”