What if real estate prices remain the same for another decade? As I look at economic trends in our nation including the jobs we are adding, it is becoming more apparent that we may be entering a time when low wage jobs dominate and home prices remain sluggish for a decade moving forward. Why would this occur? No one has a crystal ball but looking at the Federal Reserve’squantitative easing program, growth of lower paying jobs, baby boomers retiring, and the massive amount of excess housing inventory we start to see why Japan’s post-bubble real estate market is very likely to occur in the United States. It is probably useful to mention that the Case-Shiller 20 City Index has already hit the rewind button to 2003 and many metro areas have already surpassed the lost decade mark in prices. This is the aftermath of a bubble. Prices cannot go back to previous peaks because those summits never reflected an economic reality that was sustainable. A chart comparing both Japan and U.S. housing markets would be useful here.

Will the U.S. have 20 years of stagnant home prices?

Source: Pragmatic Capitalism

This chart does a simple comparison of Osaka condo and Tokyo condo prices which does not reflect the entirety of the Japanese housing market. Yet the path seems very similar. Large areas with a real estate frenzy that hit high peaks and have struggled ever since. In fact, if we look at nationwide prices we realize that Japan has seen a 20 year bear market in real estate:

Japan urban land prices are back to levels last seen in the 1980s. You have to ask if there are parallels to our current condition. The first point we all have to agree on is that both economies had extraordinarily large real estate bubbles. For the United States the answer to this assumption is a big yes. We can run off a check list of how our real estate markets run similarities:

-Massive real estate bubble (check)

-Central bank bailing out banks (check)

-Bailed out banks keep bad real estate loans on their books at inflated values (check)

-Government taking on higher and higher levels of debt relative to GDP (check)

-Employment situation stabilizes with less secure labor force (check)

-Home prices remain stagnant (check)

Now the similarities are closely aligned in terms of banking policy. Our Federal Reserve followed a more aggressive path than Japan in bailing out our large banks. Yet all this did was make the too big to fail even bigger and exacerbated underlying issues in our economy. Four full years into the crisis and we are still dealing with a massive amount of shadow inventory. Remember the initial days when the talk was about working through the backlog of properties in a clean and efficient manner? Whatever happened to that? Banks operate through balance sheet accounting and it has made more sense to pretend the shadow inventory has somehow maintained peak prices while chasing other financial bubbles in other sectors. Not a hard way to make money when you can borrow from the Fed for virtually zero percent.

Japan and U.S. see real estate as poor investments

Our earlier assumption about the double-dip real estate recessions has now materialized through home price measures:

The above chart may not seem like a big deal to some but keep in mind the United States had never witnessed a year over year drop in nationwide home prices since the Great Depression. Not only has that been surpassed but home prices are now back to levels last seen 8 years ago. The lost decade is now nipping at our heels but what about two lost decades like Japan?

Source: Debt Watch Blog

For some this may seem outrageous even to consider. The way I see it is that Japan was quickly catching up U.S. GDP in 1995 and many thought that it would at some point surpass our GDP. This was solidly the number two global economy for many years until China took that place last year. Yet the real estate bust has really been a drag on the economy for years moving forward:

Why has real estate been such a drag on the overall Japanese economy? First, Japan’s unemployment rate stabilized after these bubbles burst but it shifted to a large temporary or contract based employment economy. One third of Japanese workers operate under this new world. Relatively low security with employers and this has spiraled into lower income and money to finance home purchases. The fact that the U.S. has such a large number of part-time workers and many of the new jobs being added are coming in lower paying sectors signifies that our economy is not supportive of the reasons that gave us solid home prices for many decades. I think this is a key point many in the real estate industry fail to emphasize. How can home prices remain inflated if incomes are moving lower?

The question of affordability has always been at the center of this debate. Yet with government mortgages being the only option and banks now actually having to verify income Americans can only afford so much home when the gimmicks are removed like layers on an onion. This is why the double-dip is now fully here:

How much further will home prices fall? It can be that nationwide they fall only slightly more but in the end a lost decade is in the books. Two lost decades might be a real possibility given our demographic trends especially with baby boomers moving forward.

Massive inflation or stagnation moving forward?

One would think that with all the Bank of Japan bailout measures for the banks and government spending that inflation would run rampant in the Japanese economy. That was never the case:

Now it is clear that at least by the above reported data, Japanese inflation has been virtually non-existent for the good part of 20 years. How does this compare with the U.S.?

It is interesting to note that most of our inflation is coming from items ex-housing. As I have discussed the BLS does an interesting measure of home prices via the owner’s equivalent of rent. The reality is the above year over year changes in inflation in the U.S. are not coming from home prices.

Psychological aspects

Watching some of the global news I was seeing many young Japanese workers, some in their late 20s or early 30s, already resigned that they would never buy a home. They asked a young professional if he ever planned to buy a home and his response was (paraphrased):

“I don’t ever plan to buy. I saw my mother and father lose their marriage over trying to pay for the home payment for years. That was many of the big fights in our family. In the end we lost the home and I feel I lost my family. Why would I put pressure on myself for something like that?”

The millions of people that have lost their home and will lose their home are probably in households with children in many cases. Some may be in college and looking to buy in ten years. The notion that housing is always a great investment runs counter to what they saw in their lives. Will they even want to buy as many baby boomers put their larger homes on the market to downsize? Will they clear out the shadow inventory glut? Now I’m not sure how things are in Japan but many of our young households here are now coming out with massive amounts of student loan debt.

It was interesting to see the Wall Street Journal coming out recently with an article stating that the Class of 2011 will be the most indebted ever:

“(WSJ) The Class of 2011 will graduate this spring from America’s colleges and universities with a dubious distinction: the most indebted ever.

Even as the average U.S. household pares down its debts, the new degree-holders who represent the country’s best hope for future prosperity are headed in the opposite direction. With tuition rising at an annual rate of about 5% and cash-strapped parents less able to help, the mean student-debt burden at graduation will reach nearly $ 18,000 this year, estimates Mark Kantrowitz, publisher of student-aid websites Fastweb.comand FinAid.org. Together with loans parents take on to finance their children’s college educations — loans that the students often pay themselves – the estimate comes to about $ 22,900. That’s 8% more than last year and, in inflation-adjusted terms, 47% more than a decade ago.”

Lower incomes, more debt, and less job security. What this translated to in Japan was stagnant homeprices for 20 full years. We are nearing our 10 year bear market anniversary in real estate so another 10 is not impossible. What can change this? Higher median household incomes across the nation but at a time when gas costs $ 4 a gallon, grocery prices are increasing, college tuition is in a bubble, and the financial system operates with no reform and exploits the bubble of the day, it is hard to see why Americans would be pushing home prices higher.

And for today’s second most surreal piece of news (the first being that Osama was a fan of RedTube and Adult Friend Finder, whose stock tumbled 25% after its IPO on news that such a loyal customer is now dead), we turn to Reuters which brings us news of a “report” by centrist think tank Third Wave, due out on Monday, which finds that “the United States could plunge back into recession if inaction in Washington forced a debt default, according to a new analysis that arrives as the country reaches the legal limits of its borrowing authority….Some 640,000 U.S. jobs would vanish, the housing market’s woes would deepen, stocks would fall and lending activity would tighten if the country were unable to pay its bills, according to a report by the centrist think tank Third Way due out on Monday.” And yes, first Dow Jones and now Reuters confirms what we have been warning all this week, namely that “the Treasury Department is expected to hit its $ 14.3 trillion borrowing limit on Monday, making it unable to access the bond markets again. Lawmakers from both parties say they won’t approve a further increase in borrowing authority without steps to keep debt under control.” Yet back to the topic at hand: which is that someone actually paid money to discover what will happen to America when it filed for bankruptcy. If this was a paper out of the San Fran Fed we understand, but private industry? If there is one margin hike we approve of it is for the CME to hike the margin to 1000% cash in trivial common sense BS.

And for those who don’t have blood shooting out of their eye sockets at this point, here are the details of what the debtors prison circle of hell would look like for the US.

• Treasury bonds would lose their aura of safety, leading to a half-point increase in their interest rates. That would push up the U.S. government borrowing cost once lending activity resumed, leading to a $ 10 billion increase in annual budget deficits over the short term.
• The higher interest rates would ripple through the economy, causing gross domestic product to decrease by 1 percent and employers to shed 640,000 jobs.
• Banks would curtail lending. Small businesses would have a harder time expanding and credit-card interest rates would rise. Student loans and car loans would become more expensive.
• The S&P 500 stock index would lose 6.3 percent in value over three months, causing retirement portfolios to shrink, the report said, citing research by financial services firm Janney Montgomery Scott.
• The U.S. dollar’s status as the world’s reserve currency could be threatened as investors move cash to Swiss francs, Japanese yen, or Euros. That could boost U.S. exports but raise the cost of consumer goods like gasoline and electronics.
• Home mortgage rates, which are tied to U.S. Treasury rates, would rise. Homebuyers taking out an average mortgage for a new home, currently $ 221,900, would pay an extra $ 24,738 over the life of the loan, dealing another blow to an already struggling housing market.

“Defaulting on our debt is not an abstract idea that might affect a few institutions on Wall Street; it would harm tens of millions of Americans in profound and lasting ways,” the report says.

Multiple sets of indicators are clearly showing that the housing market is entering a second winter. Home prices are inching closer to cycle lows and indicators of housing distress are rampant throughout the country. Home prices during the troubling five years of 1928 through 1933 saw a decline of 25.9 percent nationwide and this was during the Great Depression. The latest Case-Shiller data shows that home prices in the 20 City and 10 City composite measures are down by 32 percent from their 2006 peak. This is now nominally the worst housing correction since the Great Depression. The continuing correction in housing is economically challenging middle class households in ways vastly different from those during the Great Depression. What is troubling about the new cycle lows is that the liquidity injected into the banking system by the Federal Reserve simply delayed the inevitable while diverting precious resources to a broken financial system. The painful lesson of the new reality is that household income, the gas in the engine, is simply too low to support prices even at today’s new lower levels.

This is part 32 in our Lessons from the Great Depression series:

27. Current Net Worth Drop of $ 13.8 Trillion Equivalent to 21 Percent Drop.

28. The Gospel of Economic Prosperity

29. New home sales fell 80 percent from 1929 to 1932 and fell 82 percent from 2005 to 2011.

30. Economic déjà vu from the 1937-38 recession

31. When government and financial institutions become one.

The Great Housing Crash of 2006

Source: Economist

Many were early to call a bottom in the housing market last year. It all varied on what data you were looking at. It was true that the home buyer tax credits and the Federal Reserve pushing mortgage rates lower created an artificial stimulus that did revive the market briefly. You should ask yourself what these actions covered. The home buyer tax credits and the Fed intervening made home buying cheaper only because an artificial floor was temporarily placed. Home prices for many years have not been dictated by the market in the sense of an open transparent market where sellers and buyers compete for goods in a somewhat balanced system. Home prices have so many artificial carrots and glistening bells and whistles that the real price is hard to ascertain. Imagine the government stepping in and offering a giant tax credit for buying SUVs. It is logical to assume that at least initially, sales will increase as the real price of the vehicle is pushed lower. Yet in the end market prices have to reflect more steady measures. As the tax credit evaporated and the Federal Reserve’s mortgage buying spree ended, the reality was American households simply do not have the income to support current prices. You can see the recent up and down here:

Home prices have been falling steadily since the summer of 2010. The fact that we still have close to7,000,000 homes in the shadow inventory tells us that we still have a long way to go before any normal housing market is restored. This by far is the worst housing collapse ever and it is still ongoing. This isn’t some closed chapter in our history books. We are still experiencing the actual correction. You can see from the above charts and gather a sense of how deep this correction is. Or maybe this chart can help:

Source: Economy.com

Keep in mind the above chart is inflation adjusted while the 25.9 percent correction is based on nominal levels. No matter how you slice this correction it is the worst on record. To get closer to the baseline prices would need to fall 43 percent from the 2006 peak. A number that seemed preposterous only a few years ago is now within touching distance.

Homeownership increase causes housing correction more widespread pain

Source: Census

When the Great Depression hit roughly 46 percent of Americans owned their home. Most of the mortgage debt was modest although on much shorter balloon payment deadlines that were exacerbated by the collapse. When the bubble unfolded in our current crisis nearly 70 percent of Americans were homeowners with massive amounts of mortgage debt. Most Americans derive their net worth from their home. So a collapse in housing values has sent a ripple through the balance sheets of the vast majority of Americans. Even if you are part of the one-third of homeowners with no mortgage your home values just cratered 32 percent on a nationwide basis. Depending on where you live this could be much worse or better. However it is likely you have lost a good amount of housing equity.

The problem itself isn’t so much that homeownership shot up to 70 percent but how it was financed. As many of you are well aware in the last decade U.S. median household growth was non-existent. Families are earning what they did going back to the late 1990s. Yet the cost of a gallon of gas is now up over $ 4 in many areas, local and state governments are raising taxes for dwindling budgets, medical care costs are soaring, and the cost to feed your family is also sky high. So the fact that home prices rose in light of all of this is a stunning reflection of the mania we have lived through. There will be books written on the insanity that is the U.S. housing market and history will not look favorably on many of our actions but the truth is history is still being written.

The adjustment in the housing market is still fluid and dynamic. I recall reading an article in the summer of 2009 showing some prescient insight into the market. In the article this chart was produced:

Source: Moody’s

“(Moody’s) A number of indicators of housing have bottomed, and there are tantalizing signs that the descent in house prices is at least moderating. When all is said and done, this housing correction, easily the worst on record for the U.S., will see the national Case-Shiller® house price index fall nearly 40% from its 2006 peak. The correction will be not only deep but also lengthy, with the U.S. price index bottoming in the second quarter of 2010. The national price level will not regain its 2006 high until 2020, a peak-to-peak housing cycle of 14 years. Regions will vary substantially, however, with areas that saw prices rise most taking the longest to return.”

What is interesting is that the market did hit a bottom early in 2010. Yet what wasn’t accounted for was the double-dip in the housing market which is what we are now clearly in. The enormous backlog ofshadow inventory will keep a steady stream of lower priced properties for years to come. I also find it interesting that the above chart is able to predict 12 years out and that California will see peak levels again in 2023. Frankly, I think projections going out more than 3 years for housing prices in this current market is similar to flipping a coin since all we can say with certainty is that home prices cannot go up with no significant income changes. People keep asking about certain financial ratios about when it would make sense to buy. Unfortunately we now live in a much more challenging financial world. The metrics now have to change completely. We are used to paying very little for food and fuel in relation to total household income. Other countries are used to paying more:

As we all know the cost of food is and has been going up yet income has remained stagnant or has dropped. The amount that can be spent on housing by default decreases. The Fed has essentially focused on the borrowing side of the equation by trying to lower rates to adjust to this new lower income world. Ironically this artificial intervention by the Federal Reserve has harmed most Americans while favoring investment banks around the country who really are the only sector who benefit from inflated housing costs. Lower home prices are actually beneficial to the one-third that rent. The one-third that own but have no mortgage are likely to not change their spending habits. It is the two-third that own and have a mortgage that are largely in play. If people purchase carefully and actually treat a home as a place to live, then if prices dipped another 20 percent it would not matter. The narrative that home prices need support is largely a banking propaganda piece trying to keep inflated balance sheets propped up.

As more and more disposable income is taken up by items outside of housing the amount of money Americans can finance for purchasing a home dwindles. This is why the demand for lower priced homes is healthy while markets where jumbo loans are needed are basically groveling at the feet of the government for more subsidies to keep prices inflated. Why would these supposedly rich areas need subsidies? What is it to the rich family to pay a little more from their healthy income to a house payment? The answer is that these markets are largely giant shell games where cars are leased and jumbo mortgages reign supreme. No doubt there are very wealthy enclaves with real solid incomes but you have other areas like Culver City or Pasadena where much of the economy is a paper tiger. You have households making $ 100,000 to $ 150,000 a year living as if they made $ 300,000 and above.

What can we learn from the Great Depression housing market and the one we are currently living in? First, many of the safety nets absent from the Great Depression like giant handouts to banks, food stamps, unemployment insurance, the FDIC, and stronger government intervention have made things look much better. Yet this is like a storm ravaging your property and you being happy that you have insurance. Sure, the place is covered but someone is still going to pay for the cost. I have few qualms about unemployment insurance or even food assistance since these keep people from absolute destitute situations and in terms of costs, are relatively low. For example $ 64 billion was paid out in 2010 to 40,000,000 families through food assistance. This money is spent back into the economy immediately. To put this in perspective look at the absolute failure of the home buyer tax credit:

“(WSJ) The credit wasn’t great for taxpayers, either. IRS says it paid $ 26 billion in home buyer credits in 2009 and 2010, enough to cover the maximum $ 8,000 credit for more than 3 million buyers. (It says at least $ 513 million went for fraudulent claims. Some claimants hadn’t bought houses. Some filed twice. Some were under age 18 or incarcerated.)”

Let us not forget about the multi-trillion dollar elephant in the room regarding the bailouts to the unworthy and financially broken financial system. The fact that most Americans have their wealth in housing and this was turned into a speculative casino by Wall Street is incredibly irresponsible. The reality of the new home price lows should tell you really who the bailouts were targeted for.

In the end home prices will continue to decline simply because no income growth has shown up in over a decade. Even if we do see income growth, we have to measure this with other rising costs like food and fuel. In the end, you can’t eat your house and maybe this is why the American Dream is now being redefined.

“Deficit terrorists” are gutting governments and forcing the privatization of public assets, all in the name of “deficit reduction”. But deficits aren’t actually a bad thing. In today’s monetary scheme, in which most money comes from debt, debt and deficits are actually necessary to have a stable money supply. The public debt is the people’s money.

Former vice president Dick Cheney famously said, “Deficits don’t matter.” A staunch Republican, he was arguing against raising taxes on the rich; but today Republicans seem to have forgotten this maxim. They are bent on stripping social programs, privatizing public assets, and gutting unions, all in the name of “deficit reduction”.

Worse, Standard & Poor’s has now taken up the hatchet. Some bloggers are calling it blackmail. This private, for-profit rating
agency, with a dubious track record of its own, is dictating government policy, threatening to downgrade the government’s long-held triple AAA credit rating if congress fails to deal with its deficit in sufficiently draconian fashion. The threat is a real one, as we’ve seen with the devastating effects of downgrades in Greece, Ireland and other struggling countries. Lowered credit ratings force up interest rates and cripple national budgets.

The biggest threat to the dollar’s credit rating, however, may be the game of chicken being played with the federal debt ceiling. Nearly 70% of Americans are said to be in favor of a freeze on May 16, when the ceiling is due to be raised; and Tea Party-oriented politicians could go along with this scheme to please their constituents.

If they get what they wish for, the party could be over for the whole economy. The Chinese are dumping US Treasuries, and the Fed is backing off from its “quantitative easing” program, in which it has been buying federal securities with money simply created on its books.

When the Fed buys Treasuries, the government gets the money nearly interest-free, since the Fed rebates its profits to the government after deducting its costs. When the Chinese and the Fed quit buying Treasuries, interest rates are liable to shoot up; and with a frozen debt ceiling, the government would have to default, since any interest increase on a US$ 14 trillion debt would be a major expenditure.

Today the Treasury is paying a very low 0.25% on securities of nine months or less, and interest on the whole debt is about 3% (a total of $ 414 billion on a debt of $ 14 trillion in 2010). Greece is paying 4.5% on its debt, and Venezuela is paying 18% – six times the 3% we’re paying on ours. Interest at 18% would add $ 2 trillion to our tax bill. That would mean paying three times what we’re paying now in personal income taxes (projected to be a total of $ 956 billion in 2011), just to cover the interest.

There are other alternatives. Congress could cut the military budget – but it probably won’t, since this option is never even discussed. It could raise taxes on the rich, but that probably won’t happen either. A third option is to slash government services. But which services? How about social security? Do you really want to see Grandma panhandling? Congress can’t agree on a budget for good reason: there is no good place to cut.

Fortunately, there is a more satisfactory solution. We can sit back, relax, and concede that Cheney was right. Deficits aren’t necessarily a bad thing! They don’t matter, so long as they are at very low interest rates; and they can be kept at these very low rates either by maintaining our triple A credit rating or by borrowing from the Fed essentially interest-free.

The yin and yang of money
Under our current monetary scheme, debt and deficits not only don’t matter but are actually necessary in order to maintain a stable money supply. The reason was explained by Marriner Eccles, governor of the Federal Reserve Board, in hearings before the House Committee on Banking and Currency in 1941. Wright Patman asked Eccles how the Federal Reserve got the money to buy government bonds.
“We created it,” Eccles replied.
“Out of what?”
“Out of the right to issue credit money.”
“And there is nothing behind it, is there, except our government’s credit?”
“That is what our money system is,” Eccles replied. “If there were no debts in our money system, there wouldn’t be any money.”

That could explain why the US debt hasn’t been paid off since 1835. It has just continued to grow, and the economy has grown and flourished along with it. A debt that is never paid off isn’t really a debt. Financial planner Mark Pash calls it a National Monetization Account. Government bonds (or debt) are “monetized” (or turned into money). Government bonds and dollar bills are the yin and yang of the money supply, the negative and positive sides of the national balance sheet. To have a plus-1 on one side of the balance sheet, a minus-1 needs to be created on the other.

Except for coins, all of the money in the US money supply now gets into circulation as a debt to a bank (including the Federal Reserve, the central bank). But private loans zero out when they are repaid. In order to keep the money supply fairly constant, some major player has to incur debt that never gets paid back; and this role is played by the federal government.

That explains the need for a federal debt, but what about the “deficit” (the amount the debt has to increase to meet the federal budget)? Under the current monetary scheme, deficits are also necessary to avoid recessions.

Here is why. Private banks always lend at interest, so more money is always owed back than was created in the first place. In fact investors of all sorts expect more money back than they paid. That means the debt needs to be not only maintained but expanded to keep the economy functioning. When the Fed “takes away the punch bowl” by tightening credit, there is insufficient money to pay off debts; people and businesses go into default; and the economy spins into a recession or depression.

Maintaining a deficit is particularly important when the private lending market collapses, as it did in 2008 and 2009. Then debt drops off and so does the money supply. Too little money is available to buy the goods on the market, so businesses shut down and workers get laid off, further reducing demand, precipitating a recession. To reverse this deflationary cycle, the government needs to step in with additional public debt to fill the breach.

Debt and productivity
The US federal debt that is setting off alarm bells today is about 60% of gross domestic product (GDP), but it has been much higher than that. It was 120% of GDP during World War II, which turned out to be our most productive period ever. The US built the machinery and infrastructure that set the nation up to lead the world in productivity for the next half century. We, the children and grandchildren of that era, were not saddled with a crippling debt but lived quite well for the next half century. The debt-to-GDP ratio got much lower after the war, not because people sacrificed to pay back the debt, but because the country got so productive that GDP rose to meet it.

That could explain the anomaly of Japan, the global leader today in deficit spending. In a CIA Factbook list of debt to GDP ratios of 132 countries in 2010, Japan topped the list at 226%. So how has it managed to retain its status as the world’s third largest economy? Its debt has not crippled its economy because:
(a) the debt is at very low interest rates; (b) it is owed to the people themselves, not to the International Monetary Fund or other foreign creditors; and
(c) the money created by the debt has been used to produce goods and services, allowing supply and demand to increase together and prices to remain stable.

The Japanese economy has been called “stagnant”, but according to a review by Robert Locke, this is because the Japanese aren’t aiming for growth. They are aiming for sustainability and a high standard of living. They have replaced quantity of goods with quality of life. Locke wrote in 2004:

Contrary to popular belief, Japan has been doing very well lately, despite the interests that wish to depict her as an economic mess. The illusion of her failure is used by globalists and other neo-liberals to discourage Westerners, particularly Americans, from even caring about Japan’s economic policies, let alone learning from them. [And] it has been encouraged by the Japanese government as a way to get foreigners to stop pressing for changes in its neo-mercantilist trade policies.

The Japanese economy was doing very well until 1988, when the Bank for International Settlements raised bank capital requirements. The Japanese banks then tightened credit and lent only to the most creditworthy borrowers. Private debt fell off and so did the money supply, collapsing the stock market and the housing bubble. The Japanese government then started spending, and it got the money by borrowing; but it borrowed mainly from its own government-owned banks.

The largest holder of its federal debt is Japan Post Bank, a 100% government-owned commercial bank that is now the largest depository bank in the world. The Bank of Japan, the nation’s government-owned central bank, also funds the government’s debt. Interest rates have been lowered to nearly zero, so the debt costs the government almost nothing and can be rolled over indefinitely.

Japan’s economy remains viable although its debt-to-GDP ratio is nearly four times that of the United States because the money does not leave the country to pay off foreign creditors. Rather, it is recycled into the Japanese economy. As economist Hazel Henderson points out, Japan’s debt is twice its GDP only because of an anomaly in how GDP is calculated: it omits government-provided services. If they were included, Japan’s GDP would be much higher and its debt to GDP ratio would be more in line with that of other countries.

Investments in education, healthcare, and social security may not count as “sales”, but they improve both the standard of living of the people and national productivity. Businesses that don’t have to pay for healthcare can be more profitable and competitive internationally. Families that don’t have to save hundreds of thousands of dollars to put their children through college can spend on better housing, more vacations, and other consumer items.

Turning the national debt into a public utility
Locke calls the Japanese model “a capitalist economy with socialized capital markets”. The national debt has been “monetized” – turned into the national money supply. The credit of the nation has been turned into a public utility.

Thomas Hoenig, president of the Kansas City Federal Reserve, maintains that the largest US banks should be put in that category as well. At the National Association of Attorneys General conference on April 12, he said that the 2008 bank bailouts and other implicit guarantees effectively make the too-big-to-fail banks government-guaranteed enterprises, like mortgage finance companies Fannie Mae and Freddie Mac. He said they should be restricted to commercial banking and barred from investment banking.

“You’re a public utility, for crying out loud,” he said.

The direct way for the government to fund its budget would have been to simply print the money debt-free. Wright Patman, chairman of the House Banking and Currency Committee in the 1960s, wrote:

When our Federal Government, that has the exclusive power to create money, creates that money and then goes into the open market and borrows it and pays interest for the use of its own money, it occurs to me that that is going too far. … [I]t is absolutely wrong for the Government to issue interest-bearing obligations. … It is absolutely unnecessary.

But that is the system that we have. Deficits don’t matter in this scheme, but the interest does. If we want to keep the interest tab very low, we need to follow the Japanese and borrow the money from ourselves through our own government-owned banks, essentially interest-free. “The full faith and credit of the United States” needs to be recognized and dispensed as a public utility.

Ellen Brown is an attorney and president of the Public Banking Institute, http://PublicBankingInstitute.org. In Web of Debt, her latest of 11 books, she shows how a private cartel has usurped the power to create money from the people themselves, and how we the people can get it back. Her websites are webofdebt.comandellenbrown.com.

As I have repeated numerous times, those looking for massive inflation can find it in China, not the United States. Demand for credit is so insane in China, that businesses will go to any length to get it.

Courtesy of Michael Pettis at China Financial Markets, please check out the insane way some companies in China obtain credit. Via Email, Pettis writes …

In this week’s newsletter I will argue that in spite of the rising wages, appreciating currency, and interest rate hikes we’ve seen in recent months, China is not actually rebalancing.　 Instead it is creating a change in the structure of the industrial base that may, unfortunately, be the opposite of what Beijing says it is aiming for.

But before getting into why, I want to bring up once again the goings-on in the commodity markets.　 Since January I’ve been writing about – and trying to figure out – the strange happenings in the Chinese copper market.　 The issue has been a regular topic of conversation in my central banking seminar at Peking University, where much of the most imaginative analysis I’ve seen has been done.　

China had been importing for many months far more copper than was needed for real use – and this in spite of a huge surge in domestic infrastructure and real estate development which has boosted the demand for copper.　 Imports continued even when London prices exceeded Shanghai prices by more than the equivalent of China’s value-added tax.

Instead of being shipped to end users, it seems that copper was being stockpiled in warehouses.　 Why?　 One possibility of course was pure speculation.　 If you think domestic Chinese copper use is going to soar, and with it prices too, then it might make sense to buy copper and hoard it. But there seemed to be a lot more hoarding than normal, and anyway with London prices often above the tax-adjusted Shanghai prices, why would anyone want to speculate on foreign copper when it could be bought more cheaply domestically?

It turns out, that the copper purchases were not entirely, or even mainly, speculative.　 They were part of a financing scheme for companies that, in spite of the avalanche of new lending occurring both within and outside normal RMB lending, were having trouble accessing bank credit.　

credit-starved companies were importing copper because they could obtain trade finance or some other sort of foreign financing, and then used the physical copper (or warehouse receipts, I guess) as collateral for domestic borrowing.　 The financing was continually rolled over.　 Buying copper was just a way to borrow for companies that needed loans and were otherwise unable to get them.

As I mentioned two weeks ago, when I discussed this in February with a senior executive in a major commodities company, he responded by saying that he thought the same thing might also be happening in soya.　 Borrowers are resorting to some fairly convoluted and expensive ways of obtaining short-term credit largely because they cannot obtain financing from the local banks.

Here’s how it works.　 Even when London prices are above Shanghai prices, companies eager for loans are importing copper in order to get back-door financing, whereas local traders, noticing that domestic demand isn’t strong enough to justify those import quantities, and perhaps eager to arbitrage the prices, are selling copper abroad.　 The weird distortions in the banking system, where credit isn’t rationed by price but by quantity and hierarchy, has turned China, at least temporarily, into a revolving door for copper imports and exports.　 This is great for copper traders, of course, but perhaps not so good for the overall economy since someone has to pay for those outsized trading profits.

I still need to find out more about this.　 I am only speculating and I don’t have real data to support me, but it does fit together nicely into a pretty consistent narrative on everything we are hearing in China, both about copper and about credit.

China’s share of total global demand for a selected list of non-food commodities:

China’s share of total global demand for a selected list of food commodities:

What is most noteworthy about these tables, of course, is the disproportion between China’s share of global GDP and China’s commodity consumption.　

The tables give a very good sense of what might happen to global demand for various commodities as China rebalances.　

Take iron, for example.　 If Chinese demand declines by 10%, this would represent a reduction in global demand of nearly 5%.　 I am not an expert in the commodity markets, but I guess that supply and demand considerations are fairly finely balanced, and a 5% reduction in demand should have significant price repercussions – especially if a material part of Chinese demand represents stockpiling and this stockpiling is reversed.

Copper Weekly Chart

click on chart for sharper image

Note that those companies holding copper, especially those new to this wild financing scheme, are very vulnerable to a decline in the price of copper. Alternatively, those companies taking out loans based on copper collateral then selling the copper back to the exchanges have managed to get loans with no collateral.

Interestingly, Pettis insists that credit cannot really be considered tight in China, rather demand for credit has gone through the roof.

In my model, rapidly expanding credit is a sign of a huge inflation problem. For comparison purposes, many forms of credit are still stagnant or declining in the US.

This is supposed to end well? For who?

There is much more in Pettis’ email including a more detailed discussion of China’s rebalancing that is not happening, who pays for the adjustment, and currency valuations.

Under terms of agreement with Pettis I cannot print the entire email so I picked the section on commodities to excerpt. Pettis will post more on his website later.

Mike “Mish” Shedlock