The Financial System – A House of Cards

As the Capital Research Institute pointed out on April 14th, 2011 in the article “Fed Up With Lies”,

“Currently the Fed is talking about stopping the controversial treasury purchases known as quantitative easing (QE). The Capital Research Institute (CRI) is predicting that another round of debt monetization will be announced when QE2 runs out in June.”

At the time of our article most economist, fund managers, and analysts confirmed the Fed’s stance that there won’t be further stimulus. For those of you who paid close attention may have caught the following in Fed Chairman Ben Bernanke’s speech last week on July 13th,

“the possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might re-emerge, implying a need for additional policy support”.

His statement clearly indicates that the Fed is considering further stimulus, which will most likely include asset purchases such as Treasuries during QE1 and QE2. The scary thing is that what the CRI considers being quite obvious seems to not even be on most professional economist’s radars. Since most failed to predict the 2008 crash, how can we expect these same people to analyze and predict the economy this time? Has their state of mind or belief’s that their analysis is based on changed? Probably not! So why should we listen to those same people if they failed and will fail again to predict what is happening in the global economy?

It is clear that the mainstream media with its talking heads is failing to inform the general public of what is really going on, our research and analysis here at the CRI is intended to inform the public of the truth. The reasons we belief that further stimulus is in the cards are unemployment, housing, and GDP growth.

Unemployment

Let’s have a look at how unemployment has developed during the last few months since we last reported on it. If we look at the graph of the unemployment rate over the last year one might think that it is improving, even though the unemployment rate alone illustrates a wrong picture.

In order to analyze unemployment and to determine if it is improving, a better measure is the labour force participation rate, which shows what percentage of people employed and looking for employment are actually participating in the labour force out of the total population. The labour force participation rate is close to a 30 year low as indicated in the following graph that also highlights recessions in gray. Only about 64% of the US population participates in the work force, which is the lowest rate since the 1980’s. As we can see the “Great Recession” has had a much stronger impact on the labour force than previous recessions. It will take fundamental changes to the entire economic system to recover those jobs and to bring the labour force participation rate back in line with previous decades. Without jobs there is no hope for housing to recover, since people need income in order to afford a home. Without jobs there is no disposable income to spend and fuel the US economy of which 70% is purely driven by consumption.

Housing

Without jobs there is no recovery in the housing sector since people cannot afford a home no matter how low the price may be at the moment. Existing home sales are further declining as are house prices indicated by the Case-Shiller Index.

Without a recovery in the housing market and sustained employment growth, GDP growth will also be sluggish since disposable income for consumption is curtailed. During the last decade, many Americans consumed by taking out home equity loans, effectively using their homes as collateral to fuel their excessive consumption. Without rising home prices that type of unsustainable consumption is not possible and therefore means slow economic growth for a consumption based economy.

The Deficit

Let’s be honest, there is no way for the US Government to reduce the deficit without making underlying changes how the economy operates and how government spends. With an annual defense budget of over $1 trillion plus huge costs for Medicare and Medicaid, the US is in no place to sufficiently cut spending to even significantly touch the debt mountain of $14.3 Trillion and growing. Currently Congress is talking about ideas such as changing how inflation is calculated to save $500 billion per year over a 10 year period. You might ask yourself, really? Yes! Really! They are considering fixing the problem with smoke and mirrors. Other suggestions have been for the US Mint to create trillion dollar platinum coins to fund the government. Since only the Fed is allowed to actually print money, the government can use the Mint to create coins and therefore get around the Fed. These types of ideas are ludicrous and do nothing to tackle the problems. Everything that the US government is discussing and considering is nothing more than kick the old can down the road again. US debt should be downgraded to CCC, because it is close to junk status in consideration of the facts. The sovereign debt crisis in Europe and the US is far from over and will likely stick around for several years to come.

2012 Recession

With the current policies in place and without any fundamental changes, the US economy will most likely enter a recession in the coming year. By the end of this year, 3.7 million Americans will be cut off from jobless benefits, which will further slow down consumption and therefore economic growth. Since the Fed is down to only one tool (Quantitative Easing), which is not very effective besides devaluing the US dollar and pushing stocks higher, the only option is to use that tool further to try to keep the house of cards from collapsing – more stimulus is almost a guarantee as the CRI predicted in April.

At this point I would like to thank all of our thousands of newsletter subscribers and regular visitors from 121 countries since the inception of the Capital Research Institute just a few months ago. Thank you for your time, please continue to sign up for the Capital Research Institute (CRI) newsletter, comment on articles, and recommend them on Facebook in order to help us educate the public about the truth of the global economy.