How Sustainable is the U.S. Recovery?

Guest Post by Stefan Karlsson. Stefan is an economist based in Sweden. See his blog here, and more of his articles on here.

How sustainable is the U.S economic recovery? Before I make a more definite statement on the subject, I’ll have to look at the data released later this week. But given what we know now, it appears to be very weak and vulnerable.

First of all, the durable goods order report indicated weakening investment demand, considering both the negative monthly change and the downward revision of previous numbers.

Secondly, the Chicago Fed National Activity Index showed continued contraction in August.

And both the existing and new home sales reports were disappointing.

The one positive report was the retail sales number which showed strong growth. Because of that, it is highly likely that notwithstanding the above numbers, GDP growth was positive in Q3 2009-at least compared to the previous quarter and not adjusting for terms of trade effects.

However, that gain was largely built on people taking advantage of the “cash for clunkers”-scheme. But since that is a temporary scheme, there will likely be a hangover in the form of lower sales later.

In short, current data suggests that the risk of a “double dip” recession is very high.

Visit Stefan’s blog here.

Blast-Off: Flatulent bull gores Madoff

What You See Might Not Be Real by Chen Wenling. Apparently the horned man represents Bernie Madoff, and the bull is Wall Street. This bizarre and huge sculpture is on display in Bejing.


There’s been speculation about the Madoff figure, and whether his horns are an anti-semetic statement. I have no idea. Maybe it is, or it could be an unrelated part of Chinese mythology, or an adaptation of Western demons. With all the press this piece is getting, it’ll be interesting to see if the artist responds.

Image via BBC.

Hurting for Jobs

The ratio of unemployed people to available-jobs hits an all-time high. The NYT offers this chart:


Job seekers now outnumber openings six to one, the worst ratio since the government began tracking open positions in 2000. According to the Labor Department’s latest numbers, from July, only 2.4 million full-time permanent jobs were open, with 14.5 million people officially unemployed.

Barry Ritzholtz has been all over this for months. Found this chart via his blog.

Is Curbing Bank Pay Socialist or Capitalist?

There are two arguments for curbing pay on Wall Street. The two sides argue bankers should not receive such huge compensation because:

  1. Socialist view: No individual should be allowed to earn such a disproportionate salary.
  2. Capitalist view: Government intervention allows banks to be so profitable, at cost to other members of society.

Bank apologists always attack the socialist (straw man) argument. Labeling something as “socialist” is a lot easier than addressing the real issues. “Fine, that’s just fine!”, they say. “But I hope you like communism, cause we’re gonna have to cap everyone’s salary – Bill Gates, A-Rod, Britney Spears, and Steve Jobs.”

Only the capitalists’ case holds water. While using artificial “curbs” to control bank-pay is not ideal, it is preferrable to letting them bonus themselves to oblivion. If we don’t allow banks to fail, and continue to provide endless support to them, we have to at least cap their compensation.

America’s banks cannot be described as free-market enterprises by any rational person. I will outline various ways our government subsidizes bank profits, while eating their losses. I will explain why bank executives do not deserve their current level of pay, and why this view is not socialist or anti-free-market in nature, as many claim.

Gambling With Government Guarantees

American banks are currently allowed to gamble with other people’s money. They are given dirt-cheap funds by the Fed. They loan it out at a higher rate, pocketing the difference. If and when these loans go bad, they’re bailed out with even-lower interest rates, or outright cash-injections.

Banks are also not required to hold nearly enough reserves. Why? That would limit leverage and potential profits (and losses).

Would this happen in a truly free market? Of course not. Therefore there is no reason they should receive the outsized pay packages they do. Those who argue that limiting bank pay is socialism either do not understand the issues, or are biased in favor of the industry.

Benefits For All (Finance Firms)

Cheap government liquidity has been extended to entities it was never meant for: Investment-banks like Goldman Sachs, even American Express has access to the discount window, government-debt guarantees, and more. These programs were designed to shore up banks in desperate times.

American Express, for example, has borrowed an unknown amount from the discount window. They even highlight this on their investor-relations page: “Access to the Federal Reserve discount window”. Clearly having US Government backing is a major asset. It allows financial firms to offer  huge salaries and bonuses.

Why do investment banks and credit card companies deserve access to taxpayer funds? They don’t. I question whether traditional banks,which actually lend to consumers and small businesses, should have access to this dirt-cheap cash fountain. It has enabled their insane pay packages to continue. Paul Volcker recently spoke to Congress on this very topic, specifically citing Goldman Sachs:

“There’s nothing wrong with making money,” Volcker said. “But I don’t want them to make money by taking risks with the support of the taxpayer.”

At 82 years old, Volcker is sharper than any other member of Obama’s financial team. Unfortunately his role has been minimized, and some say he has been cast out for his “anti-Wall Street” views.

There are countless other ways banks benefit from government largesse. They can currently borrow at 0%, using the capital to buy treasuries earning 2-4%. Risk-free profits. And guess what the Fed’s exit strategy involves? Paying banks more riskless interest, encouraging them not to lend money. Starting to see a trend?

Prior to ~1920, when banks wanted to borrow from the government, they were required to pay a premium to market-interest rates (which they could not get, obviously). Rightly so. If banks need cash so badly, they should pay a premium for it. Taxpayers should gain something for the risk they take. Banks need to drastically slash costs, cut bonuses, dividends, payroll, etc. This has yet to happen on the scale required. Instead we’ve offered trillions in support, asking little in return.

Video: Nassim Taleb makes the Capitalist case to Congress. Richard Bookstaber makes a more socialist argument. Taleb explains the difference:

I’ve run into the same argument numerous times. They call these arguments “socialist”, say they would “put limits on private profits”. Understand this: Banks in the US are not free-market enterprises. They own shares of the Federal Reserve. They all have access to dirt-cheap capital, and powerful ones will be bailed out unfailingly. At least while guys like Greenspan and Bernanke are in power.

Lamenting Volcker’s Absence

A chairman like Paul Volcker would have handled this much better.  He recently made statements to this effect. But the era of a responsible Fed ended with him, it seems. It’s a shame that Mr. Obama’s administration has largely ignored him in favor of Summes and Geithner.

Bernanke is of a different mind. He will continue to support maximum moral-hazard, minimum reform, and total lack of transparency. Which is why we need to force change.

See also:

Disclosure: No positions in companies mentioned
Disclaimer: None of this information is investment advice. Always consult a professional.

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