Thursday, December 30, 2010

Wrecking The Living Wage

I took the following excerpt from The Automatic Earth (TAE) where the discussion was focused on how to cope with state defaults that appear imminent in 2011. Unlike TAE I have no respect for Mike Shedlock a one sided shill for corporate robbery at all levels across the US. As postulated here, actually by TAE, his "solutions" require anyone with any kind of living wage to disrobe and take corporate thievery up the ass. And as TAE explains eloquently enough, removing the living wage from the equation means the "70% of the economy driven by consumers" fades away into nothingness and our corporate leaders continue to send jobs overseas to peasants in countries paid even less than we are. Not much of a solution at all, as we shall see as this crisis inevitably plays out to our detriment.
Mike Shedlock (we have a ton of respect for him) wrote on the same issue earlier today, and I want address what he says. I agree with Mish on many points; we famously are about the sole voices insisting that deflation is the only option going forward. But I don't like the so-called libertarian stuff. Mostly because it never really turns out to be.

Mish defines the following as solutions for the financial crisis in the American states:

Six Common Sense Solutions

•Scrap Davis-Bacon and all prevailing wage laws.

•Scrap collective bargaining for public union workers entirely.

•Implement national right-to-work laws.

•Outsource every public sector job possible including police and fire departments to the lowest cost private sector provider.

•Kill defined benefit pension plans for all new hires and for all public employees that do remain in the system.

•Tax public union retiree benefits over a certain amount.

And that, in my view, leads nowhere.

• The Davis-Bacon Act is a 1931 piece of legislation under Herbert Hoover that was basically meant to prevent a developer from bringing in hundreds of dirt-cheap and abused Chinese workers into a community where unemployment was huge, in order to build a bridge or railroad at prices that wouldn’t have allowed the local population to persist. What is so bad about that?

• Implement "National right-to-work-laws" sounds good, but not if you don't add "for a living wage". Indeed, if you don't, it doesn't sound good at all. It sounds like Hoovervilles to me.

• "Outsource every public sector job possible... " is something I’m very much against.

Mish includes police and fire departments, and undoubtedly means to include health care and schooling too. But a community needs to keep its basic needs in its own hands; food, water, sewage, safety, healthcare, you name it. You don't ever want to hand those things over to people 1000's of miles away who only got into the game to make a profit.

Your water, your health care, your kids' schools, they shouldn't be profit based. They should be community based. If, for example, a private enterprise takes over a prison, it will have to show growth from one year to the next. In other words, next year it will have to either have more prisoners or give the existing ones even worse services. Ditto for schools; ditto for hospitals. This is a major reason why the US has 5-10-50 times more domestic incarcerations than any other country that calls itself civilized. Profit.

Yes, government-run institutions are often poorly-run. But you still have no choice but to re-organize them, since the only alternative is to lose control of what you really can't afford to lose control of. I don’t want to cover all services right here and now, but you don’t for instance want to let some private company uphold and police the law in your community. After all, what would be next? Let them make the laws too? What, we’re not close enough to exactly that yet? Really, you tell me, what's the difference between making the laws on the one hand versus interpreting the existing ones on the other? Blackwater, anyone?

"Outsource every public sector job possible", Mish? I don't think so. It's the road to hell, because the Carlyle Group and Blackrock and a bunch of Chinese and Arab multi-billion dollar enterprises and sovereign wealth funds will wind up telling you what you can do and say, what health care you can get, and whether or not you’ll have clean water in the morning. And the decisions between these options will be based on profit, not on whether your kids get a good education, or a good doctor, or whether they can drink their tap water or not. "Sorry, no profit in that."

Most of all, Mish goes against his favorite enemy: unions. However, as much as there may be wrong with unions, especially the public employee variety, "Scrap collective bargaining for public union workers entirely" sounds just plain silly.

If you support a free market system, as Mish obviously does, then you will need to accept that parties within that market system have the right to organize. It’s either that, or nothing. It's either that or you must also ban the Chambers of Commerce (where employers gather), at every level they exist. Certainly on the federal level, they are at least as destructive a force as the unions are. They are the no. 1 donor, bar none, to political campaigns in the America.

If you want to prevent workers from organizing, you must also prevent employers from doing so. That said, there are plenty of astonishing instances of firemen walking away with $100,000-+ pensions. But how is that a direct and inevitable result of employees organizing? It looks more like a cancer growth to me, a fault in the system, instead of a systemic fault, but a single tumor is still not a reason to throw out the entire body.

You need to re-negotiate all contracts, all over the country, both for those who have retired and for those who are still working or will start doing so. You want to do this on an individual basis? You sure? "Scrap collective bargaining for public union workers entirely"? Sorry, I think that would be a really counterproductive idea. What you need to do is tell people that they inevitably will face a huge drop in income and benefits, no matter what. And then try and figure out a way to find middle ground.

Sure, that will be hard. But banning any and all workers' associations, be they public or private, is not an answer at all. That just makes you a free marketer telling Karl Marx he was right all along. "No collective bargaining for you": we're going to play you all against each other, until you make as much as a Chinese peasant.

And no-one can afford a Chevy anymore. Which dooms GM. Or a home. Which dooms the real estate sector, and the banks.

We have a long way down, say after me: down, to go. The fate of the individual states will guide our way down there. They can't exist on hot air anymore than we as individual people can.

We all try though!

Hey, I’ve said it for ages now: this is not a financial crisis.

This is a political crisis.

How do you know? Well, people keep on saying: "Hey, the stock markets are up, we must be recovering". But the stock markets are up only because the states are going bankrupt, and homes are foreclosed upon, and there's millions upon millions of Americans who haven't had a job for over a year. It's all about priorities. Political priorities.

Washington has elected to taper and paper over what's really awfully wrong and lost, and it's done so at the expense of the people. Any and all bail-out money spent so far, and what is it, $15 trillion, $20 trillion?!, has gone towards banks, not people. While it's the people's money to begin with.

That is a choice. It's not an inevitable one, it’s simply a choice. In this case, one that tells you who holds the real power. And it isn't you.

Wednesday, December 29, 2010

Cubans In Haiti

From Britain's Independent newspaper this article about the effectiveness of cuban medical help for Haiti, news that is not in the headlines here, and perhaps should be.
They are the real heroes of the Haitian earthquake disaster, the human catastrophe on America's doorstep which Barack Obama pledged a monumental US humanitarian mission to alleviate. Except these heroes are from America's arch-enemy Cuba, whose doctors and nurses have put US efforts to shame.

A medical brigade of 1,200 Cubans is operating all over earthquake-torn and cholera-infected Haiti, as part of Fidel Castro's international medical mission which has won the socialist state many friends, but little international recognition.

Observers of the Haiti earthquake could be forgiven for thinking international aid agencies were alone in tackling the devastation that killed 250,000 people and left nearly 1.5 million homeless. In fact, Cuban healthcare workers have been in Haiti since 1998, so when the earthquake struck the 350-strong team jumped into action. And amid the fanfare and publicity surrounding the arrival of help from the US and the UK, hundreds more Cuban doctors, nurses and therapists arrived with barely a mention. Most countries were gone within two months, again leaving the Cubans and Médecins Sans Frontières as the principal healthcare providers for the impoverished Caribbean island.

Figures released last week show that Cuban medical personnel, working in 40 centres across Haiti, have treated more than 30,000 cholera patients since October. They are the largest foreign contingent, treating around 40 per cent of all cholera patients. Another batch of medics from the Cuban Henry Reeve Brigade, a disaster and emergency specialist team, arrived recently as it became clear that Haiti was struggling to cope with the epidemic that has already killed hundreds.

Since 1998, Cuba has trained 550 Haitian doctors for free at the Escuela Latinoamericana de Medicina en Cuba (Elam), one of the country's most radical medical ventures. Another 400 are currently being trained at the school, which offers free education – including free books and a little spending money – to anyone sufficiently qualified who cannot afford to study medicine in their own country.

John Kirk is a professor of Latin American studies at Dalhousie University in Canada who researches Cuba's international medical teams. He said: "Cuba's contribution in Haiti is like the world's greatest secret. They are barely mentioned, even though they are doing much of the heavy lifting."

This tradition can be traced back to 1960, when Cuba sent a handful of doctors to Chile, hit by a powerful earthquake, followed by a team of 50 to Algeria in 1963. This was four years after the revolution, which saw nearly half the country's 7,000 doctors voting with their feet and leaving for the US.

The travelling doctors have served as an extremely useful arm of the government's foreign and economic policy, winning them friends and favours across the globe. The best-known programme is Operation Miracle, which began with ophthalmologists treating cataract sufferers in impoverished Venezuelan villages in exchange for oil. This initiative has restored the eyesight of 1.8 million people in 35 countries, including that of Mario Teran, the Bolivian sergeant who killed Che Guevara in 1967.

The Henry Reeve Brigade, rebuffed by the Americans after Hurricane Katrina, was the first team to arrive in Pakistan after the 2005 earthquake, and the last to leave six months later.

Cuba's constitution lays out an obligation to help the worst-off countries when possible, but international solidarity isn't the only reason, according to Professor Kirk. "It allows Cuban doctors, who are frightfully underpaid, to earn extra money abroad and learn about diseases and conditions they have only read about. It is also an obsession of Fidel's and it wins him votes in the UN."

A third of Cuba's 75,000 doctors, along with 10,000 other health workers, are currently working in 77 poor countries, including El Salvador, Mali and East Timor. This still leaves one doctor for every 220 people at home, one of the highest ratios in the world, compared with one for every 370 in England.

Wherever they are invited, Cubans implement their prevention-focused holistic model, visiting families at home, proactively monitoring maternal and child health. This has produced "stunning results" in parts of El Salvador, Honduras and Guatemala, lowering infant and maternal mortality rates, reducing infectious diseases and leaving behind better trained local health workers, according to Professor Kirk's research.

Medical training in Cuba lasts six years – a year longer than in the UK – after which every graduate works as a family doctor for three years minimum. Working alongside a nurse, the family doctor looks after 150 to 200 families in the community in which they live.

This model has helped Cuba to achieve some of the world's most enviable health improvements, despite spending only $400 (£260) per person last year compared with $3,000 (£1,950) in the UK and $7,500 (£4,900) in the US, according to Organisation for Economic Co-operation and Development figures.

Infant mortality rates, one of the most reliable measures of a nation's healthcare, are 4.8 per 1,000 live births – comparable with Britain and lower than the US. Only 5 per cent of babies are born with a low birth weight, a crucial factor in long-term health, and maternal mortality is the lowest in Latin America, World Health Organisation figures show. Cuba's polyclinics, open 24 hours a day for emergencies and specialist care, are a step up from the family doctors. Each provides for 15,000 to 35,000 patients via a group of full-time consultants as well as visiting doctors, ensuring that most medical care is provided in the community.

Imti Choonara, a paediatrician from Derby, leads a delegation of international health professionals at annual workshops in Cuba's third city, Camaguey. "Healthcare in Cuba is phenomenal, and the key is the family doctor, who is much more proactive, and whose focus is on prevention ... The irony is that Cubans came to the UK after the revolution to see how the NHS worked. They took back what they saw, refined it and developed it further; meanwhile we are moving towards the US model," Professor Choonara said.

Politics, inevitably, penetrates many aspects of Cuban healthcare. Every year hospitals produce a list of drugs and equipment they have been unable to access because of the American embargo which prevents many US companies from trading with Cuba, and persuades other countries to follow suit. The 2009/10 report includes drugs for childhood cancers, HIV and arthritis, some anaesthetics, as well as chemicals needed to diagnose infections and store organs. Pharmacies in Cuba are characterised by long queues and sparsely stacked shelves, though in part this is because they stock only generic brands.

Antonio Fernandez, from the Ministry of Public Health, said: "We make 80 per cent of the drugs we use. The rest we import from China, former Soviet countries, Europe – anyone who will sell to us – but this makes it very expensive because of the distances."

On the whole, Cubans are immensely proud and supportive of their contribution in Haiti and other poor countries, delighted to be punching above their weight on the international scene. However, some people complain of longer waits to see their doctor because so many are working abroad. And, like all commodities in Cuba, medicines are available on the black market for those willing to risk large fines if caught buying or selling.

International travel is beyond the reach of most Cubans, but qualified nurses and doctors are among those forbidden from leaving the country for five years after graduation, unless as part of an official medical team.

Like everyone else, health professionals earn paltry salaries of around $20 (£13) a month. So, contrary to official accounts, bribery exists in the hospital system, which means some doctors, and even hospitals, are off-limits unless patients can offer a little something, maybe lunch or a few pesos, for preferential treatment.

Cuba's international ventures in healthcare are becoming increasingly strategic. Last month, officials held talks with Brazil about developing Haiti's public health system, which Brazil and Venezuela have both agreed to help finance.

Medical training is another example. There are currently 8,281 students from more than 30 countries enrolled at Elam, which last month celebrated its 11th anniversary. The government hopes to inculcate a sense of social responsibly into the students in the hope that they will work within their own poor communities for at least five years.

Damien Joel Suarez, 27, a second year from New Jersey, is one of 171 American students; 47 have already graduated. He dismisses allegations that Elam is part of the Cuban propaganda machine. "Of course, Che is a hero here but he isn't forced down your neck."

Another 49,000 students are enrolled in the El Nuevo Programa de Formacion de Medicos Latinoamericanos, the brainchild of Fidel Castro and Hugo Chavez, who pledged in 2005 to train 100,000 doctors for the continent. The course is much more hands-on, and critics question the quality of the training.

Professor Kirk disagrees: "The hi-tech approach to health needed in London and Toronto is irrelevant for millions of people in the Third World who are living in poverty. It is easy to stand on the sidelines and criticise the quality, but if you were living somewhere with no doctors, then you'd be happy to get anyone."

There are nine million Haitians who would probably agree.

Tuesday, December 28, 2010

Loan Sharking 101

As the US housing market implodes I never cease to be amazed by the attitudes of many uninformed Americans who believe the borrowers were at fault for accepting loans that were, as we shall see practically forced on them. That's not to say that if one is offered an absurd loan one should take it, but the form of predatory lending illustrated here is such a change from the "old fashioned" type of lending practiced by the below mentioned American General Finance, that it's not surprising uninformed people would take the loans as offered. In the old days one went cap in hand to the bank and if, by the grace of God, the bank manager was firmly convinced the applicant would repay the loan then the money was, reluctantly, underwritten. In the new scenario potential borrowers were brow beaten into taking money they may or may not need or even want. It was bizarre, but easily explained when one understands the corrupted form of financing that rewarded the lenders even for failure. Failure was an acceptable outcome and was rewarded with ever larger bonuses. In this excerpt from his new book, The Monster: How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America--and Spawned a Global Crisis, investigative reporter Michael W. Hudson tells the story of Travis Paules’ first year and a half inside America’s biggest—and most predatory—subprime mortgage empire.As more borrowers signed loans and more dollars flowed in from Wall Street, Ameriquest began hiring new salespeople and opening new branches around the nation. Travis Paules was one of the company’s hires in 1998. The company recruited him away from his job at a consumer finance company and put him in charge of opening an Ameriquest outpost in Camp Hill, Pennsylvania, a suburb of Harrisburg.

Paules was twenty-eight. He had been working for three years in nearby Lancaster for American General Finance. He wasn’t, he later recalled, an upstanding guy. He smoked pot every day, boozed, gambled, frequented strip clubs when he had a little extra cash. One thing he did have going for him was a work ethic. His mother had been a disciplinarian. She’d hated laziness. When he was thirteen, his father had given him a copy of Napoleon Hill’s Think and Grow Rich, the bestselling guide to striving and success. At American General, he was a “company man,” a by-the-book branch manager, always on time and diligent with his paperwork. He cut no corners because American General made it clear that it didn’t want him to cut corners, and that he should balance the need for loan production with the need to make sure borrowers could really repay their loans. “I played within the sandbox they allotted me,” he said. “I always liked to say: My personal morals aren’t good, but I have good business morals.”

He was earning just under $50,000 a year. An acquaintance who worked at Ameriquest suggested he could make a lot more at the up-and-coming mortgage lender. As much as $150,000 a year running a branch. Soon after, Paules’s supervisor at American General told him that he’d have to wait on the promotion he had been expecting, and that he shouldn’t expect more than a 3 percent raise for the year. Paules picked up the phone and dialed Ameriquest.

About the only guidance he received before he opened the Camp Hill branch came from his new supervisor. She suggested he bring a list of American General employees and borrowers with him. He could draw from the employee list as he recruited for the new branch and hit up American General’s customers with offers to refinance their debts. Paules thought that sounded strange. It wasn’t the way he’d been taught to operate at American General. He quickly learned, though, that Ameriquest was a different company from the one he had worked at before.

Soon after he started, he traveled to Las Vegas for an Ameriquest managers’ conference. The lender had booked rooms at the MGM Grand, the world’s largest hotel-casino complex, replete with nightclubs, waterfalls, and theme-park rides. Here was a company, he mused, that knew how to reward and motivate its employees. There were free drinks and a “money booth” that offered exuberant branch managers the chance to jump in and grab as many wind-churned bills as they could stuff in their pockets. The training sessions seemed to be an afterthought.

Before Paules left Vegas, a senior executive suggested that he and Paules make a “side bet.” It was a ritual at Ameriquest. Bosses spurred underlings to greater production by betting on what their numbers would be over a specific time period. If Paules could get his branch to hit at least $1.5 million in its first full month of operation, the company would multiply the standard commissions for Paules and his employees by a factor of 1.5.

Back home in Pennsylvania, he leaned heavily on his list of American General customers. The branch recruited more than a dozen customers away from his previous employer and by the end of the month it had booked twenty-one loans in all, a company record for a new branch. Those twenty-one mortgage contracts translated into $1.6 million in loan volume.

Paules had won his bet and made a lot of money for himself and his staff. He swaggered a bit as the new month began. But he quickly learned that last month was old history. At Ameriquest, you were only as good as your current month. The branch had exhausted the leads from his pool of American General borrower. As the new month came to an end, the office’s numbers had dropped dramatically. While fellow branch managers listened in on a conference call, a supervisor chewed him out, counting off a roll call of epithets that described his performance: “one-month wonder,” “king for a day,” “shitting the bed.”

Paules regrouped, aiming to prove he was a top producer. If he’d done everything by the book at American General, it was because that’s what had been required of him. At Ameriquest, he followed cues that let him know that he needed to be creative about booking loans and making money. It wasn’t a case of an innocent being corrupted. It was a case, he said, of an unprincipled personality finding a place that encouraged his self-serving instincts. “It’s hard to have a guilty conscience if you don’t have a conscience,” he said. “Anything that benefited production—that benefited me and benefited my wallet—I’d do it.”

About the only check on his behavior was the risk of getting caught. At Ameriquest, the risk was low, if you covered your tracks and didn’t get too out of control. He let his workers fiddle with about 10 percent of the loan files, only the deals where falsifying a number or creating a fake document would provide a significant boost to the branch’s commissions. He didn’t allow his employees to alter pay stubs or tax documents, though he did allow them to use Wite-Out to alter the monthly benefit amounts listed on a couple of elderly borrowers’ Social Security award letters.

He learned from his colleagues that one of the best ways to game the system without endangering yourself too much was to employ what they termed the “Whoops Technique.” If a borrower had an annual income of $56,000, for example, he might instead report it as $66,000. If somebody in underwriting caught the discrepancy, he could explain that it was a typo— a single flubbed keystroke.

If a borrower really couldn’t afford the deal Ameriquest was writing for them, Paules learned, there were ways around that, too. As long as borrowers made their first payment, the loan officers and managers who’d put together the deal could collect their commissions.

If you gave a borrower enough cash out of the deal, they could afford to make their monthly payments for a little while, at least. Another way to ensure the borrower could make the first payment was to work out a deal with the title company that helped collate the final loan documents. The title company could slip an extra charge onto the customer’s initial loan balance, and then book a credit for that amount to serve as the customer’s first payment. The best part was that this sly arrangement also allowed loan officers to promise mortgage applicants that Ameriquest would make their first payment for “free.”

Once Paules started taking shortcuts and playing around in what Ameriquest workers called the “gray area,” it was hard not to go further. “An inch becomes a yard,” he recalled. “And a yard becomes ten thousand yards real quick.” Many of the tactics that Ameriquest employees used spread informally, through back channels and over break room bull sessions. Simply by hinting that top-performing Ameriquest branches were cutting corners to post big production numbers, Paules could nudge his underlings into employing a bit of their own derring-do to bring in loans. If somebody wasn’t figuring it out for themselves, he paired them with an experienced coworker who could demonstrate the tricks of the trade.

For those who’d already become proficient at these sleights of hand, he used various incentives to encourage them to push their production ever higher, including one that he’d learned at his first management seminar with the company: the side wager. Paules approached two of his salesmen with a proposition. Like Paules, they were young and wild. They liked to party. He promised the pair that if they could top their previous monthly bests, he’d stay after hours with them on the last business day of the month and host a private party for them— complete with a stripper. The pair won the bet, and their party. The next month, Paules increased the stakes. If the two salesmen could once again set personal records, he’d hire two strippers. Again, the salesmen beat their goal and Paules rewarded them—and himself—with an alcohol- fueled celebration in the office that didn’t let up until early the next morning.

The branch was performing so well, many months it outdid all of Ameriquest’s other Pennsylvania locations combined. Paules earned $170,000 in his first eight months at Ameriquest, more than he’d pocketed in four years at American General. After fourteen months as a branch manager, Paules was promoted to area manager. He was now overseeing his old branch and five others in the state. He hadn’t made it to his thirtieth birthday yet, and he had six branch managers, forty loan officers, and various support staff reporting to him.

Higher up the line, Ameriquest’s senior management put policies in place that encouraged managers to prod their employees to squeeze as much profit out of borrowers as possible, even those who had solid credit histories. The company awarded bonuses to area managers, Paules said, if more than 80 percent of the loans produced under their supervision included a “prepayment penalty”—a nasty surprise tucked away in loan contracts that could cost borrowers thousands of dollars if they tried to refinance and get away from Ameriquest. Hitting that target, he said, could put another $5,000 a month in his pocket.

Management also controlled employees by keeping count of just about everything they did. It counted the number of loans made each month by every branch and every loan officer, tracked how much revenue the sales reps had built into the deals, even noted how many phone calls reps were making in any given time span. The company’s computer system allowed senior executives to monitor loan officers’ telephone usage. It wasn’t unusual for Paules to pick up the phone and find his regional manager on the other end of the line, demanding to know why a particular loan officer had only made, say, eight sales calls in the past hour. Paules’s job was to go out and let the salesman know he better get himself into gear.

Paules generally didn’t find too much cause to yell at the people who worked under him—they were fun to party with and they were making him lots of money. But the pressure got to him a few months into his tenure as area manager. He was demanding more and more volume from his sales corps. Near the end of one month, his branch managers assured him that he could expect big numbers for the month. Paules reported the projections up the chain of command. When things shook out, though, production for the six branches was far below what he’d predicted. His regional manager berated him. In turn, Paules summoned all of his branch managers to a conference call and screamed at them like he never had before. His face grew a deeper shade of purple with each expletive he spat out. “Get out of your fucking glass offices and get out on the fucking floor with your fucking people!” If their salespeople didn’t start producing, he told the managers, the solution was simple: get rid of them and hire someone else. If the loan officers couldn’t close loans, the branch managers needed to step in and do it for them. Paules later calculated that he’d set a personal record: he’d used various forms of “the f-word” perhaps five hundred times in the fifteen to twenty minutes he was on the phone. Only later did one of his managers confess: Paules had been pushing them so hard that they’d been afraid to tell him the truth, and instead had given him rosy projections for how loan volume was shaping up for the month. They thought they could always find some trick to catch up.

Monday, December 27, 2010

Enabling Bank Fraud

This story reported on The Automatic Earth blew my mind. But there again we elect people to government positions who have no interest in governing. And then the voters make impossible demands, such as lowering taxes and maintaining services, and so the elected "leaders:" do just that. The idea here is to wreck social services by driving the country into debt, a tactic that is working ferociously effectively at the moment. One in seven Americans is on food stamps, real unemployment is more than 20 percent and medical services for the poor are being cut back in all states. It's hard to put up a coherent opposition to political suicide when you are literally scrambling to find food or work -in that order. And yet, despite the crushing crisis the banks have forced on all of us they continue to take public funds in secret from the Federal Reserve, they continue to award obscene bonuses and we the people continue to cover their bankruptcies by wrecking public services across the US. Only Iceland refused to spend taxpayer money to cover bank losses and that country has devalued it's currency by half and is moving ahead with no public debt and continued public services. We could learn a lesson from them, instead we have cretins like these reported below leading our country in the new congress.

Congress Threatens to Sow the Seeds of Our Next Banking Crisis
by William K. Black - Benzinga

Spencer Bachus (R. Ala.), the incoming Chair of the House Financial Services Committee, told the Birmingham News: "In Washington, the view is that the banks are to be regulated, and my view is that Washington and the regulators are there to serve the banks."

Ron Paul (R. Tex.), asked to comment on Bachus' statement, said: "I don't think we need regulators. We need law and order. We need people to fulfill their contracts. The market is a great regulator, and we've lost understanding and confidence that the market is probably a much stricter regulator."

These comments share several characteristics. First, they demonstrate that many people in positions of power have not only learned the necessary lessons from the ongoing crisis -- they have learned the worst possible lessons. Second, the comments reprise disastrous approaches that allowed the crisis to occur. Third, the comments represent the continuing triumph of ideology over facts. Fourth, the comments rely on false dichotomies that are the enemy of reasoning and good policy.

1. The U.S. and much of Europe have suffered a crisis of great proportions after they adopted deregulation, desupervison, and the de facto decriminalization of financial firms. For the U.S., this is our third major financial crisis in 20 years brought on by those triple "de's." The incoming chairs' response to these crises is increased deregulation and desupervision (and no mention of prosecuting the control frauds driving the crises). What would it take to discredit policies that produce recurrent, intensifying crises?

2. The bipartisan "Reinventing Government" movement of the 1990s (championed by then Texas Governor Bush and Vice President Gore) led the senior leaders of the banking regulatory agencies to order their staff to refer to the industry as their "clients" or "customers." It became a major agency priority to make those clients happy with the regulators.

That policy became even more destructive during the Bush administration, which chose regulatory leaders based on the intensity of their opposition to vigorous supervision. SEC Chairman Pitt's first major speech was before a group of accountants. He expressed his regret that the SEC had not always been a "kinder and gentler" place for accountants and blamed his agency for not showing accountants more love.

The Office of Thrift Supervision's (OTS) head, "Chainsaw" Gilleran, posed with the three major banking lobbyists and the number two guy at the FDIC (who was Gilleran's successor) over a pile of federal regulations. Everyone held pruning shears, except Gilleran, who demonstrated the indiscriminate nature of his hate for regulation by holding a chainsaw.

It is no surprise that among insured depositories the largest accounting control frauds were regulated by the OTS (where "regulated by" translated into "not regulated by"). The OTS went so far in its efforts to "serve the banks" that it encouraged or knowingly permitted several insolvent banks to file false financial statements relying on backdated entries.

The federal banking regulatory agencies "serve[d] the banks" by preempting state efforts to regulate abusive, predatory, and fraudulent lending. The federal banking regulatory agencies even tried to preempt State Attorney General lawsuits against the leading mortgage frauds.

Similarly, the SEC "serve[d] the [investment] banks" by creating the Consolidated Supervised Entities (CSE) program for the purpose of protecting them from serious regulation by the European Union. The CSE program was a sham. The SEC staff assigned to examine the largest investment banks in the U.S. were not examiners and did not examine the investment banks. No one believed they could because the staffing level was farcical. Banks do not need regulators to "serve" them? There is no appropriate function in which we serve banks. There are many destructive ways in which anti-regulators would serve the interest of fraudulent banks.

3. Representative Paul's claims epitomize the triumph of ideology over fact: "The market is a great regulator, and we've lost understanding and confidence that the market is probably a much stricter regulator." No, the "market" is not a "great regulator" and the ongoing crisis is only the latest example of that point. Efficient, non-fraudulent markets would be a very good thing. Inefficient, markets with fraudulent participants can be a catastrophically bad thing.

The "market" also does not deal effectively with externalities (and they can be lethal) and with market power. The neoclassical claim that cartels cannot persist and that potential entry solves prevents all serious ills proved false in the real world. Here, however, I will discuss only why control fraud turns "markets" perverse. Accounting control frauds are guaranteed to report high profits in the early years. This is why Akerlof & Romer (1993) agreed with white-collar criminologists that such frauds were a "sure thing." I've explained why the four-part recipe for optimizing fictional accounting income maximizes executive bonuses -- and real losses. In the interest of brevity I will merely mention four ways in which accounting control frauds make markets, and "private market discipline" perverse.

The fictional profits fool creditors and shareholders -- they are eager to lend to and invest in firms reporting record profits. Rather than discipline accounting control frauds, creditors and shareholders fund their massive growth.

The fictional profits and the large bonuses they drive create a "Gresham's" dynamic in which bad ethics tends to drive good ethics out of the marketplace. The CFO that fails to emulate the fraud recipe will report far lower profits in the near term and will fear losing his job. More junior executives whose compensation is based on the firm's reported income have perverse incentives to engage in accounting fraud to ensure that the firm "hits the number" and have reduced incentives to blow the whistle on frauds.

Lenders engaged in accounting control fraud create "echo" epidemics of fraud. They use their powers to hire and fire and create compensation systems to create perverse incentives in other fields: among their employees, "independent" professionals, and agents (e.g., loan brokers).

When several large lenders follow similar fraud strategies they can hyper-inflate financial bubbles.

Anti-consumer control frauds can also turn markets perverse by creating Gresham's dynamics. Chinese infant formula provides a good example. Dishonest firms drove honest firms from the market -- maiming hundreds of thousands of infants' health. In the case of nonprime loans, for example, both principals (the borrower and the lender) typically lost utility as a result of the loan -- reverse Pareto optimality. The unfaithful and fraudulent agents, however, won big.

Even when private market discipline did finally kick in it did not perform as advertised. Instead of differentiating between good and poor credit risks and honest v. fraudulent actors it simply shut down hundreds of markets.

Rep. Paul's comparative statement -- implying that the markets were tougher regulators than the regulators -- fails on two bases. One, as pathetic as the anti-regulators were, they were commonly better than the market, e.g., warning about concentrations in commercial real estate well before the crash. Two, claiming that regulation is a failure because the ideological foes of regulation controlled the agencies and so completely desupervised the financial sector so completely that they created a self-fulfilling prophecy of regulatory failure is an act of chutzpah.

4. Rep. Paul's other remark, however, illustrates the false dichotomies that underlie the ideological assault on regulation. He notes that we "need law and order." He thinks that proves we don't need regulation, but it proves the opposite. The banking regulators are the "cops on the beat." We have nearly a million police and guards that deal almost exclusively with blue collar criminals. Control fraud creates a Gresham's dynamic because it means that cheaters prosper.

As regulators, we do "serve the [honest] banks" by taking away the ability of the cheaters to prosper -- when we regulate effectively. The OCC and the OTS did zero criminal referrals during the current crisis. We did thousands as regulators during the S&L debacle. We prioritized the most severe frauds (the large control frauds) and made the support of criminal prosecutions a top agency priority. The result was over 1000 priority felony convictions of S&L elites. Without the regulators' expertise the FBI cannot possibly stop an "epidemic" of mortgage (FBI House testimony, September 2004). In the ongoing crisis, the Department of Justice, denied regulatory support and relying instead on the Mortgage Bankers Association - the trade association of the "perps" -- has secured zero convictions of any senior officers of the large lenders specializing in nonprime lending/securitization.

Effective regulations and regulators are not the enemy of private markets or private market discipline, but rather one of the essential requirements for efficient, honest markets in a modern economy.

Sunday, December 26, 2010

Weather Changes

As we in the US watch a new Republican dominated House of representatives take office in ten days, the rest of the industrialized world,is wondering about the weather which this winter has done a nice job of replicating last winter's record setting cold spells. Of course we in the US refuse to accept any notion that climate might be changing, human caused or otherwise. Let it snow might be the attitude, because science will play no part of a discussion dominated by myth making and speculation. Whether or not human activity has anything to do with climate change is a moot point in a country which as a whole refuses to countenance the notion that climate might be changing at all. Me? I have no offspring so I sit on the sidelines and wonder if the Keys will simply be kind enough to stay above sea level for the rest of my short life. This article from Britain's Independent newspaper is asking some hard questions and getting unpleasant answers.
Scientists have established a link between the cold, snowy winters in Britain and melting sea ice in the Arctic and have warned that long periods of freezing weather are likely to become more frequent in years to come.

An analysis of the ice-free regions of the Arctic Ocean has found that the higher temperatures there caused by global warming, which have melted the sea ice in the summer months, have paradoxically increased the chances of colder winters in Britain and the rest of northern Europe.

The findings are being assessed by British climate scientists, who have been asked by ministers for advice on whether the past two cold winters are part of a wider pattern of climate change that will cause further damaging disruption to the nation's creaking transport infrastructure.

Some climate scientists believe that the dramatic retreat of the Arctic sea ice over the past 30 years has begun to change the wind patterns over much of the northern hemisphere, causing cold, Arctic air to be funnelled over Britain during winter, replacing the mild westerly airstream that normally dominates the UK's weather.

The study was carried out in 2009, before last year's harsh winter started to bite, and is all the more prescient because of its prediction that cold, snowy winters will be about three times more frequent in the coming years compared to previous decades.

The researchers used computer models to assess the impact of the disappearing Arctic sea ice, particularly in the area of the Barents and Kara seas north of Scandinavia and Russia, which have experienced unprecedented losses of sea ice during summer.

Their models found that, as the ice cap over the ocean disappeared, this allowed the heat of the relatively warm seawater to escape into the much colder atmosphere above, creating an area of high pressure surrounded by clockwise-moving winds that sweep down from the polar region over Europe and the British Isles. Vladimir Petoukhov, who carried out the study at the Potsdam Institute for Climate Impact Research in Germany, said the computer simulations showed that the disappearing sea ice is likely to have widespread and unpredictable impacts on the climate of the northern hemisphere.

One of the principal predictions of the study was that the warming of the air over the ice-free seas is likely to bring bitterly cold air to Europe during the winter months, Dr Petoukhov said. "This is not what one would expect. Whoever thinks that the shrinking of some far away sea-ice won't bother him could be wrong. There are complex interconnections in the climate system, and in the Barents-Kara Sea we might have discovered a powerful feedback mechanism," he said.

In the paper, submitted in November 2009 but published last month in the Journal of Geophysical Research, Dr Petoukhov and his colleague Vladimir Semenov write: "Our results imply that several recent severe winters do not conflict with the global warming picture but rather supplement it."

Arctic sea ice has been in retreat over recent decades, with record lows recorded in September 2007. The normal recovery of the sea ice during winter has also been affected, especially in the Barents and Kara seas which have seen significant losses of ice cover over the past decade.

Stefan Rahmstorf, professor of physics of the oceans at the Potsdam Institute, said the floating sea ice in winter insulates the relatively warm seawater from the bitterly cold temperatures of the air above it, which can be around -20C or -30C.

"The Arctic sea ice is shrinking and at the moment it is at a record low for mid-to-late December, which provides a big heat source for the atmosphere," Professor Rahmstorf said. "The open ocean actually heats the atmosphere above because the ocean in the Arctic is about 0C, and that's much warmer than the atmosphere about it. This is a massive change compared with an ice-covered ocean, where the ice operates like a lid. You don't get that heating from below.

"The model simulations show that, when you don't get ice on the Barents and Kara seas, that promotes the formation of a high-pressure system there, and, because the airflow is clockwise around the high, it brings cold, polar air right into Europe, which leads to cold conditions here while it is unusually warm elsewhere, especially in the Arctic," he explained.

The scientists emphasised that the climate is complex and there were other factors at play. It is, they said, too early to be sure if the past two cold winters are due to the ice-free Arctic.

"I want to be cautious, but basically in the past couple of months the sea ice cover has been low and so, according to the model simulations, that would encourage this kind of weather pattern," Professor Rahmstorf said.

"The last winter of 2009-10 turned out to be fitting that pattern very well, and perhaps this winter as well, so that is three data points. I would say it's not definite confirmation of the mechanism, but it certainly fits the pattern," he said.

The computer model used by the scientists also predicted that, as the ice cover continues to be lost, the weather pattern is likely to shift back into a phase of warmer-than-usual winters. Global warming will also continue to warm the Arctic air mass, Professor Rahmstorf said.

"If you look ahead 40 or 50 years, these cold winters will be getting warmer because, even though you are getting an inflow of cold polar air, that air mass is getting warmer because of the greenhouse effect," he said. "So it's a transient phenomenon. In the long run, global warming wins out."

Saturday, December 25, 2010

The President's Birth Certificate

From the New York Times this article which highlights the racism and stupidity of a large segment of the noisy population that won't face uncomfortable facts. To argue the veracity of this fact is stupidity: what will the noisy fools do when the uncomfortable facts about our economic future come to light?
HONOLULU — Gov. Neil Abercrombie of Hawaii, who befriended President Obama’s parents when they were university students here, has been in office for less than three weeks. But he is so incensed over “birthers” — the conspiracy theorists who assert that Mr. Obama was born in Kenya and was thus not eligible to become president — that he is seeking ways to change state policy to allow him to release additional proof that the president was born in Honolulu in 1961.
Marco Garcia/Associated Press

“It’s an insult to his mother and to his father, and I knew his mother and father; they were my friends, and I have an emotional interest in that,” Governor Abercrombie said in a telephone interview late Thursday. “It’s an emotional insult. It is disrespectful to the president; it is disrespectful to the office.”

The governor, a Democrat and former congressman, said he has initiated conversations with the state’s attorney general and the chief of its Health Department about how he can release more explicit documentation of Mr. Obama’s birth on Aug. 4, 1961, at Kapiolani Maternity and Gynecological Hospital. He said he has done so of his own accord, without consulting the White House, which declined to comment.

“He’s a big boy; he can take sticks and stones. But there’s no reason on earth to have the memory of his parents insulted by people whose motivation is solely political,” Mr. Abercrombie said. “Let’s put this particular canard to rest.”

Mr. Abercrombie was regarded as an independent operator in Congress, a free spirit who embodies his state’s “aloha” tradition of inclusiveness and harmony. He returned a reporter’s phone call at 11:30 p.m. on Thursday — he had just gotten the message, he said, and was worried about deadlines — and spent 30 minutes chatting animatedly about Mr. Obama, Hawaii and his own recent election, saying that he had based his campaign on “our diversity defining us rather than dividing us” — much the same message that Mr. Obama used in 2008.

Now that he is in office, Mr. Abercrombie is facing a $71 million deficit this year and 10 times that amount in the years to come. Mr. Obama talked about the problem at a news conference Wednesday in Washington when he spoke, imprecisely, about “schools that are laying off so many teachers that they start going to four days a week, as they’ve done in Hawaii, for example.” In fact, Hawaii instituted furloughs to avoid layoffs.

Even so, the new governor said he was having the time of his life.

“If I was having a better time,” he said, laughing, “I’d have to be arrested.”

But on the matter of the birthers, Mr. Abercrombie grew serious. “I’m going to take care of that,” he said, though he acknowledged that they would be difficult to convince.

The birther movement began during the 2008 campaign when some of Mr. Obama’s critics claimed, without offering proof, that he was born in Kenya, like his father, Barack Obama Sr. The elder Mr. Obama was an exchange student at the University of Hawaii when he met and married Mr. Obama’s mother, Stanley Ann Dunham. The Obama campaign ultimately responded by releasing a “certification of live birth,” an official document from the Hawaii Department of Health, and posting it online.

Two fact-checking groups, and PolitiFact, concluded the document was authentic. A reporter for The Honolulu Advertiser also found two separate newspaper announcements of the president’s birth, one in The Advertiser on Aug. 13, 1961, and another in The Honolulu Star-Bulletin the next day. Both carried the words “Mr. and Mrs. Barack H. Obama, 6085 Kalanianaole Highway, son, Aug. 4.”

Still, the questions persisted. The certificate number is blacked out on the Internet copy, and Mr. Obama’s detractors have demanded the release of his original long-form birth certificate, which in Hawaii is not considered a public record. The state was so besieged by inquiries that Mr. Abercrombie’s predecessor, Linda Lingle, a Republican, signed a law allowing officials to ignore the queries as nuisances.

“I certainly hope by the fourth year of our administration that we’ll have dealt with this burgeoning birth controversy,” the White House press secretary, Robert Gibbs, told reporters last year. The fact-checkers at PolitiFact sounded similarly frustrated in a 2009 post: they thought they had put the matter to rest. “Oh, how naïve we were,” the post’s writer, Robert Farley, said.

Mr. Abercrombie, 72, said that although he did not see the elder Obamas at the hospital with their newborn son, he did remember the couple bringing the baby to social events. He says the critics who suggest that Mr. Obama’s mother slipped off to Kenya to give birth are engaging in a “demonological fantasy.” And he is angry about legislation in several states that would require presidential candidates to document that they were born in this country. A similar bill died in Congress last year.

“My thought was, ‘Wait a minute, why didn’t you ask me, my friends in the national Congress, the House of Representatives?’ ” he said. “They know me, they know that I was here, but they didn’t even bother to have the courtesy to do that, which is disappointing to me, because it is very difficult for me not to conclude that bills like that are meant as a coded message that he is not really American. My thought is, rather than get into some kind of argument or play into that mentality, why not just simply try to authenticate this and let the facts speak for themselves?”

Thursday, December 23, 2010

Retiring Retirement

From the New York Times' Michael Cooper and Mary Williams Walsh this story which shows us where the economic attacks will come in 2011. It has been my contention that the social contract in the United States fell apart when our leaders pushed globalization on us. It was cheaper and thus more profitable to move real manufacturing jobs offshore, to countries where pay and benefits we thought could never be paid here in the US. It wasn't that corporations weren't profitable in the US, it's that corporations expected to be more profitable manufacturing in Indonesia or China. Now we have just twelve million Americans working in manufacturing and the rest of us shuffle useless paper in a Finance, Insurance and Real Estate economy, which as we can see isn't working too well for us. In the drive to bring us down to Indonesia's level we will now see the destruction of all social security in this country, government jobs de-unionized to pay less than a living wage, pensions wrecked and health insurance rendered too expensive. This story about an insignificant town in Alabama shows us how it will be done across the United States.

PRICHARD, Ala. — This struggling small city on the outskirts of Mobile was warned for years that if it did nothing, its pension fund would run out of money by 2009. Right on schedule, its fund ran dry.

Last week, retirees asked the City Council for some help before Christmas. More Photos »
Then Prichard did something that pension experts say they have never seen before: it stopped sending monthly pension checks to its 150 retired workers, breaking a state law requiring it to pay its promised retirement benefits in full.

Since then, Nettie Banks, 68, a retired Prichard police and fire dispatcher, has filed for bankruptcy. Alfred Arnold, a 66-year-old retired fire captain, has gone back to work as a shopping mall security guard to try to keep his house. Eddie Ragland, 59, a retired police captain, accepted help from colleagues, bake sales and collection jars after he was shot by a robber, leaving him badly wounded and unable to get to his new job as a police officer at the regional airport.

Far worse was the retired fire marshal who died in June. Like many of the others, he was too young to collect Social Security. “When they found him, he had no electricity and no running water in his house,” said David Anders, 58, a retired district fire chief. “He was a proud enough man that he wouldn’t accept help.”

The situation in Prichard is extremely unusual — the city has sought bankruptcy protection twice — but it proves that the unthinkable can, in fact, sometimes happen. And it stands as a warning to cities like Philadelphia and states like Illinois, whose pension funds are under great strain: if nothing changes, the money eventually does run out, and when that happens, misery and turmoil follow.

It is not just the pensioners who suffer when a pension fund runs dry. If a city tried to follow the law and pay its pensioners with money from its annual operating budget, it would probably have to adopt large tax increases, or make huge service cuts, to come up with the money.

Current city workers could find themselves paying into a pension plan that will not be there for their own retirements. In Prichard, some older workers have delayed retiring, since they cannot afford to give up their paychecks if no pension checks will follow.

So the declining, little-known city of Prichard is now attracting the attention of bankruptcy lawyers, labor leaders, municipal credit analysts and local officials from across the country. They want to see if the situation in Prichard, like the continuing bankruptcy of Vallejo, Calif., ultimately creates a legal precedent on whether distressed cities can legally cut or reduce their pensions, and if so, how.

“Prichard is the future,” said Michael Aguirre, the former San Diego city attorney, who has called for San Diego to declare bankruptcy and restructure its own outsize pension obligations. “We’re all on the same conveyor belt. Prichard is just a little further down the road.”

Many cities and states are struggling to keep their pension plans adequately funded, with varying success. New York City plans to put $8.3 billion into its pension fund next year, twice what it paid five years ago. Maryland is considering a proposal to raise the retirement age to 62 for all public workers with fewer than five years of service.

Illinois keeps borrowing money to invest in its pension funds, gambling that the funds’ investments will earn enough to pay back the debt with interest. New Jersey simply decided not to pay the $3.1 billion that was due its pension plan this year.

Colorado, Minnesota and South Dakota have all taken the unusual step of reducing the benefits they pay their current retirees by cutting cost-of-living increases; retirees in all three states are suing.

No state or city wants to wind up like Prichard.

The city’s rapid decline began in the 1970s. The growth of other suburbs, white flight and then middle-class flight all took their tolls, and the city’s population shrank by 40 percent to about 27,000 today, from its peak of 45,000. As people left, the city’s tax base dwindled.

After having good credit for years, Nettie Banks, 68, a retired police and fire dispatcher who worked for Prichard for 25 years, declared bankruptcy when her pension checks stopped coming.

Prichard’s pension plan was established by state law during the good times, in 1956, to supplement Social Security. By the standard of other public pension plans, and the six-figure pensions that draw outrage in places like California and New Jersey, it is not especially rich. Its biggest pension came to about $39,000 a year, for a retired fire chief with many years of service. The average retiree got around $12,000 a year. But the plan allowed workers to retire young, in their 50s. And its benefits were sweetened over time by the state legislature, which did not pay for the added benefits.

For many years, the city — like many other cities and states today — knew that its pension plan was underfunded. As recently as 2004, the city hired an actuary, who reported that “the plan is projected to exhaust the assets around 2009, at which time benefits will need to be paid directly from the city’s annual finances.”

The city had already taken the unusual step of reducing pension benefits by 8.5 percent for current retirees, after it declared bankruptcy in 1999, yielding to years of dwindling money, mismanagement and corruption. (A previous mayor was removed from office and found guilty of neglect of duty.) The city paid off its last creditors from the bankruptcy in 2007. But its current mayor, Ronald K. Davis, never complied with an order from the bankruptcy court to begin paying $16.5 million into the pension fund to reduce its shortfall.

A lawyer representing the city, R. Scott Williams, said that the city simply did not have the money. “The reality for Prichard is that if you took money to build the pension up, who’s going to pay the garbage man?” he asked. “Who’s going to pay to run the police department? Who’s going to pay the bill for the street lights? There’s only so much money to go around.”

Workers paid 5.5 percent of their salaries into the pension fund, and the city paid 10.5 percent. But the fund paid out more money than it took in, and by September 2009 there was no longer enough left in the fund to send out the $150,000 worth of monthly checks owed to the retirees. The city stopped paying its pensions. And no one stepped in to enforce the law.

The retirees, who were not unionized, sued. The city tried to block their suit by declaring bankruptcy, but a judge denied the request. The city is appealing. The retirees filed another suit, asking the city to pay at least some of the benefits they are owed. A mediation effort is expected to begin soon. Many retirees say they would accept reduced benefits.

Companies with pension plans are required by federal law to put money behind their promises years in advance, and the government can impose punitive taxes on those that fail to do so, or in some cases even seize their pension funds.

Companies are also required to protect their pension assets. So if a corporate pension fund falls below 60 cents’ worth of assets for every dollar of benefits owed, workers can no longer accrue additional benefits. (Prichard was down to just 33 cents on the dollar in 2003.)

And if a company goes bankrupt, the federal government can take over its pension plan and see that its retirees receive their benefits. Although some retirees receive less than they were promised, no retiree from a federally insured plan in the private sector has come away empty-handed since the federal pension law was enacted in 1974. The law does not cover public sector workers.

Last week several dozen retirees — one using a wheelchair, some with canes — attended the weekly City Council meeting, asking for something before Christmas. Mary Berg, 61, a former assistant city clerk whose mother was once the city’s zookeeper, read them the names of 11 retirees who had died since the checks stopped coming.

“I hope that on Christmas morning, when you are with your families around your Christmas trees, that you remember that most of the retirees will not be opening presents with their families,” she told them.

The budget did not move forward. Mayor Davis was out of town.

“Merry Christmas!” shouted a man from the back row of the folding chairs. The retirees filed out. One woman could not hold back her tears.

After the meeting, Troy Ephriam, a council member who became chairman of the pension fund when it was nearly broke, sat in his office and recalled some of the failed efforts to put more money into the pension fund.

“I think the biggest disappointment I have is that there was not a strong enough effort to put something in there,” he said. “And that’s the reason that it’s hard for me to look these people in the face: because I’m not certain we really gave our all to prevent this.”

Tuesday, December 21, 2010

A Medieval Future

The following essay by Cam Fitzgerald, was carried by Collapsenet.

The T-Bond market is groaning. Like a great, creaking ship lurching to one side, the sounds of shifting portfolio positions have grown louder and more ominous by the hour, accompanied by the clamor of bailout pleas and a mad scramble for the life rafts. Rates are on the rise and prices falling. Bonds are dead, long live Bonds!

The pirates off the stern, meanwhile, smell blood and are sizing up the opportunity to take down one of the fattest, easiest targets they have seen in all their sorry lives. They know they can take this craft down with words alone. If only they can spread fear above board and on the decks, they know the crew and its passengers will rush for safety, setting off a panic that sees all hands clinging to the rails on one side, capsizing the ship. But there are not enough life preservers! Blimey! It’s a salty, seafaring epic in the making.

Meanwhile, back in the landlubber’s world there seem to be quite a few asset classes that are being stretched and distorted. Equities in domestic markets have virtually regained their pre-recession highs in the absence of any real buyers other than high-frequency computer traders. Most other investors, insiders, mutual funds and individuals have abandoned equity markets in fear already. And yes, that is a bit of an exaggeration, because many people do remain invested. But we all know the big picture has changed. There are nagging doubts about the sustainability of markets. Who is really interested in buying stocks anymore when markets are looking overbought by computers alone?

Currency Debasement

We have to also contend with currency debasement, which means in other words that holding cash itself is not a good investment at this time, particularly with record-low interest rates. Well, if Bonds are in a bubble about to burst, and holding cash is just a surefire way to watch your wealth and buying power decline, then where do you go for safety?

In the background, the world’s third biggest economy, Japan, struggles under a debt burden that is almost epic, while the United States itself appears headed for a crisis of confidence as it monetizes its own debt obligations, guaranteeing a very painful adjustment in the future. Europe, as we all know, is on the ropes, and the likelihood that its currency union will fail seems a foregone conclusion. It is all about variables. In Europe there are just too many conflicting ideas about engineering a real recovery that have come up against a wall of public disenchantment, political bickering and even rioting from Athens to Paris. Even London is getting in on the action. Clearly, there are just too many moving parts in the machine.

And now China, the engine of the world’s functional economy — the country the world has pinned its hopes on to lead us out of deep and seemingly intractable recession, is itself forming what could prove to be the biggest real estate and credit bubble the world has ever seen. When that bubble bursts, the crash will be worldwide, since China’s influence now reaches all corners of the globe. With major investments on every continent from Africa to South America, and a regional dominance that encompasses dozens of countries, including Japan, Korea, Malaysia and many others significantly dependent on its trade, we now have the makings of something far worse than the Asian contagion of years gone by. With Western nations now heavily invested there too — from the corporate level all the way down to Ma and Pa’s nest egg being held in Asian growth-mutuals, there is no escaping the day when China’s real estate bubble implodes. And it will. It’s just a matter of time, unless the basics rules of economics suddenly cease to exist.

Bullion Rising on Fear

Gold and silver, meanwhile, are rising on fears of global indebtedness, sovereign default risk, inflation, and the aggressive debasement of the world’s reserve currency, the U.S. dollar. Those who think a bullion bubble is forming are steering clear of its bull market.

Others, mainly those with weak stomachs and a fear of heights, are moving toward the exits but finding few compelling alternatives. Piggybacking on the heated interest in precious metals, commodities such as cotton and copper are in parabolic rallies. Speculative plays that most people thought were dead following the credit crisis have actually sprung back to life with a vengeance. J.P. Morgan was recently revealed to have stretched the limits by buying up almost half the world’s inventory of copper and warehousing it in London. That gambit could secure their very survival if their paper investments or widely reported, massive short position in Silver blow up.

And they are not alone. A single European buyer attempted not long ago to corner Cocoa, while only months ago we watched from the sidelines as the world’s largest miner, BHP Billiton, came within a whisker of controlling almost half the world’s active potash deposits. The Chinese, meanwhile, have shown a sudden reluctance to share their unique wealth in rare-earths. As controllers of 97% of the global supply, they are in the catbird seat as the rest of the world looks no, wondering how they will obtain crucial supplies.

I hope that all of these recent developments are not being lost on investors, because there is a common thread running through them. It should now be perfectly clear that this commodity boom has significant, long-term implications for all of us. And it has legs, so not being invested is just foolhardy. By now, too, nearly everyone has recognized the strong correlation between Gold and most natural resources. These asset classes should outperform for many years, gaining impetus as populations explode higher and demand from the developing world accelerates at an increasing rate, while in the background sovereign default risk crowds out the willingness to lend.

Paper at Risk

One thing else should now be clear: Some paper investments and cash itself are the risk trades in a world of growing scarcity and expanding populations. Currency trading remains the flavor of the day nonetheless, and I have noticed lately that people with virtually no investment experience are taking an interest. This is just one more destabilizing factor among a phalanx of hazards that are gathering steam. Meanwhile, anyone capable of controlling a single commodity class is almost certain to reign supreme. The new landlord owns much more than land these days. He controls the rights to access of critical resources like food, metals and energy. He holds the keys to power that governments are losing as they destroy the value of their respective currencies. This trend augurs the basis of a new power game. Not that it did not exist all along — only that today there are so many more interests competing for fewer resources, and that is certain to continue driving prices even in the absence of real demand. The new interests include countries, of course, and some of them have very deep pockets. We are nearer the middle of the next great bubble, in my opinion, but this one involves all regions, all countries and every last soul on earth.

So the gold rush in resources is alive and well, but it too represents a distortion in our system as food prices have now almost doubled in the Third World. Famine awaits where intervention and support will not go, and it is one whose roots are not found in drought but in outcomes of a global financial system straining to remain in balance and a banking system that many still believe is in tatters. Its roots are in the shift of money from perceived risky investments into those that are real. Hard assets are today’s play.

The outcome of sudden price increases in commodities is certain to set off political instability in some the poorest places on earth. Food is a big worry in countries where incomes range below a dollar or two per day. Food is a big worry for those governing too, as they are often toppled as an outcome of a food crisis. This is a concern for everyone. The last thing the world needs right now is more political instability, and it is not just Africa, (Egypt and Ethiopia coming first to mind) that are now primed for discord over price hikes.

Food Riots

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Many of you will recall, for example, the food riots that broke out across the Third World in 2008. There is also widespread poverty in regions of India, Pakistan and even rural China, where wages are minuscule compared to the West. Food price-shocks are seen as very threatening to the governments of those countries. The advent of rising interest rates does nothing to quell the fears of many in the developing world as its low standard of living drops further yet.

That is only the beginning, though, and we need to keep in mind that as energy prices rise (which I fully expect) that the underpinnings of discord will arrive on the shores of North America too. Unlike Africa, we need to heat our homes, and it is not cheap. Nor will it get less costly as this boom accelerates. We are a widely dispersed population, dependent on vehicles that are in turn dependent on fuel to operate. An energy-price shock here will be met with dismay. Inflation will be the outcome, but it is the wrong kind because this inflation will not be accompanied by rising wages. On the contrary, wages will be falling due to ongoing global competitive forces that seem to still be a mystery to most people, particularly the trade unions. Hello! Those foreigners do all the same things we do nowadays, and they do it much cheaper. What did you think the outcome would be?

In any event, energy costs are set to rise. It is an inevitability that cannot be avoided.

But here again, the commodity boom is just another distortion in the system. Just as all hands on board the “Good Ship Bond” I mentioned above, and the analogy of passengers scurrying from port to lee, we are seeing investors everywhere looking for refuge from a coming storm, yet finding little real safety or even understanding how to both protect their wealth and build on their investments.

Resource Hedges

So they run from pillar to post in confusion, like so many headless chickens. A great deal of money is shifting to hard assets at this time, and it is not uncommon for a portfolio to have a resource hedge against an unknown future. The hedge is also likely to hold some fraction in gold these days, although many will be feeling underweight, especially after having seen the spectacular returns their neighbours have earned.

Well, this is where it all gets so interesting. Partly as a result of the credit crisis, partly as a result of past excesses and bubbles, many are living through a period of confusion and loss. Many more have never fully regained confidence in our systems nor in our investment choices of the past. There is no certainty anymore. The massive transfer of wealth into bonds has not yielded results so much as it has extra risk. Many even question if the original investments will be returned, given all the default fears. Nothing looks secure anymore — not cash, not bonds, not equities and not real estate. Distortions keep appearing as cracks in our banking and financial systems, as well as in countries themselves. The overriding concerns naturally are related to worries about debt that cannot be serviced in the future and obligations that cannot be met.

Might the whole system unravel almost overnight? Are we entering a moment in history where all investments carry a high degree of risk, and a major failure in any part of the system could bring down all of the others? We all “know” that something has to give, but we are collectively helpless to prevent it. Systemic risk is obvious to everyone. System risk suggests that if Japan, for example, touches off an orgy of monetization that sends them down the hyperinflationary road, we will all suffer the consequences. No country would be immune. Unfortunately, this is hardly unlikely. The Japanese are growing less and less confident in their government, and an aging population is facing retirement with a much lower standard of living. Peace and tranquility are not the words that spring to voters’ minds there. Borrowing, meanwhile, cannot help them pare current debt levels that seem to be pointing toward insolvency.

Not Just Japan

But it is not just a risk that Japan will default against her own people, as there are in fact a myriad of other distortions around the world, each a potential mine field — from the growing threat of a real estate bubble in China, to the very real possibility of European debt defaults and a pan-European currency failure. Even America’s moribund economy starts to look like an attractive investment, relatively speaking. To some of us, the housing collapse looks to be closer to its end than its beginning. Prices may well fall another 30%, but there is a certainty of a bottom, and that should not be doubted by anyone. It is just a matter of when.

So let’s recap. Bonds may well be headed for the trash heap. With rates on the rise, cash is a loser, buying power erodes, resource speculators rule, and stocks are expected to plunge momentarily. We cannot invest safely for the long term in Europe, Japan or China while politics, debt default, credit bubble concerns and currency issues weigh variously on those regions and all of their satellites. I suppose there will always be canned goods, roasted gopher with mint sauce, and buckshot, but something tells me the problems we will confront are much bigger than that, and there is nowhere to run. We are all in this mess together, and we need solutions now. Do we have a “Plan B” if The System actually crashes? In fact, we are trying to live in a world community that cannot even agree on the basics of banking — a world where small minds scuttle every good idea, and true leadership is in extremely short supply. If ever there were a time for serious discussions between nations, it is now. We need a back-up plan, and quickly. The System could unravel at any moment.

Mother of All Shorts?

So perhaps bonds are going to be the Mother of All Shorts. I am not so sure the pirates will collect their booty in a currency that has much value to them, though. The other long trade in a growth pattern now is commodity-based, since resources are at the heart of the shift in power across the globe. Poorer nations are struggling to maintain their fair share of the wealth, while stronger, militarized nations seek to protect their rights. I anticipate considerable political upheaval, and that in essence is what this article is trying to warn you about today.

By that same token, we can understand on an intuitive level the part that resources will play in settling debts between nations in the future. It cannot be understated that the day may come when we will trade off ownership and rights to those to whom we are indebted. This is hardly an unusual relationship, and it is worth noting here that Germany itself made war reparations in the form of agricultural products, industrial goods and other resources. Some have noted that U.S. debt levels can only be compared to similarly high liabilities run up during a war — food for thought and a partial explanation of the rush into commodities that is under way around the world.

Back to Serfdom

The resource trade will not be without its pitfalls, not from an investment standpoint. Nor will it be free of political unrest as rich and poor go eyeball to eyeball. Some serious setbacks are already on the horizon, particularly if China’s real estate markets suffer the same fate as all bubble markets do. Commodity prices will certainly decline; however, it is becoming increasingly clear that strong hands will move in and buy on weakness, exchanging their falling currencies for rights to build mines, cut forests, farm lands or dam and drain rivers and lakes. So the trend will remain intact as companies and governments coalesce around what is in the ground and steadily move away from paper trades that could become worthless overnight.

In the dark ages, the big land holders held all the power, serfs lived and died at the whim of their masters, and those without resources or armies were the weakest of all. We may not see an exact repeat of those bitter times when getting kicked off the land was a virtual death sentence, all but guaranteeing starvation, but it could be close. We’ll need to keep in mind the poorer nations, whose resources we often covet, as we attempt to rebalance the world’s financial relationships. Sharing the gains is essential for stability, particularly as it impacts our key allies and trading partners in far-flung corners of the globe.

Meanwhile, it seems that not much has changed concerning the dynamics of power over the centuries. It is impossible to avoid inequities, but we can still strive for fairness. We live in an age of discord and imbalance in search of a new kind of stability. The planet is being divvied up and there are already big winners and big losers. The developing world is on the rise and wants its fair share. It will come down to who owns the real goods, the hard assets and the lifeblood of the global economy. That is where the real money is.

Monday, December 20, 2010

The Health Of The State

Previously I reproduced essays by the Nominal Man, Dan Weintraub, and this the third one published at The Automatic Earth he lays out a scenario that I find both disturbing and highly likely. It postulates that our leaders agree with us when we express fear and pessimism about our future, but like us, they have no clue how to get out of this impossible dilemma. All they are doing is delaying the inevitable hoping against hope that something will come out of the clouds to save us. War most likely says Weintraub. Not so far fetched when you consider yesterday's discussion of the meaning of War.

"…Love is the answer and you know that for sure, Love is the flower you got to let it, you got to let it grow..."
John Lennon

"…War is the health of the State. It automatically sets in motion throughout society those irresistible forces for uniformity, for passionate cooperation with the Government in coercing into obedience the minority groups and individuals which lack the larger herd sense...

To most Americans of the classes which consider themselves significant the war [World War I] brought a sense of the sanctity of the State which, if they had had time to think about it, would have seemed a sudden and surprising alteration in their habits of thought.

In times of peace, we usually ignore the State in favor of partisan political controversies, or personal struggles for office, or the pursuit of party policies…With the shock of war, however, the State comes into its own again…

For the benefit of proud and haughty citizens, it is fortified with a list of the intolerable insults which have been hurled toward us by the other nations; for the benefit of the liberal and beneficent, it has a convincing set of moral purposes which our going to war will achieve; for the ambitious and aggressive classes, it can gently whisper of a bigger role in the destiny of the world…"
Randolph Bourne

In one of the many tragic ironies that define our fickle species, only war, deviously waged, has the ability to grant us a reprieve from our boundless greed, from our lawlessness and spiritual emptiness, from our gluttony and darkly comical self-delusion.

War is the sole industry that can effectively defy the self-aggrandizing forces of corporate off-shoring and the resultant impact of global wage arbitrage. War is the one enterprise that can, through the adroit fermentation of that loveliest of intoxicants (we call) "nationalism", dampen the destabilizing and tectonic forces of class struggle. War is the only industry capable of "employing" (distracting?) tens of millions of poor and disenfranchised and terminally indebted young American men and women away from the hopelessness that colors their futures. War, implies Mr. Scrooge, graciously decreases the surplus population.

War is indeed, as Randolph Bourne stated close to a century ago, the health of the state.

Conservative commentators in the United States are quick to chastise men like Paul Krugman for their unabashed and shameless support for additional trillions in government stimulus. These critics accuse the Krugmans of the world either of being wholly ignorant as to the implications of unbridled increases in the fiat money supply, or worse, of being in cahoots with the billionaire banking class and with its proxies on Capitol Hill.

In my opinion, these fury-fueled criticisms miss the mark. What Krugman fears most is austerity. He is concerned that moves toward austerity do not simply (and disproportionately) hurt society’s most vulnerable, but that such policies provide a fertile environment in which extremism and ultra-violence thrive. Krugman is thus willing to support "extend and pretend" fiscal policies in the present because he is afraid of the alternative.

In fact, I would characterize the Krugman position as a delaying tactic: kicking the fiscal can down the road for a while longer so as not to allow civil strife - the discontent that always accompanies increases in austerity along with its attendant human suffering (both real and perceived) - a foothold in the United States. Another, perhaps more cynical view, could be this: Better to watch the other nations of the world implode under the pressures of austerity than to let it happen here first.

And what of our oft-vilified Federal Reserve chairman? When confronted with the opinion that many people, both in the general public and in the field of economics, believe "QE2" to be a bad idea, Federal Reserve Chairman Ben Bernanke states, "...I know some people think that, but what they are doing is they’re looking at some of the risks and uncertainties with doing this policy action, but what I think they’re not doing is looking at the risk of not acting…".

It has been written time and time again - even by many conservative policy critics - that without the bailouts of 2008, the United States may very well have experienced a more immediate and steep systemic contraction than occurred that autumn. (It is true that these same critics argue that we must take our medicine sooner rather than later, and that the debt must be cleared before economic recovery can commence. I am simply pointing out that there are individuals on either side of the ideological spectrum who acknowledge that a removal of stimulus and a tightening of monetary policy will, at least in the short term, make things worse.)

Again, allow me to take a contrarian position to those who would argue that the Bernanke imperative illustrates the ignorance of those promoting loose monetary policies. I think that Chairman Bernanke understands all too well that his accommodating monetary policies will fail to fix the underlying and most fundamental and socially destructive of all economic ills-those of an ever-widening gap between rich and poor, and the absolute disaster caused by an ever-shrinking, formerly self-sustaining American middle class.

But here’s the deal: Like Paul Krugman, Ben Bernanke also believes - and this is why his voice cracks and his lips quiver when he speaks "confidently" of the Fed’s policies - that hedging against what would be pretty much instantaneous chaos here in America (if all support was withdrawn from the system, no matter how problematic such support is over the long term) through the infusion of trillions of fiat dollars into the economy is the only possible path to follow. (As for the growing austerity-driven crisis in Europe, we’ll just have to wait and see. I mean if war breaks out, it won’t be fought in our streets, right Mr. Chairman?)

I must be a member of the ruling elite to adopt such a seemingly apologetic tone toward men like Bernanke and Krugman.

But I am not. I am a nominal man living in a real world. In the real world, austerity and poverty hasten the arrival of civil strife. In the real world, real hunger and real suffering leads inevitably to the rise of radical and violent political and social movements.

And while it is certainly true that the American middle class is being summarily destroyed by the fraud perpetrated by the Wall Street moguls and by the complicity of the Constitution Avenue oligarchy, and while it is also true that financial hopelessness is on the rapid ascent throughout the land, our descent into the realm of Banana Republicanism (as opposed to Constitutional Republicanism) is neither precipitous nor volcanic. It is, at present, a slow burn.

And while I wholly and entirely agree with those who argue that three-plus decades of fraud and profligacy and lawlessness in the financial sector and in Washington have brought us to the edge of the abyss, I also believe that, at least for the past two years, we have the Federal Reserve and the Congress to "thank" for keeping us from falling off of a cliff.

Do not misunderstand me. While it may appear as if I am making a grotesque gesture of apparent gratitude to the very men whose policies and avarice have ruined the future for so many, please hear me out as I clarify my complete argument.

A question: Why would intelligent men and women, regardless of moral considerations, promote fiscal policies that many now agree can only buy them, at best, a few years of financial respite? Is it because they just want to grab as much of the metaphorical pie as is possible before the next leg down?

Is it because they truly believe that the "Pax Americana", arguably in force since 1918, can be sustained via the creation of trillions of new irredeemable dollars? Is it because they simply don’t understand how credit and debt function when all trust in the system evaporates? The answer, you see, lies within Randolph Bourne’s prescient words of a century past.

I am a nominal man with a pretty good understanding of how things work in the real world. In the real world, war comes, one way or the other. War always comes. And in the real world, governments pursue war not because it is the righteous or just thing to do, but because more often than not they view it as the only viable thing left to do.

Of course governments will always attempt to create and nurture an ethos of righteousness and justice surrounding the wars they wage, and it is far easier to convince the citizens of the nation that "civilizing" wars and wars of foreign liberation (Take up the White Man’s Burden?) are the most righteous causes of all. (Far easier to convince the people of that than to convince them to fire upon their own, in the streets) And so with nowhere seemingly left to turn, governments pursue wars of aggression, of impetus, and of pre-emption, rather than waiting for the collapse of their own state into civil war.

I am a nominal man living this real American tragedy. I live moment to moment, paycheck to paycheck. I have sold my car and many of my possessions so that I can feed myself and my children. I have purchased with the last of my dollars a small piece of land in rural America. There I will erect a humble 250 square foot cabin. I will grow vegetables to barter at the local marketplace. I will recede from that which I simply can no longer afford nor sustain.

And while I must admit to often feeling a great rage and despair at what has become of my world, and while I want to blame the masters of greed - the Bernankes and the Blankfeins and the Buffets - for the destruction of this world, I am also compelled to consider that Krugman and Bernanke are pursuing policies whose aim is to keep civil strife from destroying, in the near term, the very fabric of American society.

War will come. Perhaps men like Bernanke and Krugman are simply trying to let it arrive first in a foreign land.

I cannot offer any ethical defense for the actions of my country. I more often than not find such actions overwhelmingly reprehensible and amoral. But I must wonder: Why do conservative thinkers attack men like Ben Bernanke and Paul Krugman for promoting monetary policies aimed at keeping America free of civil unrest (and by logical extension delaying an American crisis while Europe begins to burn in the fires of austerity), when these same ideologues more often than not support military solutions abroad to many of our policy dilemmas?

It strikes me that the solutions offered by the Federal Reserve-policies of quantitative easing and of corporate bailouts and "printed" monies for food stamps and unemployment insurance and Medicaid, etc.-that these policies are poorly disguised attempts to let the rest of the world devolve into global austerity-driven conflict, while America uses the extra time bought by such policies to eventually pursue "righteous and just" wars; wars fought on foreign soil, to clean up the mess and to once again come to the rescue and to make the world a better and safer place for humanity.

Perhaps pursuing policies aimed at "extending and pretending" is in fact better than the alternative. Perhaps continuing on the clearly unsustainable, and I would argue eventually disastrous, path of debt monetization in order to extend unemployment benefits to those without jobs and in order to provide food stamp subsidies to those without any other way to feed their children and in order to fund health care benefits for our nation’s elderly and infirmed; perhaps that is the better choice-at least for the near term, and at least, in the eyes and hearts of our political leaders, as a way to prepare the nation for the inevitability of the great wars to come.

For individuals who view themselves as citizens of the world first, and of nations second, these policies are repugnant. But governments never view themselves as such, save only to profit through the mendacious efforts of such institutions as the World Bank and IMF.

War is the health of the state, but only if the war is fought somewhere else, correct? The policies currently pursued by our Congress, by our President, and by extension by the U.S. Federal Reserve, are policies aimed at keeping the peace at home just long enough so as to let other lands face the fury of a citizenry betrayed.

I am a nominal man living in the real world, and in this real world in which I toil and about which I mourn, love may be the answer for me and for my wife and children, but war remains the health of the state.

Sunday, December 19, 2010

The End Of Consumerism

From The Press of new Zealand this primer on how things seem set to change over the next few years. Because it comes from a foreign country perhaps, this explanation of diminishing supplies of cheap energy lacks some of the Hollywood attributes of home grown collapse essays. It looks to a future of profound change without the drama of gun fuelled violence and fear. Once you understand the money equals energy the basic underpinnings of our world are laid bare and everything is made clear. Our leaders understand this relationship, which is why we still have military bases all around the world- not least in Iraq. The exact amount of daily consumption of liquid energy by planet is a little bit in dispute but the round number most frequently agreed to is 82 million barrels and the US consumes about one quarter of that. Think of it this way: Cuba survives on very little daily oil. Look at their way of life. Mexico is running out of cheap and abundant oil from the Cantarell field (down by three quarters!): look at how change is coming to their society...And soon we like Europe will face the brick wall of rising energy costs, huge debt burdens and social demands. It would be nice to think a few of us have understood what's coming before it arrives. Here's a chance to think about the collapse before it happens.
It's not the end of the world, just the end of consumerism. We are about to wave goodbye to the dream of endless economic growth - always, every year, more stuff. However, we have enough already. We really do.

Dr Susan Krumdieck, an engineering professor at the University of Canterbury, addresses her audience with a smile. The message is radical, but she believes it will be good news once we have had time to get used to it.

A change is about to be forced on society because energy consumption pretty much is the economy. And we are about to run short of the cheap energy which has been driving the past century of unchecked economic expansion.

There is this myth going round, says Krumdieck, that with every decade we have grown wealthier because we have collectively become smarter and more productive. If everything is bigger, better, brighter, well, it has been earned.

Yet actually we have just been digging up and burning more fossil fuel. Graph the world's energy consumption against its gross domestic product (GDP) and the two lines track. So get down to the nitty gritty and this is what it has all been about. Converting oil or coal into shoes, hamburgers, cellphones and SUVs.

However, a reckoning is coming. The ecological limits on growth have come into view. Climate change and over- population. But peak oil most immediately.

Over the past year, this has even become semi-official. Towns like Dunedin and Timaru have just voted in their first "peak oiler" councillors. Parliament's research department recently released a rather unwelcome document, The next oil shock?. A group of Kiwi scientists has set up - a think tank for the second, post-fossil fuel phase of the human story - and issued their manifesto for "strong sustainability".

Everywhere the meetings have been gathering pace. A cross-party conference of Members of Parliament met to talk about the threat to the economy. And now there is this e-conference, Signs of Change, organised by Krumdieck. People seem ready to face some hard truths.

Of course, it could be just the doomsters talking. Anyone who can remember the last oil crisis of 1979 - President Jimmy Carter warning of national catastrophe in the United States, car-less days in New Zealand - will also remember how swiftly the world moved on again.

The Club of Rome's The Limits to Growth, a study based on an alarming set of computer predictions, was briefly a fashionable read; it fell out of fashion, along with flared pants.

But biophysical constraints to growth are back on the agenda, says Krumdieck. And once people get over the initial shock, once they have adjusted to the idea of a future of having to live within our ecological means, they will see how it will all work out in the end, she adds, offering another hopefully reassuring smile.

In truth, several factors underpin economic growth.

The availability of capital is one - a free flow of credit to build factories and launch businesses. Population is another. More people means more production. And technology. That goes without saying. We would like to think human inventiveness is the biggest single reason for continually rising living standards.

However, "biophysical economists" like Charles Hall, a professor at State University of New York, argue that the modern era is predominantly the story of how we have turned the energy so conveniently locked up in buried fossil fuels into an ever-expanding array of consumer goods and services.

It even accounts for empires. Great Britain arose because it had the ready supply of coal to turn iron into ships and cannons. The US became a world power because it had the sweet light oil fields of Pennsylvania and Texas.

Hall says it is obvious energy is needed to make things. Or even grow them. When the tractors, fertilisers and all the other energy inputs are totted up, it takes about four litres of oil to put the food on our plates each day.

But Hall says what really matters is the gap between the price we pay for energy and how much value we can then extract from it - the energy returned on the energy invested (EROEI). This is the profit margin which makes the difference between us feeling rich or poor as nations.

For a century, oil and coal have seemed so cheap that economically they have barely been a talking point. It has only cost about a barrel of oil for every 20 barrels extracted. So petroleum has been inexpensive to deliver. The EROEI story for coal-mining has been very similar. Then, because economic activity is energy consumption by another name, this has created plenty of head- room in the economy as a whole.

Hall's analyses show that in the 1990s and into the 2000s, the energy bill to run the US was less than 10 per cent of its GDP. Which, after all the necessary costs of life, like infrastructure, health and education, were taken into account, still left a quarter of the entire economy for discretionary spending - the enjoyment of wealth.

But, he asks, what if the price of oil were to double - as it did in the 2008 spike that preceded, and may have even provoked, the financial meltdown? Or quadruple as it did in the 1970s, and some are suggesting might happen again if oil supplies become constrained?

Hall says energy could suddenly become 20 per cent of society's running costs, or even more than a third. And the cuts to balance the books would have to come off the discretionary spending. So that sense of easy wealth would fast be wiped out. A quarter could shrink to next to nothing fairly rapidly.

These are back of an envelope calculations perhaps, admits Hall. But broadly it can be seen we rely on a world where our energy sources are not just plentiful but also dirt cheap. A profit margin has to be built in to rig the national GDP game. And when that era ends, we had better have a plan B ready, Hall says.

The focus is on petroleum because oil and natural gas are still overwhelmingly the prime fuel sources for the world.

According to the annual BP statistical review of world energy, oil makes up 35 per cent of the global energy budget, while natural gas is another 24 per cent. Coal is then 29 per cent, while nuclear is just 5 per cent and renewables, like hydro and wind, answer for the remaining 7 per cent.

And while New Zealand often pats itself on the back for being a hydro nation, dams meeting 31 per cent of our needs, we are in fact even more reliant on oil than average. A long skinny country, connected by a lot of roads and a lot of trucks, oil is nearly 40 per cent of what we use.

The peak oil argument is that the Earth's supply of petroleum is limited and we have burnt through a trillion barrels of crude oil now. Our appetite has been exponential - each year always more. We have also quite naturally been pumping the cheap and easy-to-get-at oil first, the large reservoirs found in places like Alaska and the Middle East.

So eventually, we will be left with only a diminishing supply of the dirty and hard-to-recover oil. The deep sea wells that blew up in the Gulf of Mexico, the tar sands that will have to be open-cast mined in Canada, the scattering of smaller fields that might remain spotted around the world.

Which is when Hall's EROEI and the law of diminishing returns kicks in. Steadily the cost of producing oil will rise and its in- built profit margin will begin to shrivel.

FACT BOX Top 10 oil producing countries. Amounts are barrels per day.

* 1 Russia 9,932,000

* 2 Saudi Arabia 9,764,000

* 3 United States 9,056,000

* 4 Iran 4,172,000

* 5 China 3,991,000

* 6 Canada 3,289,000

* 7 Mexico 3,289,000

* 8 United Arab Emirates 2,798,000

* 9 Brazil 2,572,000

* 10 Kuwait 2,494,000

* 58 New Zealand 61,150

* Source: Central Intelligence Agency factbook