posted January 23, 2011
Obama’s Horns & Predictions 2011

As the Obama administration approaches its two-year mark, it finds itself impaled on the horns of a dilemma. The ‘horns’ are the chronic 25 million still unemployed in the U.S. economy and the 10 million cumulative home foreclosures that will have occurred by year-end 2010.

Unemployment has hovered consistently around 16%-17% of the work force since the summer of 2009, as measured by the Labor Department’s more accurate ‘U-6’ statistic. That’s more than 18 months at that level. Mainstream economists, perplexed and unable to explain why, increasingly call it the ‘new normal’—meaning little can be done about reducing unemployment much and we should all get used to 20-25 million unemployed as a permanent feature of the U.S. economy for years to come.

Homeowners have fared even worse. Foreclosures have continued to rise since Obama came into office, from 2.3 million in 2008 to 3.2 million in 2009 to more than 3.4 million in 2010. That’s more than 10 million since the recession began in 2007. And that number doesn’t include millions more in ‘short sales’ that are just foreclosures by another name. Or the millions more that are 60 days or more delinquent, to whom banks have not yet sent official foreclosure notices.

Obama’s most recent answer to the 10 million foreclosures, new home sales and housing construction now down 75% from previous highs, and home prices once again starting to decline has been to turn over the task of resurrecting the residential housing market to the Federal Reserve and the central bank’s most recent policy initiative, called ‘Quantitative Easing 2’ (QE2). QE2 is the Federal Reserve’s policy, introduced this past fall, to print money to buy up $600 billion in mortgage and other bonds. However, the Fed and QE2 are doomed to fail in the effort to revive housing, now in the process of collapsing once again, for reasons to be explained shortly.

The administration’s answer to the chronic, near depression levels of unemployment, promises even less likelihood of success. Now that its $787 billion fiscal stimulus package of early 2009 has dissipated, with virtually no impact on new job creation the past 18 months, the administration has all but given up on proposals to create jobs. Its policy is simply to continue to try to extend unemployment insurance benefits. But extending unemployment benefits, while clearly necessary, does not create jobs. Moreover, the likelihood of meaningful job creation in 2011 appears increasingly remote, given the incoming Congress and its obsessive focus on deficit reduction and implementing fiscal austerity, and the Obama administration’s signaling almost every day its willingness to join them in deficit cutting and austerity.

Two years ago in this publication, in December 2008, this author predicted austerity would be the eventual policy of the Obama administration. It was noted at that time that “The real Obama economics program is yet to come?…?a classic austerity program could become Obamanomics 2?. That austerity is now coming. Its early indicators are the reports issued last November, one by the Obama appointed ‘Deficit Commission’ (Bowles-Simpson Report) and the other released almost simultaneously by the Bipartisan Policy Center, called the Rivlin-Domenici Report’.

Both reports together represent the two poles within which proposals for deficit reduction will likely be debated. Like the exclusion of all discussion and debate over single payer healthcare in the recent health reform legislation passed earlier this year, the choices debated will be within the parameters of these two reports; that is, between the draconian and the merely devastating for middle and working class America—calling for cuts in Medicare, Medicaid, employer provided health insurance, Social Security benefits, public employees’ wages and jobs at all levels of government, pensions, unemployment benefits, and the gutting of previously off-limits middle class tax cuts like the alternate minimum tax (AMT) and the mortgage deduction in particular.

Both the Federal Reserve’s QE2 policy and the new Congress/Obama administration’s forthcoming austerity policy that will unfold in early 2011 constitute the two centerpieces of policy to deal with the continuing economic crisis. Together, both will not only fail to generate a sustained economy recovery in 2011-2012, but will actually cause a further deterioration of the economy. The reference to ‘horns’ in the title of this article thus has a double meaning. If jobs and housing are the horns that have impaled the Obama administration, QE2 and fiscal austerity might be considered a second set of ‘horns’ that will soon gore the middle and working classes as well. Fed by $4 trillion worth of bailouts in 2008-09, and sitting on a hoard of another $1 trillion in cash at present, the Wall St. bull is charging once again. It has mortally wounded the Obama administration, despite the latter having done its bidding. And it will continue to charge in 2011, swinging its horns in all directions, trampling all who stand in its path.

The QE2 Desperate Gamble

The Federal Reserve is the bull’s main provider. And quantitative easing is its main meal. QE2’s initial printing and distributing of $600 billion is its low end estimate. The Fed has publicly committed, if needed, to at least a minimum of $1 trillion in direct purchase of bonds via money printing. This $600 to $1000 billion comes on top of the Fed’s previous QE1 policy, implemented in 2009, when it printed and spent an additional $1.75 trillion. QE1 was designed to resurrect the then (and still) moribund housing and commercial property markets. About $1.45 trillion of that $1.75 trillion was directed specifically toward these mortgage markets, with another $300 billion in Fed purchases of long term treasury bonds from investors.

But if $1.45 trillion failed to resurrect the housing market in 2009—now collapsing once again in terms of home construction, sales, and home prices as of late 2010—how might another $600 billion succeed when more than twice that amount failed barely 18 months ago? The official justification for QE is that by directly buying up mortgages the Fed removes bad assets from banks’ and mortgage lenders’ balance sheets, freeing up their reserves to lend to new homeowners. More reserves and lending will mean mortgage interest rates will fall, thereby stimulating demand and sales for homes and clearing out millions in supply of foreclosed homes. With more demand and less supply, home prices will then rise instead of fall. Rising prices in turn will bring more buyers into the housing market, stimulating price and sales further. And so the process of recovery in the mortgage markets will become self-sustaining. At least that’s the official ‘theory’ of how it is supposed to work.

But it didn’t work in 2009 and it won’t work again in 2011. Already it has begun to fail. Despite the Fed’s $600 billion recent announced injection, mortgage rates have actually begun to rise instead of fall in the closing months of 2010. Housing demand and sales have continued to decline—not rise. And expectations that home prices will fall are growing, producing a self-fulfilling condition. So what’s going on? What’s QE2 really about?

There are several possible explanations. First, QE2 (like QE1 before it) is really designed to subsidize banks and financial institutions that are growing increasingly fragile and unstable. QE2 is really a means with which to bail out many of the 7700 or so regional-community banks continuing to lose billions in the mortgage markets, as well as the big 5 banks that service most of the mortgage payments. In other words, its another bank subsidy and bailout in another name. If growing numbers of these 7700 second-tier banks go under, the government will have to put up hundreds of billions more in direct bailouts. The agency handling the wind-down of these tier two 7700 banks, the Federal Deposit Insurance Corporation (FDIC), does not have sufficient funds to insure depositors money from its current sources of funding. About 300 of these tier of banks have failed by year-end 2010, with another 900 on the FDIC’s endangered list—a list moreover that is growing weekly.

Secondly, QE2 is also an indirect way of bailing out the government agencies, Fannie Mae, Freddie Mac, as well as the Federal Housing Authority (FHA)—all of which are continuing to experience growing losses by the week. Initially bailed out back in August 2008 at a cost of at least $200 billion, losses have continued to exceed that amount for both Fannie and Freddie and now the FHA as well. Hundreds of billions more will therefore be needed before the end of 2012. Congress won’t put up the tab for political reasons. Thus the Federal Reserve, the only remaining bailout game in town, is once again printing money to buy up more of the bad debt of Fannie and Freddie.

But the Fed faces a major contradiction. By purchasing bad mortgage debt via QE (i.e.to further subsidize banks, mortgage lenders, and big bank mortgage servicers) it is weakening the economy and recovery in other ways. First, pumping up to a trillion dollars more into the economy will cause the value of the dollar to decline relative to other key currencies. This will raise the cost of imports for American consumers and thereby reduce their real incomes further in 2011. They will therefore spend less on goods and services produced by US based employers, in turn slowing the recovery. Food and oil-gasoline prices can be expected to rise noticeably in 2011. With less consumption of US produced goods, US based businesses will have less incentive to hire.

Employment will be negatively affected due to QE2 in yet another way. QE2 has already set off a currency war between the US and other key countries, in particular the Eurozone, Canada, Australia, Japan, Brazil and elsewhere. A declining dollar means the US will divert exports sales from these countries to exports from the US. QE2 is thus designed to stimulate the export manufacturing sector of the US economy, as well as housing. The US manufacturing sector was growing and adding jobs in early 2010, but has since weakened and manufacturing jobs disappearing once again. But the other countries can also take action to reduce their currencies in response to the Fed and QE2, and that has begun as well. The situation globally is thus becoming reminiscent of the 1930s, when each country, experiencing trouble getting their domestic economy going, started ‘beggaring their neighbor’ by stealing their exports by devaluing their own currencies. QE2 has precipitated a currency war, that may yet deteriorate into a full blown general trade war as countries become more desperate. The outcome is a general slowing of the entire global economy.

QE2 is thus a desperate move by the Fed and the Obama administration, aimed at stimulating the housing and manufacturing sectors of the US economy that have begun this past summer to falter once again. It is designed to add bailout liquidity to financial institutions in the US that really have not recovered. It is designed to raise inflation and thereby halt the current dangerous drift toward deflation now underway in the US. But it is simultaneously reducing real income, consumption, and thus job creation in the US; precipitating a currency war; and leading possibly to a more general trade war and further consequent slowdown in the global economy. QE2’s negative effects on the economy will therefore likely far outweigh its hoped for positive impact. It represents a desperate gamble on the part of the Fed and the Obama administration.

Deficit Cutting and Fiscal Austerity

The single greatest contributing cause of deficits is the collapse of tax revenues due to recession. By not taking appropriately aggressive action in 2009 to generate sustained recovery, the Obama administration doomed itself to lagging tax revenues and growing deficits. Of course, declining tax revenues are not the sole cause of deficits. A trillion dollar annual bill for total defense spending contributes significantly as well. So does the annual hundreds of billions in the Bush tax cuts, the benefits of which largely accrued in 2010 to the wealthiest 5% households and multinational corporations. So does the bailouts of banks and non-bank corporations like the auto (GM, Chrysler) and insurance companies (AIG). Were there no wars the past decade, no bailouts, no Bush tax largesse for wealthy investors and corporations, and no banking induced financial-economic crisis, there would be no $trillion dollar deficits this year or the projected next five years. In other words, the cause of the deficits is not social security benefits, public employees’ wages and pensions, education and other social program costs. In fact, social security alone has produced a surplus of more than $2 trillion over the past two decades—a surplus used to subsidize and reduce the general budget deficit by that amount. Social Security has carried the federal budget not contributed to the budget deficits.

Nevertheless, the focus in 2011 will be on cutting the federal government deficit. The outlines of fiscal austerity are only beginning to emerge. Proposals to extend the Bush tax cuts for another two years are but the first phase of a broader strategy. It appears the consensus among the political elites of both parties is to pass the Bush tax cuts extension before moving on to deficit cutting. Addressing both simultaneously would prove more difficult. Moreover, extending the tax cuts, and thus raising the deficit by hundreds of billions more in the process, provides even further justification for reducing social spending.

Subsequent deficit cutting will include raising the retirement age for Social Security to 69 years (or even 70) for full retirement and increasing early retirement at reduced benefits to 65 years. Cost of living adjustments will also be reduced. For Medicare, contributions and other out of pocket payments will increase significantly and some benefits will be capped. Public employee retirement ages will also rise, and employees will have to contribute more while benefits are simultaneously reduced. Many states, cities, and school districts will cut wages and benefits—a move already announced for federal workers. Housing, education and public transport will be reduced, as will federal contributions to Medicaid. In contrast, defense spending cuts will occur mostly as a result of attrition and by outsourcing of non-combatant activities. Cuts in spending on military equipment will be minimal.

Following the next budget, a general revision of the tax code will occur. As part of this revision, the Bush tax cuts will be extended beyond 2012. Personal income tax brackets will almost certainly be reduced from the current six to no more than three, representing a return to the Reagan years. Fewer brackets always mean tax cuts for those at the highest end. Almost certainly the top rate currently of 35 percent will be reduced over time to something less. For corporations, depreciation write-offs (a de facto investment tax cut) will be accelerated to full deductions in the first year, replicating what has already been introduced for small businesses this past year. For multinational corporations, the foreign profits tax will be restructured to their advantage. The corporate tax rate will be reduced to offset the phasing out for businesses of their current tax deduction for employee health care contributions. This latter measure will significantly raise health care costs, where monthly premiums have already begun to rise 10 to15 percent annually once again. Health-care price increases will thus join with food and oil-gasoline price hikes to depress consumer spending in other areas, where prices will continue to deflate. Revision of the tax code may not prove as beneficial to the middle classes, however. Once sacrosanct tax deductions such as the mortgage interest payment deduction and the middle class exemption from the Alternative Minimum Tax (AMT) are likely to be eliminated. To make it palatable, these tax hikes on the middle class would be delayed until after the 2012 election and phased in after 2012 in stages.

Those advocating deficit reduction and austerity for middle and working class America have as their true objective not balancing the budget, but ensuring first and foremost the continuation of Bush tax cuts for wealthy households, investors, and corporations. The deficit (cutting) hawks clearly have the upper hand. The Obama administration’s attitude, evident since the beginning of his term, has been to seek bipartisanship at any cost. The hawks will take advantage of this attitude and leverage it to the extreme. The outcome will not be an austerity package where all share more or less equally the burden, but one that is heavily uneven in burden sharing—much as the policies and programs of the Obama administration during its first two years have proved heavily uneven in bailing out banks, corporations and investors and not consumers, workers and small businesses.

Liberal mainstream economists like Paul Krugman and Joseph Stiglitz have played a role in enabling the rise of the deficit hawks and their growing policy hegemony. They have simply proposed over the past two years that the administration spend a greater magnitude than it has. Their argument is that the recovery has faltered because the administration spent too little, which is correct but only partly so. By simply calling for more magnitude of spending, liberal mainstream economists have let themselves open to the criticism from the right (i.e. Republicans, deficit hawks, corporations, etc.) that “Obama spent $787 billion and we still didn’t get job creation; so it must be that government spending doesn’t work. So let’s cut spending.? The liberals have not focused enough on the composition of that spending and not just the magnitude. It is not a matter of just ‘more spending’ but a matter of what kind of spending that explains why Obama’s programs the past two years did not reduce unemployment, failed to rescue homeowners, and did not result in a sustained economic recovery. Spending should have focused not just on subsidies to prevent a further collapse of consumption, but spending on direct job creation and on reducing homeowners’ mortgages and payments instead of subsidizing the handful of mortgage lenders and mortgage servicing banks.

For the past two years the Obama administration has relied on ‘the markets’ to create jobs, on the banks to lend, and on businesses to invest. This was supposed to lead to job creation. His strategy has always been simply to put a temporary floor under the collapse of consumption, waiting for, and in hope that, ‘the markets’ would eventually take up the slack and generate recovery. But the failure of ‘the markets’ is what produced the crisis in the first place. Despite trillions of bail out and infusion of cash, despite return to full profitability, and despite the accumulation of $1 trillion in reserves, the banks did not lend the past two years to the engine of job creation in the US—small and medium businesses. They still resist doing so. And despite accumulating nearly $2 trillion in cash on hand, businesses large and small, domestic and multinational, are still not investing or hiring. And when hiring, it has been predominantly thus far only part time and temporary labor.

PREDICTIONS 2011-12

This writer’s analysis of that global economy is based on a theory of what is called ‘Epic Recession’. That analysis has enabled prediction of major turning points and events since the economic crisis began. Past predictions included that Obama would turn to austerity policies and programs; that major banks would fail in the US in 2008; there would be layoffs and unemployment on a massive scale before year end 2008; more than 25 million would become jobless by end of 2009; and that “the euro financial system will be shaken in 2010 by one or more debt defaults on its periphery?. In keeping with that practice, predictions for 2011-2012 are:

· The Eurozone sovereign debt crisis will spread beyond the current four economies (Ireland, Portugal, Spain, Greece) and engulf Italy, Belgium, and potentially (though less likely) France.

· The Euro currency will decline from its current $1.3 to one Euro to roughly parity (1 to 1) between the dollar and Euro

· A restructuring of the EU currency system will result in a kind of ‘two-tier’ Euro currency

· Currency wars will intensify between the US, Eurozone, Brazil-China, and others

· The Eurozone’s diverging stability problems between North (Germany, France) vs. Periphery (Portugal, Ireland, Greeece, Spain) will be replicated in Asia. China-India will grow more slowly but Japan, Singapore, Thailand, Philippines, etc. will experience double-dip recession.

· The Fed’s QE2 policy will not succeed in generating a recovery of either housing or manufacturing sectors, nor will it stop the drift toward deflation for the core consumer price index

· A new phenomenon of ‘Def-Inflation’ will emerge in the US. Select goods will rise in price (food, gasoline, healthcare) while other products and services will enter a deflationary phase.

· U.S. home prices will fall another 10%-15% and home construction and sales continue to decline.

· Both Japan and the Eurozone economies will weaken faster than the U.S.

· State and Local governments and school districts will continue to face a deepening fiscal crisis, resulting in still further budget cutting, more layoffs, program reductions, and wage and benefit cuts. No further subsidies from the Federal government will be forthcoming to bailout this sector.

· The $2.8 trillion U.S. municipal bond market will experience financial crisis (further exacerbating state and local governments’ fiscal crises).

· Fannie Mae, Freddie Mac, and the FHA will require a further bailout of $200 billion

· A minimum of 200 more regional-community banks will fail in 2011, bringing the total to more than 500 by year-end 2011.

· Health care sector will experience a deepening crisis on multiple fronts: physicians will increasingly abandon Medicare patients; States will increasingly opt out from the Medicaid system; health insurance premiums will resume double-digit annual increases; and employers will accelerate dropping health insurance

· Several provisions of the Dodd-Frank Financial Regulation law passed in June 2010 will be repealed.

Jack Rasmus

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