The Illusion of Recovery Thickens

The economy is in a prelude to a major correction

What a marvellous flimflam! So obvious... and yet so effective! It’s a pleasure to watch.

Yesterday, the Dow soared over the 10,000 mark. If it keeps going at this rate – up 144 points yesterday – it will soon equal the post-’29 bounce. All we need is two more days and we’re there.

Oil rose over $75. Gold closed the day at $1,064 after a big move to the upside over the last few days. And the dollar fell – to just $1.49 per euro.

The reason for yesterday’s big move is announced on the front page of almost every financial rag this morning:

“JP Morgan profits lift the Dow.”

JP Morgan, the Wall Street firm that was bailed out by the feds a year ago, reported income of $3.6 billion in the third quarter. With that kind of profit in the financial sector, it won’t be long before the whole economy is running red hot, right?

That’s what the papers seem to think. The International Herald Tribune says the bank’s profits are just another sign that a major recovery is underway. Investors seem to believe it, too. “Earnings optimism,” is behind the buying, says a broker.

But is it true? Is the real economy growing, expanding and making money? Let’s look:

“Still on the job, at half the pay,” is a headline in the New York Times. It tells the story of an airline pilot whose position has been downgraded and whose pay has been cut in half.

The fellow is now earning $30,000 a year rather than $60,000. He is not counted in the unemployment statistics but he has much less spending power than he had a year ago. Practically all his discretionary spending power has been wiped out.

The NYT:

“The Bureau of Labor Statistics does not track pay cuts, but it suggests they are reflected in the steep decline of another statistic: total weekly pay for production workers, pilots among them; representing 80% of the workforce.

“That index has fallen for nine consecutive months – an unprecedented string over the 44 years [for which] the bureau has calculated weekly pay – capturing the large number of people out of work, those working fewer hours and those whose wages have been cut. The old record was a two-month decline, during the 1981-1982 recession.

“‘What this means,’ said Thomas J Nardone, an assistant commissioner at the bureau, ‘is that the amount of money people are paid has taken a big hit; not just those who have lost their jobs, but those who are still employed.’”

All over the country incomes are falling. Officially, about 15 million people have no job. Many others have given up looking for jobs.

And now, for the first time ever, more than half of those who lose their jobs run out of unemployment benefits before they find another one. Many others never get any benefits at all, because their jobs are not eliminated – they are merely cut back... either in the number of hours they can work or in the compensation itself.

Yesterday, we reported that baby boomers are actually working longer hours... but earning less. The boomers are in an especially tight spot. They’ve got only a few years to save money for their retirements... and it won’t be easy in this slumpy economy.

And we reported the plight of the callow youths... whom Business Week has called the ‘Lost Generation’. Their unemployment rate is twice the national average. They’re at the bottom of the labour pool, and unless the economy begins to expand, they’ll have a very hard time finding the bottom rung of the ladder.

Take all the people who are unemployed... who are working fewer hours... who have given up looking for work... whose positions have been downgraded... and add the family members who depend on them for their daily bread... and you have nearly a quarter of the population.

How can companies expect to increase sales and profits with a quarter of the population forced to cut back severely?

They can’t. The earnings numbers are misleading. Most of the earnings that we’ve seen come from cost-cutting, not growing top-line sales.

How do businesses cut costs? By trimming employees!

In other words, the earnings figures we’re seeing are contributing to the slump... not alleviating it.

You can see how, in the short run, this can lead to increased profits. But it can’t go on for long. The more businesses cut costs the more their sales go down, because consumers (who are also their employees) have less money to spend.

And according to a Wall Street Journal report, with too much capacity... and falling sales, businesses “are hesitant to reinvest such profits into their businesses”.

That’s why business investment, as we reported two days ago, is falling even faster than sales. And it’s why people who are looking for a job are going to have a hard time finding one.

But let’s return to JP Morgan... after some bad news for the pound:

“Right now, as UK investors, we face one of the gravest ever threats to our wealth,” writes Nick Sudbury for The Zurich Club.

“There is a real danger that we’re about to see a major collapse in the pound."

“Why will this matter to you?

Well let me take you back to 1967, when we were in a similar situation. It will illustrate how disastrous the consequences could be.

“Back in the time of Sergeant Pepper and The Summer of Love, the UK’s public finances were in trouble. National debt was around 80% of GDP and the balance of payments was showing a huge deficit.

Dock strikes and closure of the Suez Canal were disrupting Britain’s exports and contributing to the strain on sterling. And – in a chilling parallel with today – a costly military campaign in the Middle East (culminating in Britain’s withdrawal from Aden) was sapping public finances and confidence in Britain from overseas.

“Harold Wilson’s Labour government repeatedly denied that they would ever devalue the pound. And yet – after burning through our gold and dollar reserves in attempts to shore up the pound – that’s exactly what they did. Back then the exchange rate was pegged to the dollar, so rather than just leaving it to the market the prime minister had to publicly announce that the pound was being cut from $2.80 to $2.40. Devaluing sterling would help to boost Britain’s struggling exports and was perhaps the least painful solution.

“The repercussions were to be felt for years to come. Bank lending rates were increased to 8%, defense cuts were announced and capital expenditure was put on hold. The 1968 Budget introduced new indirect taxes, and a bill restricting wage rises to 3.5% set the scene for a run-in with the unions. By 1976, after average wages had increased by 27.6% the preceding year, and with inflation rampant, Britain called in the IMF.

“The situation today looks even bleaker than in 1967.

UK National Debt is now over £800 billion and the government expects this to go up another £400bn by 2011.

This would put it above 100% of GDP for the first time since the mid sixties.

The pound is now trading at around $1.60. This is a third less than after the 1967 devaluation, and almost a quarter below the near $2.10 peak that the pound reached little more than two years ago…

“…Creating inflation is a neat way of reducing Britain’s burden of debt.

After inflation has worked its magic, the debt becomes less onerous to service and repay in real purchasing power terms. The wave of money unleashed by Quantitative Easing is one way to stoke inflation. And the other is to let the pound fall in value.

“So how can you protect yourself from this erosion of wealth? Well, I’d like to show you a safe haven for your money. It’s a strong currency backed by huge oil reserves and prudent government finances…”

The House of Morgan:

How did JP Morgan earn so much money in such a bad economy?
We begin with a bit of scepticism. After all, we know consumers aren’t borrowing. Consumer credit is going down. So they can’t be making money there. And we know businesses aren’t expanding, so they can’t be making money by lending to corporations either.

Wait a minute. JP Morgan is a bank, right? Don’t banks make money by lending money? Yes... that’s what we thought. Then who is JP Morgan lending to?

The only net borrower is the government.

The Financial Times confirms that Morgan’s “ US consumer businesses continued to bleed, with its credit card unit losing $700 million in the quarter and its retail bank... barely breaking even.” It wrote off $7 billion in uncollectible consumer loans – more than twice as much as last year.

Its mortgage group lost money too. And it surely didn’t make any money helping US business build new factories and expand payrolls.

All the components of the business that have to do with the real economy are losing money or barely breaking even. What’s left?

The news reports attribute the huge profits to “trading”. But trading is a broad category. And our guess is that if you look more closely you will find that JP Morgan made its money the old fashioned way; by ripping off the government.

‘You mean, JP Morgan took the feds’ money and is now showing huge profits because it is just lending money back to the people they got it from?’

Yes. But not only that. They’re also probably speculating on gold, oil and stocks... along with everyone else. The feds’ money has pushed all these speculative trades into profit.

‘And now, they’re going to pay themselves big bonuses, aren’t they?’

Yes. The papers tell us that “bonuses explode on Wall Street to a new record”.

‘So, then... when the next crisis comes... they won’t have any money in the banks, will they?’

Nope.

‘So they’ll have to get bailed out again?’

Yep.

‘But maybe the next time the feds will wise up and just let them go broke.’

Not a chance. Wall Street has plenty of friends in the highest places in Washington.

A report from today’s media tells us that “Geithner Aides Reaped Millions Working for Banks, Hedge Funds.” The aides earn about $150,000 for their government work. On the side, they advise the financial firms they’re supposed to be regulating – and get paid millions.

Such a nice relationship. They make sure Wall Street prospers – even when it does stupid things. Wall Street makes sure they prosper – even when they advise the government to do stupid things. And when their gig is over in Washington they go back to Wall Street where they earn millions more.

America ’s centres of political and financial power have a cozy little game going. It won’t end any time soon. It’s too profitable for both of them.

Bill Bonner