Treasury Market-Rigging Further Disrupts the Middle Class


By Barry Elias | Friday, 02 Oct 2015 06:48 AM

The U.S. Department of Justice and the New York State Department of Financial Services are looking into possible manipulation of the U.S. Treasury market by banks and brokers that serve as primary dealers to underwrite government debt.

To date, 23 lawsuits have been filed, with 2 more coming soon, that allege collusion by these institutions to enhance their profits at the expense of their investor clients. More than half of the cases brought forth thus far have been on behalf of pension funds, which predominantly serve the middle class.

The allegations claim the dealers inflated the price of newly issued Treasury securities that they sold to investors and lowered the price for securities they purchased from the U.S. Treasury. If accurate, this raises the cost of issuing Treasury security debt to taxpayers.

These cases include a comparable price analysis that was used in the market manipulation trials over the Libor — the London Interbank Offered Rate and the benchmark interest rate for lending between banks — and the currency markets, which resulted in more than $5.6 billion in penalties from six banks.

Gregory Asciolla, a partner at the law firm Labaton Sucharow, which is the lead counsel in two cases that involve the State-Boston Retirement System and Arkansas Teacher Retirement System, claims the auction and pre-auction market — also known as “when issued” — are “rigged.”

The Cleveland Bakers and Teamsters Pension Fund alleges the price was reduced in 69 percent of the auctions for securities in the secondary market — or those already in circulation. This analysis included data between 2007 and 2015.

Declining comment are the U.S. Treasury, The Federal Reserve Bank, and primary dealers contacted by The Financial Times.

Once again, high powered financial institutions continue to prosper at the expense of the middle class.

© 2015 Newsmax Finance. All rights reserved.

Banks Bank on Saving Billions Using Bitcoin Blockchain


By Barry Elias | Friday, 25 Sep 2015 09:36 AM

Banks are investing millions of dollars in the development of the bitcoin blockchain technology in the hopes of saving billions of dollars down the road.

Nine investment banks are collaborating with start-up R3CEV, a New York-based group of trading and technology executives, to develop governing standards and procedures to implement a more effective and efficient settlement system for asset movements between counterparties. They have invested several millions of dollars in seed capital with R3CEV thus far for the research, experimentation and design of prototypes.

The blockchain methodology is viewed as an instant, real time update of payment ledgers in multiple locations without a single, centralized authority overseeing the process. Banks, financial exchanges, and settlement clearinghouses are exploring how to harness this technology for the automatic execution of contracts that could potentially save billions of dollars in bank operational expenditures.

The nine investment banks are Goldman Sachs, JPMorgan, Credit Suisse, Barclays, Commonwealth Bank of Australia, State Street, RBS, BBVA, and UBS. Many banks, including Barclays and UBS, are working toward their own blockchain model or partnering with other start-ups, as a way to hedge their bets and align with the best possible option in the future.

Advocates of this industry collaboration point to the successes of other ventures such as the Depository Trust Clearing Corporation, to clear trades for corporate stocks and bonds, municipal bonds, and money market instruments; the CLS, to clear funds for global currency trades; and the Society for Worldwide Interbank Financial Telecommunication (SWIFT), a global financial messaging system.

Circle Internet Financial recently became the first firm to be issued a BitLicense by the New York Department of Financial Services (DFS), permitting it to offer digital-currency services in New York. The company was founded two years ago and backed by Goldman Sachs.

The DFS said 22 firms applied for the license, including CoinSetter, Consensys, Gemini (founded by Cameron and Tyler Winklevoss), ItBit, and Symbiant, and it expects more approvals shortly.

The BitLicense was originally introduced by then- DFS Superintendent Benjamin Lawsky in January 2014. The license allows digital-currency firms to expand their services while protecting clients with anti-money-laundering compliance and cybersecurity protocols.

Circle is able to offer mobile payment services to receive, hold, and send U.S. dollars and bitcoins via text messaging that does not require conversions from one form to the other.

Circle is pursuing this same option with other currencies, such as the euro.

There seems to be no turning back from bitcoin.

© 2015 Newsmax Finance. All rights reserved.

Market Manipulation Is Menacing to the Middle Class


By Barry Elias | Friday, 18 Sep 2015 05:54 AM

Wealth and income inequality has risen substantially since the Great Recession, and market manipulation is making matters even worse for the middle class.

Richard Grasso, former chairman and chief executive of the New York Stock Exchange from 1995 to 2003, suggests the average person is severely disadvantaged relative to Wall Street institutions and the causes need to be thoroughly investigated and corrected.

Prompting this remark was stock trading the morning of August 24, when the Dow Jones Industrial Average tanked approximately 1,000 points within the first six minutes on news of a dire Chinese economy that may portend poorly for the world.

The large sell orders precipitated nearly 1,300 trading halts, as ETF indices were unable to execute transactions in an optimal fashion and prices fell below the underlying stocks they held. TD Ameritrade experienced volumes 10 times larger than average in the first half-hour of trading, causing severe price volatility: 30 percent for Facebook within several minutes as its price moved from $86 to $72 to $84.  (Trading is halted for five minutes when there is a price move of 5 percent or more in either direction.)

Ironically, the ETF products are marketed to middle-America so they can participate in the American dream of investing in a cost-effective and diversified manner. However, the lack of adequate trading liquidity and the capital losses that result may greatly offset the low trading cost.

Grasso believes high frequency traders receive proprietary trading information ahead of others and transaction speed trumps competition and fairness. He suggests the trading of shares on more than 60 venues makes execution at the best possible price quite difficult and costly to the little guy.

Jeffrey Sprecher, chairman and CEO of Intercontinental Exchange Inc., also says the stock market is overly complex and needs simplification.

Evidence of market rigging has been uncovered in the pricing of the gold fix, LIBOR and foreign currency exchange.

Recently, 12 banks and two institutions agreed to pay $1.87 billion to settle allegations that they manipulated the $16 trillion credit default swap market by prohibiting exchanges from placing these products on open, regulated platforms where pricing is more transparent.

The 12 banks named in the suit are Bank of America, Barclays, BNP Paribus, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan Chase, Morgan Stanley, Royal Bank of Scotland and UBS, along with the International Swaps and Derivatives Association (ISDA) and Markit Group, a data provider.

The Los Angeles County Employees Retirement Association and several Danish pension funds claimed the banks influenced the ISDA to deny intellectual property to the exchanges, such as auction price data.

As part of the agreement, the ISDA will form a committee, comprised of banks and investors that are independent of its board of directors, to license credit derivative products to exchange-like venues.

Currently, ISDA decisions are made by its board, which until 2009 was comprised entirely of bank representatives.

Dark pools have also been under intense scrutiny lately. These venues permit stock trading with greater anonymity than on the stock market exchange, amounting to a competitive disadvantage to many.

Credit Suisse tentatively agreed to pay $85 million to New York and the federal authorities for this practice. Last month, Investment Technology, a New York Brokerage, set aside $20.3 million to settle allegations of wrongdoing.

In January, the UBS Group agreed to pay $14 million for creating an unfair playing field using dark pools. And Barclays is in negotiations with the New York State Attorney General and the Securities and Exchange Commission regarding their involvement in this area.

The middle class has been ill-served by the current financial climate. Perhaps progress is afoot.

© 2015 Newsmax Finance. All rights reserved.

The Time Is Ripe for a Third-Party Presidential Candidate


Donald Trump essentially represents an independent third-party candidate, since he is a self-financed, non-ideologue, who seems to believe as I do that neither political party has a monopoly on poor public policy.

While never a politician or government employee, Trump brings transferable skills and experiences to the table: an innovative, creative and productive entrepreneurial record.

The following article was originally published on Friday, November 15, 2013.


By Barry Elias | Friday, 15 Nov 2013 07:17 AM

The credibility and trustworthiness of both political parties have waned significantly over the past few decades.

Extreme political polarization in Congress and recent polling that indicates many people would not elect their current Congressman suggests the time is ripe for a centrist, third-party candidate for president.

Republicans and Democrats created the public policy landscape that caused the financial crisis, which continues to this day.

After a $29 trillion Wall Street bailout, Main Street has barely felt a nudge, and Obamacare and the government shutdown have further eroded the future of our fiscal integrity.

Andrew Huszar, a former Federal Reserve official in charge of administering the massive bond-buying program labeled quantitative easing (QE), suggested in a Wall Street Journal op-ed piece that this was the first time in the nearly 100-year history of the Fed in which mortgage bonds were purchased from banks.

The result was a huge windfall for banks. They received nearly $4 trillion in capital over a five-year period from the Fed and recorded massive profits as a result of low-borrowing costs, bond capital gains and brokerage commissions for the bond-purchasing transactions.

However, this $4 trillion expenditure created only $40 billion in economic growth, or 1/4 of 1 percent — a very poor return for the American people indeed.

Further, Democrats are beset by Obamacare and Republicans by the government shutdown and intransigent social policies.

The Real Clear Politics eight-poll average indicates Congressional net disapproval has grown from 22 percent to 75 percent over the past four or five years (a 53-point negative move). Since the beginning of his term, the president’s net approval has fallen from 44 percent to -11 percent (a 55-point negative move). Net approval of their own Congressperson fell from 47 percent in 1990 to 1 percent today (a 46-point negative move), according to the Gallup.

In 1992, Ross Perot won nearly 19 percent of the presidential vote when the political chasm was much smaller. Eighty years earlier, Theodore Roosevelt captured more than 27 percent of the vote in the 1912 presidential election running as the Progressive “Bull Moose” candidate, garnering more votes than his Republican counterpart, William Taft.

Today, a third-party presidential candidacy can be viable, since both party brands have been severely tarnished in recent decades.

This independent candidate must embrace the best of both parties — a fiscal conservative who demonstrates compassion toward the indigent and a social moderate who empathizes with the vast complexities of the human condition.

New Jersey Gov. Chris Christie will have a very difficult time surviving the Republican primary despite his social conservative credentials, and Hillary Clinton is beset with huge policy failures that will hurt her at the national level.

The issues surrounding Hillary Clinton include the Benghazi debacle and her overwhelming support for the sinking Obamacare legislation. The Affordable Care Act (ACA) is eerily reminiscent of the massive universal healthcare overhaul in 1993 that she chaired under President Bill Clinton, which was jettisoned in bipartisan fashion.

Recent efforts by Bill Clinton to remedy the ACA may prove insufficient in salvaging her reputation. Bill Clinton has recommended that President Obama fulfill his powerful, oft-repeated promise that you can keep your doctors and insurance plan if you so choose.

There is a tremendous void in the center that awaits an independent, third-party candidate for president — one who can champion a clear path toward economic prosperity, individual responsibility, equal opportunity and respectful empowerment for those facing tough times.

If ever there was a time for an unprecedented independent win, this is it.

© 2015 Newsmax Finance. All rights reserved.

The Fed Is Becoming Less Relevant


By Barry Elias | Friday, 11 Sep 2015 11:40 AM

The Federal Reserve implicitly acknowledges that it is ill-equipped to fulfill its dual mandate of optimizing the levels of inflation and employment in the broad economy.

The Fed was charged with these objectives when the Humphrey-Hawkins Full Employment and Balanced Growth Act became law in 1978.

Now, the Fed believes employment is a non-monetary phenomenon — as I have and still do.

In their Statement on Longer-Run Goals and Monetary Strategy, the Fed recognizes that “maximum employment is largely determined by non-monetary factors that affect the structure and dynamics of the labor market.”

They also understand that these factors “may not be directly measurable.”

Alan Blinder, an economics professor at Princeton and a former vice-chairman of the Fed, claims the Fed is “clueless” about the growth of labor productivity. Despite lackluster growth of 0.65 percent each year on average since 2010 — and only 0.3 percent last year, excluding farming — the Fed anticipates productivity to grow at approximately 1.75 percent annually: a very unrealistic projection.

The Fed also recognizes that inflationary data and projections are not well understood. James Bullard, President of the Federal Reserve Bank, recently said, “There is definitely less confidence, a lot less confidence” in how inflation operates.

The Phillips Curve, an economic model that posits the rate of inflation and unemployment move in opposite directions — e.g., high unemployment suggests low inflation — has not been empirically accurate in recent years.

The rate of Inflation has declined less than expected following the financial crisis when unemployment hovered near 10 percent, and is now rising less than expected — currently below 2 percent — as the unemployment rate has fallen to 5.1 percent and labor demand is at record levels, with 5.8 million job openings advertised in July.

(While inflation for goods and services remain low, expansionary monetary policy has inflated financial assets, thereby increasing income and wealth inequalities to near historic levels.)

Economists are reevaluating the inflationary model based on behavioral psychology and empirical data. Simon Gilchrist, a Boston University professor, and Egon Zakrajsek, a Fed board economist, suggest when cash and credit levels dwindle during financial crises, firms may actually increase prices in the short-term, even if they risk the loss of long-term customers.

This dynamic would especially apply to essential products and services, such as food, energy, healthcare, and residential rent.

Stanley Fischer, Vice Chairman of the Federal Reserve, suggests currency exchange rates play an important role in formulating monetary policy as well.

There is now evidence that the strong U.S. dollar may not necessarily translate into lower import prices and domestic inflation in the U.S., as compared with other countries.

For a long time, many economists believed that inflationary expectations are critical in forecasting future inflation. These expectations are typically represented in bond yields, with low rates suggesting low inflation going forward. The low government bond yields of late suggest low inflationary concerns from the market, which might contradict the Fed’s intent to raise interest rates soon.

Given this information, the Fed “should be a little more uncertain about forecasting inflation than it was,” says Athanasios Orphanides, a former governor of the Central Bank of Cyprus, a Fed economist, and a professor at the MIT Sloan School of Management.

Alan Greenspan, former chairman of the Federal Reserve, says fiscal policy, or the government’s tax and spending programs, is more important than central bank monetary policy, and the Fed will “become utterly irrelevant” if lawmakers undermine their fiscal responsibilities.

The Fed has limited tools to work with. Adjusting interest rates and the money supply is insufficient to deal with fiscal issues, such as federal debt and income inequality.

Blinder believes the importance and power of the Federal Reserve is overstated, and they can only address these “around the edges.”

If they are uncertain as to the cause of price movements, how can they know when to adjust interest rates and by how much?

Further, the Fed needs to be thinking more outside the box. Unemployment levels may be less important than other parameters. In May 2004, when employment was at 5.6 percent, the Fed believed this signaled a near onset of rising inflation and the need to increase interest rates.

The effective federal funds rate then rose from 1 percent in May 2004 to 5 percent in June 2006, while the unemployment rate fell to 4.6 percent.

However, this large, rapid rise in rates precipitated the financial crisis. The quantity of outstanding adjustable-rate subprime residential mortgages was so large that many homeowners no longer maintained the income to support the huge increase in monthly debt service payments — causing significant and rapid sales to meet cash flow obligations, depressed prices, excessive foreclosures, and a dire economic recession.

The Fed also needs to be prescient of global economic developments. The recent Chinese economic slowdown may have enormous impact on emerging economies as well as the U.S. in terms of lower imports and weaker commodity and energy prices.

Monetary policy is experiencing diminishing returns, and fiscal reform is the best tool we have to resuscitate our economy. My tax proposal is a good place to begin.

© 2015 Newsmax Finance. All rights reserved.

Bankers Getting On-Board With Bitcoin Blockchain

By Barry Elias   |   Friday, 04 Sep 2015 12:50 AM


Bankers are going bonkers for the bitcoin blockchain.

Go figure. Several years ago, the financial industry was abhorrently opposed to the introduction of bitcoin, a virtual currency that would revolutionize the way we conduct our banking business. Fearful of a massive professional upheaval, the financial cognoscenti steeled themselves in undermining this virtual currency.

Fast forward a few years, and ironically, Wall Street is now the largest proponent and investor in this space and the momentum continues to grow.

The financial industry has taken exceptional note of the possible applications of the blockchain distributed ledger methodology that underpins the bitcoin technology. Essentially, the blockchain functions as a trusted “third party” to verify the validity of a digital asset transfers. However, this third party is comprised of the entire universe of bitcoin market participants, rather than a centralized authority subject to unpredictable behavior. Digital miners independently confirm that all the ledger transactions are bona fide, for which they are compensated.

The blockchain method is now being viewed as a way to digitize any good or service so its ownership can be transferred accurately, timely, cheaply, transparently, and securely. In particular, the financial industry has its eye on utilizing this ledger system to trade currencies, public and private equities, corporate bonds, and syndicated loans.

Goldman Sachs, Santander and BBVA have invested in start-ups that focus on harnessing this technology. Citigroup and JP Morgan have been conducting internal groups to assess how best to enter this area. And Barclays would like to implement this technology to offer consumer products that are less expensive than credit cards and direct money transfers.

Bank of America and more than a dozen financial institutions have met with R3Cev to coordinate a foreign currency exchange platform using the blockchain ledger apparatus. This has huge implications, since the daily trading of foreign currencies was $5.3 trillion in April 2013, according to the September 2013 Triennial Survey of the Bank of International Settlements.

Nasdaq OMX Group has embarked on what may be the largest project in this area. It would like to use the blockchain to process privately held equity transfers. Currently, these transactions take as long as several weeks to complete. The Nasdaq Group believes this new methodology is more efficient, transparent and secure than the current techniques.

The U.S. Federal Reserve Bank and the Bank of England are also in the mix.

Further, the applications for other industries are significant, since this model provides a more effective and efficient accounting system. Governments are looking into this for more robust record keeping and the music industry sees potential in tracking and tabulating artist royalties based on internet download activity.

The consensus now among bankers is the blockchain technology is here to stay. The new question is not when it will be adopted, but how.

© 2015 Newsmax Finance. All rights reserved.

China Shows Worrying Signs of Slowdown as Investors Weigh Risks

The Global Recession of 2008 took decades to manifest. The recovery may take just as long.

More than four years ago, I suggested the Chinese economy was headed toward economic slowdown, which would have adverse consequences for the rest of the world. Today, that prognostication seems frighteningly real.

From 2001 to 2010, consumption as a share of GDP in China fell to 36 percent from 46 percent, while the near reverse occurred for investment, rising to 47 percent from 36 percent.

This high level of investment, which was financed with large quantities of debt, could not be supported by the current levels of income. In essence, the Chinese built homes, offices and manufacturing plants that they neither needed nor had the ability to support financially.

Since 2007, China embarked on a debt-driven plan to increase domestic investment, income and economic growth, expanding total debt from $7 trillion to $28 trillion.

As a share of GDP, its debt more than doubled from 130 percent in 2009 to 282 percent by mid-2014, making it larger than that of the United States or Germany.

Roughly half of the loans are associated directly or indirectly with China’s real estate market; unregulated shadow banking now accounts for approximately half of all new lending; and the debt of many local governments is likely unmanageable, according to a McKinsey & Co. study.

China maintains a large presence on the world’s economic stage. By 2011, it contributed 40 percent of the world’s economic growth. In 2014, China was the third-largest importer, closely behind the United States and the European Union, with $1.96 trillion of imports, and the largest exporter with $2.34 trillion in sales. Currently, it accounts for 16 percent of world economic activity, the equivalent of the U.S. in purchasing power parity terms.

China purchases about half the world’s aluminum, nickel and steel, and nearly a third of its cotton and rice, as well as iron ore, copper and coal, which created a boon in commodity prices.

It also expanded its foreign direct investment program, growing ten-fold from 2005 to 2013, and was the largest investor in five of the 10 riskiest countries.

Given China’s premier global economic standing, its difficulties are metastasizing worldwide. It has begun reducing capital investment, causing commodity prices to fall and hurting many of its trading partners, including South Korea, Japan, the U.S., Taiwan, Germany, Australia, and Brazil.

China now contributes 30 percent to world GDP growth, down from 40 percent four years ago.

Structural demographic trends portend poorly for China, since its working-age population is beginning to contract. Lower employment, income and economic growth may precipitate asset sales to service outstanding debt — leading to real estate price declines, lower loan collateral, and less lending.

Further complicating matters, in 2007, Li Keqiang, now China’s premier, told the U.S. ambassador that the Chinese GDP figures are “man-made” and therefore unreliable, according to a memo released by WikiLeaks.

Since then, macroeconomic research firms have attempted to measure these data more independently. The official Chinese estimate of economic growth stands at 7 percent. This is in stark contrast to that suggested by Capital Economics at 4.1 percent, Conference Board/Hitotsubashi at 3.8 percent and Lombard Street at 3.7 percent.

In a bit of monetary and financial schizophrenia, China has recently vacillated between a market and state-driven economy to manage its economic affairs.

In an attempt to have the renminbi included in the International Monetary Fund’s Special Drawing Rights, China sought a more flexible exchange rate, only to see it plunge in value. This led it to strengthen the currency with daily purchases totaling tens of billions of dollars.

Investors suspect the yuan will weaken an additional 4 percent to 6.75 percent relative to the dollar. This anticipated decline is in addition to the 4.4 percent drop since August 11.

Daily trading in yuan options skyrocketed to $12 billion following the currency intervention by the People’s Bank of China from an average of $4.2 billion. The cost to insure $100 million against a weaker yuan ballooned from $30,500 to $1.7 million during this time, suggesting further currency erosion.

In a reversal, after discouraging the use of borrowed funds to purchase stocks, the Chinese government sanctioned this activity by providing funds to state lenders. In addition, it limited IPOs to reduce competition with existing equities; permitted a pension fund to purchase stock; limited stock sales by large shareholders; forced company stock buyback programs; lowered interest rates and deposit reserve requirements; and spent more than $200 billion buying Chinese stocks since early July, with the likelihood that this rate of spending would need to be indefinite.

The Chinese concluded this stock-propping program was unsustainable and decided to discontinue its operation. The gains of 60 percent since December 2014 have evaporated completely.

In March 2007, nine months before the beginning of the Great Recession, the U.S. experienced a government security yield curve inversion, when short-term interest rates were higher than long term rates: the three-month Treasury bill at 5.1 percent and two-year Treasury note at 4.6 percent.

Typically, longer-term investments are more risky and warrant greater returns on investment. However, yield inversion signifies greater short-term risk associated with an anticipated economic downturn.

Since 1970, yield inversions predicted an economic contraction six of seven times. By March 2008, the yield inversion was reversed, and short-term rates were lower than long-term: 1.11 percent for the three-month Treasury bill and 1.33 percent for the two-year Treasury note.

In the case of China, the yield inversion has lasted more than four years. On August 25, the two-year Chinese government bond stood at 3.50 percent and the 10-year bond at 3.48 percent: a minor inversion still exists.

This long duration signals the economic slowdown may continue for many years and possibly approach zero growth with negative global implications.

© 2015 Newsmax Finance. All rights reserved.

China Economy May Drag World Down

This article was originally published on December 16, 2011.

As China goes, so goes the world.

My column of June 24, 2011 (“China Yield Inversion May Portend Economic Slowdown”) opened with the following sentence:

“The yield on Chinese bonds are inverting at an accelerating rate. This does not portend well for the Chinese economy, and this may have negative implications globally.”

China’s contribution to global economic growth this year is nearly 40%.

The reason: property construction in China boomed significantly during the previous decade.

The Chinese government controls all the allocation of land. Beginning in 1998, Chinese authorities permitted individuals to buy the “right” to use property for 70 years. Domestic capital controls, which limited investment outside China, increased demand for this asset.

As a result, property construction boomed. The increased supply resulted in high levels of employment, income, and demand for residential and commercial properties.

The problem: insufficient demand to absorb the excess investment in property development.

According to the National Bureau of Statistics in China, real estate development for 2011 will total nearly $1 trillion, a 32% increase over last year. This investment represents approximately 15% of GDP, as calculated by the World Bank.

According to Jonathan Anderson of UBS, this is “the single most important sector in the entire global economy, in terms of its impact on the rest of the world.”

The reason: significant, productive economic activity is dependent on this sector.

Forty percent of Chinese steel use is related to property construction. China produces more steel than the next 10 steel producing countries combined, deeming it the most important procurer of iron ore, a key input for steel manufacturing.

Other essential steel manufacturing inputs are copper, cement, coal, and power generation. These activities generate a significant amount of income that is used to purchase global products and services.

Today, the average home price in China equals 9 times average annual income. The price for luxury apartments in Versailles Residentiel de Luxe La Grand Maison, located in the city of Wenzhou, are 350 times average annual income.

The perspective: at the peak of the U.S. real estate bubble, this ratio was 5.1. It is currently near 3, the historic average.

Using the current income level in China, real estate prices would need to fall by two thirds to be sustainably priced. Should income rise 50% in the coming decade (4% per annum), prices could fall 50% to achieve a stable equilibrium.

In the past year, real estate transactions (sales) and prices have fallen dramatically. At the current rate, prices may drop 50% within over the coming decade.

This decline has been due to low income demand at the current price level and the tremendous supply of inventory (approximately 20 years based on current vacancies, pending projects, and future population projections).

Demand for property development is decreasing. Less construction translates into lower income, personal, corporate, and governmental (local government derives 40% of its income from property sales). Smaller incomes suggest lower demand for global products and services.

In addition, lower property values imply less collateral for future credit, thereby limiting growth prospects.

This portends poorly for the global economy.

China’s annual trade surplus has been halved since 2008 to roughly $150 billion. This reflects a decrease in export and import growth, with exports declining at a greater rate. This decline is partially a manifestation of decreased demand by the eurozone and China’s domestic market.

In recent years, China increased the required reserve ratio for bank deposits to limit monetary growth, reduce aggregate demand, and minimize inflationary pressures.

However, due to the impending global economic slowdown, China recently reduced the reserve requirement to foster economic growth.

Deleveraging of the massive global debt, which is 3 times global income, will reduce monetary velocity (transactions) and income over the next decade.

Increases in monetary aggregates, credit, and liquidity may provide meager assistance in the immediate term.
In fact, it will delay, and possibly exacerbate, the underlying economic dysfunction, thereby extending anemic global growth for years to come.

Moreover, the increased money supply, without much increase in value added product supply, will increase transaction demand for existing products, thereby placing upward price pressures.

Lower government revenues may require additional debt issuance at higher interest rates to attract scarce capital. Existing economies of scale may not be sufficient to offset a possible increase in borrowing costs. Upward pressure on retail prices may result, creating an inflationary spiral.

Global stagflation may be the new paradigm over the coming decade.

© 2015 Newsmax Finance. All rights reserved.

China Yield Inversion May Portend Economic Slowdown

This article was originally published on June 24, 2011.

The yield on Chinese bonds are inverting at an accelerating rate. This does not portend well for the Chinese economy, and this may have negative implications globally.

An inversion of the yield curve occurs when short-term interest rates are higher than long-term interest rates.

Typically, the opposite occurs, since long-term investments are associated with more risk. Additional risk, such as price inflation, currency depreciation, default, and lost opportunities, cause investors to demand higher rates of return for longer-term investments.

An inversion of the yield curve is usually the result of an anticipated slowing of future economic activity over the coming year or two. This anticipation is reflected in lower demand for short-term corporate debt, which simultaneously depresses prices and increases rates for this debt.

In addition, this prognostication is followed by decreased demand for corporate equities based on unfavorable business conditions and lower profit potential in the near term (one to two years).

The China yield curve, which has been inverted for nearly six months, continues to move in this direction with greater velocity.

The Shanghai Interbank Offer Rate (SHIBOR) is the short-term rate of interest that Chinese banks are willing to lend other Chinese banks. The current rates for one week, one month, three months, one year, and 10 years are: 9 percent, 8 percent, 6 percent, 5 percent, and 4 percent, respectively.

Note: The longer the term, the lower the rate.

In the past 50 years, this indicator correctly predicted all but one economic slowdown.

The identical scenario occurred in the U.S. in February 2007 prior to the financial crisis. At that time, the yield for the two-year Treasury note was 4.93 percent, while that for the 10-year Treasury bond was 4.81 percent.

The National Bureau of Economic Research (NBER) determined the economic recession began in December 2007, 10 months later.

The reason for the Chinese yield inversion: the currency exchange rate mechanism

Since 1980, China has purposely devalued its currency (yuan) to increase the demand for its export products. When the Chinese yuan devalues, the yuan is equivalent to less foreign currency. Therefore, an export product priced in yuan requires less foreign currency, which translates into more demand for Chinese exports.

In 1980, the U.S. dollar purchased 1.50 yuan. By 1994, it purchased 8.46 yuan. Today, the rate is 6.50.

The Chinese do not allow the market to adjust the currency exchange rate: it is determined by government policy. The low relative value of the yuan has increased demand for Chinese products tremendously. This has created a huge demand for yuan and an inflow of foreign currency reserves (approximately $3 trillion).

The increase in demand would typically increase the value of the yuan, bringing supply and demand into equilibrium. Since, the currency exchange rate remains fixed, demand for yuan exceeds supply. Therefore, the Chinese create yuan to satisfy the demand.

Wu Xiaoling, vice chairman of the Financial and Economic Affairs Committee of China’s National People’s Congress, recently said, “In the past 30 years, we have used excessive money supply to rapidly advance our economy.”

China has the highest ratio of broad money (M)-to-income (GDP) in the world. This suggests there is an excess of money and a lack of transaction velocity (V), since GDP = M times V.

During the past decade, the broad money stock in China increased nearly 20 percent per annum, while real GDP grew at 10 percent per annum. In the U.S., money and income growth per annum were only 5 percent and 3 percent, respectively.

The large quantity of money has created an increase in demand for many asset classes, including land, housing, and commodities. The result has been an increase in asset prices. urrently, annual inflation is approaching 5 percent.

Inflation and inflationary expectations portend future uncertainties and risk. This unfavorable climate reduces demand for foreign and domestic investment as well as domestic exports.

To combat inflation, China is attempting to reduce the quantity of money available by increasing interest rates and required bank reserves (20 percent of deposits). The former restricts demand for loans, while the latter restricts supply of loans.

Ironically, further threatening growth and income are the downward price pressures on commercial and residential real estate. The former has excess supply and the latter has deficient demand

Price depreciation of these assets will likely dampen collateral values and reduce the supply and demand for loan and credit activity. This suggests a reduction in economic activity and income.

These dynamics indicate an economic slowing in the near term (one to two years) as money is removed from the system. The business environment may be less profitable, which may depress equity prices in the near term as well (one to two years).

This may have negative implications globally as well.

As excess money is removed from the Chinese system, velocity will increase, permitting more stable, long-term income growth.

© 2015 Newsmax Finance. All rights reserved.

Middle-Class Jobs Still Remain Elusive

The middle class continues to suffer during this economic recovery.

The U.S. Labor Department typically releases employment figures for the overall economy and particular industries.

However, these data exclude the income levels associated with these opportunities – a highly critical parameter.

Since the inception of our Great Recession, middle class jobs have yet to recover – far from it – while those at the upper and lower ends are ahead of the pre-crisis period, according to Georgetown University’s Center on Education and the Workforce in a recent study that focused on 485 occupation groups.

The middle third of workers shed 2.8 million jobs from 2008 through 2010, while those in the top third lost 1.9 million positions and the bottom third suffered a loss of 1 million opportunities. Since 2010, the middle class gained 1.9 million jobs; the upper class gained 2.9 million positions; and lower class opportunities grew by 1.8 million.

Nearly all of the 2.9 million high wage positions – or about 2.8 million – went to individuals with at least a bachelor’s degree. The net employment result since the beginning of the recession was a loss of 900,000 middle income jobs; a gain of 1 million high wage positions; and an increase of 800,000 low wage opportunities.

This Georgetown analysis defines high wage earners as full-time employees with salaries of at least $53,000 on average. More than two-thirds of these workers receive employer-provided health insurance and slightly less than two-thirds have employer-provided retirement plans. Occupations in this sector include financial analysts, physicians, registered nurses and software developers.

Those in the bottom third earn less than $32,000 on average. Only one-third in this group have employer-provided health insurance and only one-quarter receive employer-provided retirement benefits. Middle-wage occupations have average earnings between $32,000 and $53,000, and include occupations such as automobile mechanics, truck drivers and welders.

Growing the middle class is essential for robust, long-term economic growth. Unleashing our potential in the energy sector can move us in that direction, as I described in a previous article here.

Developing molten salt reactors will enable energy independence for a virtual eternity that is safe, efficient, affordable, and carbon-free while generating a great number of middle and upper-level jobs over long periods of time.

Coupled with my tax plan, strong economic growth can become a way of life.

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