Despite what the President might think, he can’t create any jobs.  (Well he can by building roads, bridges, and schools – all things we need.  But that’s not likely to happen soon.)   But he can’t create jobs in most private companies – for that we need private entrepreneurs will to take risks and start companies in return for commensurate rewards.  In addition, the President is going to have a hard time changing our country’s current corporate predilection for outsourcing, not because the U.S. manufacturing labor force isn’t competitive with China or India – it is.   3 years into this recession, labor costs are relatively inexpensive, especially when you consider the enhanced productivity of the U.S. labor force compared to those other countries – we are a lot more efficient and operate with much lower friction costs (fraud, theft, etc.).    He is going to have a hard time changing things because he is unwilling to do the very simple task of changing our immigration laws for highly educated engineers, of which the country is in very short supply.  Bring in more engineers, and you’ll get more manufacturing jobs.   Send engineers overseas, and watch the manufacturing jobs disappear.   It’s simple.

So what’s the problem?   Regulation.   Not just regulation of financial companies, which is going to drive down their returns until they resemble utilities.   Overall stupid, needless regulation – sometimes regulation that is so mind-numbingly dumb as to defy belief.   Now wait a second you’re probably saying to yourself, some regulation is good – environmental regulation, for instance.   And I agree that some regulations are a good thing, particularly when without it companies can get a “free rider” benefit from using public resources (clean water) for private gain (dumping toxic sludge into rivers).    But the U.S. immigration visa requirements that send home engineers and Ph.D.’s as soon as they earn their degree here, instead of encouraging them to stay in this country (which many want to do) and start companies here, make no sense at all.    Think this is a Wall Street free-market rant?   Actually, this issue is a very hot topic in Silicon Valley.   Steve Jobs recently had some interesting comments on this.  Among them:

'You're headed for a one-term presidency," Steve Jobs told President Obama at the beginning of a one-on-one session the president requested early last year.  As described in the authorized biography by Walter Isaacson, Apple's founder said regulations had created too many burdens on the economy.



According to Mr. Isaacson, Jobs "stressed the need for more trained engineers and suggested that any foreign students who earned an engineering degree in the U.S. should be given a visa to stay in the country." The president reportedly replied that this would have to await broader immigration reform, which he said he was unable to accomplish. "Jobs found this an annoying example of how politics can lead to paralysis," Mr. Isaacson writes. "The president is very smart, but he kept explaining to us reasons why things can't get done," Jobs said. "It infuriates me."

Jobs told Mr. Obama that Apple employs 700,000 factory workers in China because it can't find the 30,000 engineers in the U.S. that it needs on site at its plants. "If you could educate these engineers," he said at the dinner, "we could move more manufacturing jobs here."

The whole article (which is fairly short) can be found here.

It’s really simple – keep the smart, energetic people that can grow this country here.  Entrepreneurial immigrants made this country great – and I’m not talking just recently.  I’m talking from the country’s founding.   Why change what has worked for us for over 200 years because it’s politically expedient to do so?   Oh right, because it’s Washington, and if something smart can be done, it can be twisted and corrupted for political gain as well.  But this time, the whole country is suffering because of it.

Wasn't it nice when Eurotrash meant an annoying group at the bar and not Sovereign Debt?  Anyway, despite what you might have read in the paper or seen on the news, the recently announced rescue package isn’t a rescue at all.   It’s like sending someone who can’t swim into a riptide to rescue a drowning swimmer.   Or to use another analogy, Europe is like 2 drunks staggering down the street leaning on one another.   They think they are sober and fine until one stops walking.   Then they both fall over.   Lending money from one broke country to another broke country doesn’t make the first one less broke.  It just props it up for a while.  See our note from yesterday for more on this issue.
Since the solution to the problem is easy, clear, and everyone seems to actually know what it is, why won’t it happen?  Simply put, just like the US fears a second Great Depression, Germany fears a second Great Inflation.   They are worried that monetizing the debt via the European Central Bank (ECB) will cause rampant inflation.   Secondarily, the German leaders have a political problem.   They can be seen by their citizens (who have actually done a good job of saving and not over-extending themselves) as bailing out the lazy early-pension-taking partiers in southern Europe, or they can wait for Greece and Italy to default (“voluntary reduction”, sorry) and then backstop their own banks.   The amount of money at stake is about the same (for the Germans).  But it is much more politically palatable to give German money to German banks than to give it to Greece so that German banks don’t take losses on Greek bonds.   Simple right?  

So what are the Germans afraid of?  Art Cashin is the best writer on Wall Street.  His daily notes are a must read.   So instead of doing his history a disservice, I have quoted it in its entirety below.   Enjoy.

An Encore Presentation

By Art Cashin

Originally, on this day (-2) in 1922, the German Central Bank and the German Treasury took an inevitable step in a process which had begun with their previous effort to "jump start" a stagnant economy. Many months earlier they had decided that what was needed was easier money. Their initial efforts brought little response. So, using the governmental "more is better" theory they simply created more and more money.

But economic stagnation continued and so did the money growth. They kept making money more available. No reaction. Then, suddenly prices began to explode unbelievably (but, perversely, not business activity). So, on this day government officials decided to bring figures in line with market realities. They devalued the mark. The new value would be 2 billion marks to a dollar. At the start of World War I the exchange rate had been a mere 4.2 marks to the dollar. In simple terms you needed 4.2 marks in order to get one dollar. Now it was 2 billion marks to get one dollar. And thirteen months from this date (late November 1923) you would need 4.2 trillion marks to get one dollar. In ten years the amount of money had increased a trillion fold.

Numbers like billions and trillions tend to numb the mind. They are too large to grasp in any "real" sense. Thirty years ago an older member of the NYSE (there were some then) gave me a graphic and memorable (at least for me) example. "Young man," he said, "would you like a million dollars?" "I sure would, sir!" I replied anxiously. "Then just put aside $500 every week for the next 40 years." I have never forgotten that a million dollars is enough to pay you $500 per week for 40 years (and that's without benefit of interest). To get a billion dollars you would have to set aside $500,000 dollars per week for 40 years. And a…..trillion that would require $500 million every week for 40 years. Even with these examples, the enormity is difficult to grasp.

Let's take a different tack. To understand the incomprehensible scope of the German inflation maybe it's best to start with something basic….like a loaf of bread. (To keep things simple we'll substitute dollars and cents in place of marks and pfennigs. You'll get the picture.) In the middle of 1914, just before the war, a one pound loaf of bread cost 13 cents. Two years later it was 19 cents. Two years more and it sold for 22 cents. By 1919 it was 26 cents. Now the fun begins.

In 1920, a loaf of bread soared to $1.20, and then in 1921 it hit $1.35. By the middle of 1922 it was $3.50. At the start of 1923 it rocketed to $700 a loaf. Five months later a loaf went for $1200. By September it was $2 million. A month later it was $670 million (wide spread rioting broke out). The next month it hit $3 billion. By mid month it was $100 billion. Then it all collapsed.

Let's go back to "marks". In 1913, the total currency of Germany was a grand total of 6 billion marks. In November of 1923 that loaf of bread we just talked about cost 428 billion marks. A kilo of fresh butter cost 6000 billion marks (as you will note that kilo of butter cost 1000 times more than the entire money supply of the nation just 10 years earlier).

How Could This All Happen?

In 1913 Germany had a solid, prosperous, advanced culture and population. Like much of Europe it was a monarchy (under the Kaiser). Then, following the assassination of the Archduke Franz Ferdinand in Sarajevo in 1914, the world moved toward war. Each side was convinced the other would not dare go to war. So, in a global game of chicken they stumbled into the Great War.

The German General Staff thought the war would be short and sweet and that they could finance the costs with the post war reparations that they, as victors, would exact. The war was long. The flower of their manhood was killed or injured. They lost and, thus, it was they who had to pay reparations rather than receive them.

Things did not go badly instantly. Yes, the deficit soared but much of it was borne by foreign and domestic bond buyers. As had been noted by scholars….."The foreign and domestic public willingly purchased new debt issues when it believed that the government could run future surpluses to offset contemporaneous deficits." In layman's English that means foreign bond buyers said – "Hey this is a great nation and this is probably just a speed bump in the economy." (Can you imagine such a thing happening again?)

When things began to disintegrate, no one dared to take away the punchbowl. They feared shutting off the monetary heroin would lead to riots, civil war, and, worst of all communism. So, realizing that what they were doing was destructive, they kept doing it out of fear that stopping would be even more destructive.

Currencies, Culture and Chaos

If it is difficult to grasp the enormity of the numbers in this tale of hyper-inflation, it is far more difficult to grasp how it destroyed a culture, a nation and, almost, the world.

People's savings were suddenly worthless. Pensions were meaningless. If you had a 400 mark monthly pension, you went from comfortable to penniless in a matter of months. People demanded to be paid daily so they would not have their wages devalued by a few days passing. Ultimately, they demanded their pay twice daily just to cover changes in trolley fare. People heated their homes by burning money instead of coal. (It was more plentiful and cheaper to get.)

The middle class was destroyed. It was an age of renters, not of home ownership, so thousands became homeless.

But the cultural collapse may have had other more pernicious effects.

Some sociologists note that it was still an era of arranged marriages. Families scrimped and saved for years to build a dowry so that their daughter might marry well. Suddenly, the dowry was worthless – wiped out. And with it was gone all hope of marriage. Girls who had stayed prim and proper awaiting some future Prince Charming now had no hope at all. Social morality began to collapse. The roar of the roaring twenties began to rumble.

All hope and belief in systems, governmental or otherwise, collapsed. With its culture and its economy disintegrating, Germany saw a guy named Hitler begin a ten year effort to come to power by trading on the chaos and street rioting. And then came World War II.

That soul-wrenching and disastrous experience with inflation is seared into the German psyche. It is why the populace is reluctant to endorse the bailout. It is also why all the German proposals have each country taking care of its own banks. (It gives them more control.) The French plans tend to socialize the bailout. There's more disagreement in these plans than the headlines would indicate.

To celebrate have a Jagermeister or two at the Pre Fuhrer Lounge and try to explain that for over half a century America's trauma has been depression-era unemployment while Germany's trauma has been runaway inflation. But drink fast, prices change radically after happy hour.

Late last night (actually really early this morning) as everyone knows by now, Europe “solved” the Greek debt crisis.   According to Reuters:

Euro zone leaders struck a deal with private banks and insurers on Thursday for them to accept a 50 percent loss on holdings of Greek government bonds as part of a plan to lower Greece's debt burden and try to contain the two-year-old euro zone crisis.

In an agreement reached after more than eight hours of sometimes harsh negotiations, the private sector said it would voluntarily accept a nominal 50 percent cut in its investments to reduce Greece's debt burden by 100 billion euros, cutting its debts to 120 percent of GDP by 2020, from 160 percent now.

At the same time, the euro zone will offer "credit enhancements" or sweeteners to the private sector totaling 30 billion euros. The aim is to complete negotiations on the package by the end of the year, so that Greece has a full, second financial aid program in place before 2012.

The value of that package, EU sources said, would be 130 billion euros — up from 109 billion euros when a deal was last struck in July, an agreement that subsequently unraveled.

"The summit allowed us to adopt the components of a global response, of an ambitious response, of a credible response to the crisis that is sweeping across the euro zone," French President Nicolas Sarkozy told reporters afterwards.

The stock market rallied strongly on this, pushing the monthly gain for the S&P 500 to its highest level since 1987.   We expected this rally, and expect continued market strength in over-sold sectors, although the overall market will probably fade a bit here.  However, those who understand how the markets work in Europe don’t think this is a permanent solution – just like the first Greek “solution” over 2 years ago wasn’t the solution either.  But it works now, and we’re in the here and now business, not the “ivory tower what’s right” business.   This is a big move and the markets are working off of a big oversold condition last month.   Our long call starting October 5th was about as good as it gets, but its nearing time to tip the man and go home.    

Quoting our trader at Goldman, Sachs: 



We are not rallying because Europe “got done.” It didn't. We are rallying because the market wants to rally. After 6 months of pain and lack of direction, investors need to cheer on something and what better reason to cheer than headlines which seemingly tackle the scariest of all global problems - the one of disintegration of the second biggest Monetary Union in the world.   As a colleague noted, why be contrarian when:

• realistically there is one month of trading left
• most trading strategies seem to be flat at best year to date, so few bears seem to have the risk appetite to "call" the market in here
• there are still a lot of crowded shorts/hedges out there
• it seems like politicians just solved the biggest macro issue at least through year-end 

It simply doesn't pay to take the other side of this rally for the time being even though most probably one should.

The problem is that the deal struck doesn’t solve the problem at all.  First, the details are wildly unknown.   The haircut on private debt hasn’t yet been agreed to by those taking the actual losses, the structure of the credit enhancements isn’t done, and the details of how to actually swap the bonds weren’t even discussed yet.  For a good discussion of the issues, read this Financial Time article.

But the real problem, and why this deal won’t work, is that the EFSF cannot fix the problem.   The European Central Bank (ECB) needs to print money to buy (effectively monetize) the debt and absorb the losses.   But the German’s don’t like printing money, as they are deathly afraid of runaway inflation.   (See my note tomorrow on the Germans and the Weimar inflationary period after WWI).  So we are stuck playing the game of kick the can down the road – a fun game as a kid, but not so much when dealing with a sovereign debt crisis.   Simply put, the EFSF is like New York and New Jersey lending money to a bailout fund (i.e., the EFSF) that will then lend to California.   All it does is move the bad paper from one holder to another.  It's as if all the US states got over leveraged, and so they all got together to fund each other – it makes no sense.  To clarify, the ECB (i.e., our Federal Reserve) is needed because it can simply print money and absorb unlimited losses, while the EFSF nominally needs funding from other countries, and won’t be able to sustain another country defaulting, like Italy.  So having a limited amount of firepower means that it is likely to be needed and will prove to be too small in the end. 

For a good summary of why this deal won’t work, please click here for a summary from Warren Mosler of Mosler Economics.

The Chinese, despite popular press to the contrary, are not an economic model to emulate.   While their country appears to be growing at the same time the U.S. is stagnating, the reality is that their growth is being “bought” with cheap credit, which will not be repaid.   Banks are lending tremendous amounts of money to enterprises without profits and without the prospect of profits.   The new loans are simply going to be spent on getting the lights on and the payroll paid. 

Why are they doing this?  Economic expansion in China is necessary to maintain societal calm, particularly in the countryside, where poverty is still rampant.   Without new factories and jobs with which to satisfy their citizens’ demands for higher wages, the ruling members of the Communist Party of China and its very industrious military would lose control over the populace.   Given China’s thousands of years of history of regime change via popular unrest, and the subsequent death of the previous leaders, it is understandable why the current leadership will maintain growth at literally any cost.  For an interesting article on this topic, click here.

For an interesting perspective on the real risk to our economy from over-regulation by a Congress that is run by lobbyists, read this interesting article on Google's Eric Schmidt's discussion of Washington politics.

Some highlights:

"So we get hauled in front of the Congress for developing a product that's free, that serves a billion people. OK? I mean, I don't know how to say it any clearer," Mr. Schmidt told the Post. "It's not like we raised prices. We could lower prices from free to . . . lower than free? You see what I'm saying?"

He contrasted innovation in Silicon Valley with innovation in Washington. "Now there are startups in Washington," he said, "founded by people who were policy makers. . . . They're very clever people, and they've figured out a way in regulation to discriminate, to find a new satellite spectrum or a new frequency or whatever. They immediately hired a whole bunch of lobbyists. They raised some money to do that. And they're trying to innovate through regulation. So that's what passes for innovation in Washington."

An interesting and quick read - and one you won't see again for awhile.

For an interesting look at how past Presidents have tried (and failed) to bully business into doing their bidding, read this article in the Wall Street Journal about FDR's response to the double-dip recession of 1937.  (For those who weren't around back then, industrial production fell by 1/3, stocks by 50%, payrolls by 35% and unemployment reached 20% - all 5 years AFTER the recovery began).  

Some interesting portions: 

"Privately, FDR told Robert Jackson, head of the Justice Department's antitrust division (and a future Supreme Court justice), "Bob, I'm sick of sitting here kissing [businessmen's] asses to get them to" invest and increase employment. Publicly, Jackson agreed in a December 1937 speech that the country faced a "strike of capital" by business in order to get New Deal legislation repealed. He denounced the notion that the president's program was antibusiness. Given the "astounding profits under the present administration," he said, "big business will never be able to convince the American people that it has been imposed on, destroyed, or even threatened. It has merely been saved from ruin and restored to arrogance."

FDR told former speechwriter Rex Tugwell late in 1937 that he "wanted to scare these people into doing something." It was an odd strategy, trying to vilify business into creating jobs. And it didn't work well.

The full article can be found here. 

On Friday Dallas Fed President Richard Fisher gave another of his honest and frank speeches.  I have quoted part of it below, and posted the link to the speech itself here.  Washington needs to get going on regulatory and fiscal reforms soon, or there will be nothing left to fight over.

From his speech:  "And yet, even in this blessed state, there are too many unemployed and underemployed, just as there are in the rest of America. We can do better. America must do better.

The question is: How?

To create employment, we must have economic growth.

The simplest of econometric equations posits that the key components of economic growth are: domestic consumption, plus foreign demand for U.S.-produced exports, plus investment by businesses, plus spending by government.

I think it is pretty clear to everyone who lives on the planet that in order to expand our economy and put our people back to work, we must rely on our ability to curry to domestic and foreign consumption and invest here at home to produce the goods and services to sell into the marketplace here and abroad. You’d have to be from Mars to believe that our financially strapped federal and state governments will be the source of much direct spending stimulus to the economy going forward."



At the beginning of this talk, I mentioned Ambassador Mike Moore of New Zealand. His most recent book is dedicated “To honorable public servants, elected or otherwise,” as he put it. He then inserts a quote from Martin Luther King Jr. as follows: “Cowardice asks the question—is it safe? Expediency asks the question—is it politic? Vanity asks the question—is it popular? But conscience asks the question—is it right? … There comes a time when one must take a position that is neither safe, nor politic, nor popular, but one must take it because it is right.”[6]

I would suggest to you that the time is now. Our nation’s economy is at risk. The Federal Reserve is doing everything it can to bolster unemployment without forsaking our sacred commitment to maintaining price stability. I personally don’t care which party is in the White House or controls Congress. All I know is that the “honorable” members of Congress, Republicans and Democrats alike, have conspired over time, however unwittingly, to drive fiscal policy into the ditch. They purchased their elections and reelections with popular programs so poorly funded that they now threaten the economic well-being of our children and our children’s children. Instead of passing the torch on to the successor generation of Americans, the Congress is simply passing them the bill. This is the opposite of honorable, and it must stop.