Guest Post: The Fake Recovery

Submitted by Edward Harrison of the site Credit Writedowns

I last posted on “Credt Writedowns” on Thursday before the Easter Holidays in two posts very much at odds with one another. The overall thrust of the first post was that the financial services industry in the United States was due to gain from some very advantageous circumstances in 2009. Meanwhile, the later re-post pointed out the continued fragility of the U.S. economy and banking system and focused on liquidity and solvency as unresolved issues. I would like to bring these two posts together here because I believe the concept behind the dichotomy is best described as the Fake Recovery.

Why ‘Fake’? This is a fake recovery because the underlying systemic issues in the financial sector are being papered over through various mechanisms designed to surreptitiously recapitalize banks while monetary and fiscal stimulus induces a rebound before many banks’ inherent insolvency becomes a problem. This means the banking system will remain weak even after recovery takes hold. The likely result of the weak system will be a relapse into a depression-like circumstances once the temporary salve of stimulus has worn off. Note that this does not preclude stocks from large rallies or a new bull market from forming because as unsustainable as the recovery may be, it will be a recovery nonetheless.

The real situation
In truth, the U.S. banking system as a whole is probably insolvent. By that I mean the likely future losses of loans and assets already on balance sheets at U.S. financial institutions, if incurred today, would reveal the system as a whole to lack the necessary regulatory capital to continue functioning under current guidelines. In fact, some prognosticators believe these losses far exceed the entire capital of the U.S. financial system. Witness a recent post by Nouriel Roubini:

The RGE Monitor new estimate in January 2009 of peak credit losses (available in a paper for our RGE clients) suggested that total losses on loans made by U.S. financial firms and the fall in the market value of the assets they are holding would be at their peak about $3.6 trillion ($1.6 trillion for loans and $2 trillion for securities). The U.S. banks and broker dealers are exposed to half of this figure, or $1.8 trillion; the rest is borne by other financial institutions in the US and abroad. The capital backing the banks’ assets was last fall only $1.4 trillion, leaving the U.S. banking system some $400 billion in the hole, or close to zero even after the government and private sector recapitalization of such banks and after banks’ provisioning for losses. Thus, another $1.4 trillion would be needed to bring back the capital of banks to the level they had before the crisis; and such massive additional recapitalization is needed to resolve the credit crunch and restore lending to the private sector.

Now, obviously, if we were to face up to this situation, there would be no chance of recovery as the capital required to recapitalize the banking system would mean a long and deep downturn well into 2010 and perhaps beyond. This is not politically acceptable as 2010 is an election year. Nor is the nationalization of large financial institutions acceptable to the Obama Administration. Moreover, bailing out banks to the tune of trillions of dollars while the economy is in depression is equally unacceptable to the American electorate. The Obama Administration is keenly aware of this fact.

These constraints, some artificial and others very real, leave the Administration with limited options.

Engineer recovery
With the preceding constraints in mind, we should remember that the first priority of elected officials in Washington is not necessarily to make the best long-term choices for the American people, but rather to get re-elected in order to have the opportunity to make those choices. It should be patently obvious that a downturn which began in December 2007 would be fatal to many politicians if allowed to continue well into 2010. This is why recovery of some sort must take place before that time – irrespective of whether it is sustainable.

How to engineer recovery is another question altogether. Here again there are a set of political constraints which make things more challenging. First, there are large swathes of the population that are uncomfortable with the huge debt load and deficit spending that a stimulus-induced recovery creates. Moreover, a government-sponsored nationalisation or recapitalisation plan would only increase this deficit spending and these debts.

As a result, the Obama Administration has crafted a plan to circumvent these obstacles.

  1. Moderate fiscal stimulus. The Obama Administration decided not to seek massive stimulus earlier this year because they deemed it non-viable politically.This clears the first obstacle: deficit hawks. Most economists understand that the output gap that has opened up in the American economy is $2 trillion or more whereas the Obama stimulus package was only $800 billion. That leaves a massive hole in output in the U.S. Moreover, the immediate effective stimulus is less. Much of this ‘stimulus’ will be saved or will not come into play until months from now. Obviously, this is not going to meet the grade (See my comments on this from February).
  2. Quasi-fiscal role for the Fed. Having partially assuaged deficit hawks, Obama still needed to close the output gap. Enter the Federal Reserve. You will have noticed that the Federal Reserve has added legacy assets as eligible for the TALF program. In effect, this allows banks to slip tens or even hundreds of billions of dollars in so-called toxic assets off their balance sheets. Mind you, these are assets already on the books impairing banks’ ability to loan money. Under normal circumstances, one would expect the Federal Government to take these assets out of the system (bad bank, good bank, nationalization) after being given legislative approval to do so. However, as I have previously stated this approval is not going to be forthcoming. This is why the Federal Reserve is taking these assets on. In so doing, the Federal Reserve is taking on a quasi-fiscal role that re-capitalizes the banking system in order to stimulate the economy by increasing credit availability.
  3. Quasi-fiscal role for the FDIC. The new PPIP is a similar end-run around Congress. After all, the role of the FDIC is that it “maintains the stability and public confidence in the nation’s financial system by insuring deposits, examining and supervising financial institutions, and managing receiverships.” Meanwhile, the PPIP has the FDIC guaranteeing dodgy assets in a massive transfer of wealth from taxpayers to banks and select investors. (See my previous comments on this issue).
  4. End of mark-to-market as we knew it. You should have noticed that most of the assets written down in the past two years have been marked-to-market. Securities traded in the open market are marked to market. Loans held to maturity are not. This is one reason that large international institutions which participate in the securitisation markets have taken the lion’s share of writedowns, despite the low percentage that marked-to-market assets represent on bank balance sheets. But, this should end because of new guidelines in marked-to-market accounting. However, the new guidelines do have two major implications. First,there are still many distressed loans on the books of U.S. banks that if marked to market would reveal devastating losses. Second, there will also now be many distressed securities on bank balance sheets that if marked-to-market would reveal yet more losses. In essence, the new guidelines are helpful only to the degree that it prevents assets being marked down due to temporary impairment. If much of the impairment is real, as I believe it is, we are storing up problems for later.
  5. Interest rate reductions. One reason often given for a large increase in writedowns at financial institutions had been the coming reset of Alt-A adjustable-rate mortgages in 2009. With the subprime writedowns mostly accounted for, a souring of the much larger pool of Alt-A and Prime residential mortgage loans is the real Armageddon scenario. Well, part of this problem has been temporarily relieved because the Federal Reserve has reduced short-term interest rates to near zero and has begun trying to manipulate long-term interest rates lower by buying long-dated treasury securities.
  6. Bank margin increases. Key to the whole program is banks’ ability to earn massive amounts of money and re-capitalize themselves through retained earnings as opposed to shedding assets or receiving additional paid-in capital (see post from last April on these three methods of recapitalizing). The market for bank assets is distressed and few banks can get enough capital from private sources or investors. Therefore, Obama’s plan hinges on the ability to allow these banks to earn shed loads of money as quickly as possible. If the banks cannot do this, we are going to have a big problem very quickly (Of course, I think the can).

The stimulus to come from these measures is still in the pipeline and, by the end of this year, will probably add a big kick to the economy. You should note that only the fiscal stimulus required legislative approval. All of the other ‘stimulus’ has been done without Congressional approval and largely without Congressional oversight. These activities have been specifically designed to be opaque. The government’s claims of wanting to increase transparency ring hollow (see my post on Bloomberg’s suit against the Fed as an example of what is really happening).

I should also mention that the Federal Reserve has been a large factor here. It is acting in concert with the executive branch in a non-arms length fashion which I believe will have consequences regarding Fed independence down the line.

Other positive economic factors

There are a number of so-called green shoots (a phrase coined by Norman Lamont) of note.

  • Jobless claims have plateaued and comparisons to last year are actually declining (see post).
  • The U.S. trade deficit is declining significantly as U.S. import demand has fallen off a cliff.
  • Inventory liquidation will put U.S. manufacturers in a better position by Q4 and help make quarterly and yearly comparisons favourable.

I linked to the first two bullets of these other factors. And I wanted to spend a little time on factor number three because I think it is important. Niels Jensen of Absolute Capital Partners has a very solid write-up on this in his most recent newsletter: (do sign up for his free newsletter because it is quite informative. Click here to see the newsletters and sign up.)

Turning my attention to the global economy, after a rather muted beginning, manufacturers around the world have now begun to react aggressively to the economic downturn and inventories are falling aggressively. Chart 5 below depicts US manufacturing inventories as published recently by the Census Bureau. Inventory changes can have a meaningful impact on GDP. There is one example from the 1981-82 recession where the inventory correction subtracted 5% (annualised) from GDP in just one quarter. The current inventory correction is very negative for GDP in Q1 and possibly also in Q2, but it is very difficult to quantify the effect it is going to have. We will have to wait and see.

However, as we must remind ourselves, the stock market is not trading on what is going to happen in Q1 and Q2 of this year. Projecting at least 6-9 months ahead, the stock market is probably already looking ahead to Q4 and possibly even Q1 of next year. And the inventory adjustment currently underway is very bullish for GDP growth later this year and into next. The reason is simple. Manufacturers always overreact. Come Q3 or Q4, they will suddenly sit up and realise that inventories have fallen too much and that they need to produce more. There is no reason to believe that this recession will be any different.

Obviously, this means that U.S. Q1 and perhaps even Q2 GDP will be very low due to the subtraction of inventories now being purged. However, when we get to Q3 and Q4, this effect will be gone and quarterly and yearly comparisons will look favourable. So the inventory purge may mean a huge upside surprise to GDP in the second half of the year and early 2010 – potentially enough to see positive GDP numbers.

A brief reminder of what lurks beneath
Despite the positives from the previous section, there are significant headwinds which may even preclude a positive GDP number. They include:

  • Rising joblessness
  • Increased savings as households rebuild balance sheets
  • Spending cuts by local and state governments
  • Decreased capital spending by companies
  • A calamitous GM bankruptcy

Moreover, credit availability –and hence GDP will be constrained by numerous factors including the following:

  • Declining home values
  • Increasing foreclosures
  • Commercial property writedowns
  • Credit card-related writeoffs
  • Junk bond defaults

All of this means that a cyclical rebound is not a foregone conclusion at all.

Tying the threads together
You should be under no illusion that the coming rebound is permanent. Much of it is not. What we are seeing is the makings of a cyclical recovery that might begin as early as Q4 2009 or Q1 2010. How long or robust that recovery is remains to be seen. Moreover, it is still questionable whether we will get any meaningful recovery at all in spite of the ‘green shoots’ because the banking system in the United States is severely undercapitalised and more asset writedowns are coming due. This is a fake recovery underneath which many problems remain.

Nevertheless, banks are going to earn a lot of money and that is bullish for their shares – at least in the medium-term. Yes, the stock market is overbought right now. However, if banks put together some decent earnings reports over the next few quarters, their shares will rise.

Furthermore, if the banks can earn enough, this cyclical recovery will have legs as banks will then have enough capital to resume lending and that is supportive of the broader market as well. It is still too early to tell how this will play out over the longer-term. For now, I am much more positive on financials, and somewhat positive on the broader market as well.

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. In Debt We Trust

    It’s only a short stretch from defrauding the taxpayers to defrauding China. Which is why Beijing is so rightly concerned w/the American ideology of paper shuffling.

  2. S

    First of all green shoots is a cnbc term and immediatly threads the credibility. it is the stuff of disinformazia.

    Second, the idea that banks can recap faster than economy tanks is predicaed blowing a confidence bubble – we don;t hgave any assets left. leave wall street/nyc and that simply isn;t happening.

    Third, the US gov’t need to roll almost $2Trillion befor deficits. Where is the money coming from when the death spiral begins?

    Forth, house prices as a function of lower interest rates are a short term bong hit. What happens when rates rise? Price go down further, in the context of no wage growth anf limited to no job creation.

    Banks recapping themselves at the expense of the US dollar is an utterly unhealthy prescrition.

    I HIGHLY suggest reading the Hussamn missive on the repugnant protection of bondholders.

    History may be one lie commonly agreed, until it isn’t

  3. Anonymous

    confidence will rebound unless overwhelmed by volatility:

    yes it’s a fake recovery as long as debt/gdp ~ 3.5 and the feds are transmuting bad bank assets at something like par into treasury obligations….

    the social contract is broken. the two party system has begun mutual assured destruction. strauss and howe got it right a dozen years ago in the fourth turning. we’re headed for war or revolution or the crashing and burning of the american empire

  4. fresno dan

    from Fresno Dan in Wonderland
    with apologies to Lewis Carroll

    “Would you tell me, please, which way I ought to go from here?”
    “That depends a good deal on where you want to get to,” said the Cat.
    “I don’t much care where–” said Alice.
    “Then it doesn’t matter which way you go,” said the Cat.
    “–so long as I get SOMEWHERE,” Alice added as an explanation.
    “Oh, you’re sure to do that,” said the Cat, “if you only walk long enough.”

  5. Lillie Yifu

    hihi, I think this post is very important for people to read, but I wanted to correct detail. The stimulus package is 800 billion over two years, where the output gap is 2 trillion per year.

    I remember this because I edited a post for someone who made the same mistake.

  6. killben

    The demand side of the equation is the unknown factor. Plus GM, Chrysler, unexpected bankruptcies and job losses!

    let us see how all these fare by Q4!

    How green are the green shoots?? I would be surprised if the green shoots are really green!!

  7. Scrooge McDuck

    Total US Debt so far: $301 Trillion dollars. $1.0M per person

    all with the latest data

    9.8T in bailouts

    11T in government debts

    17T in corporate debts

    1T in credit card debts

    11T in mortgages

    52T in social security/medicare obligations–Social-Security-Ow

    Like other government trust funds (highway, unemployment insurance and
    so forth), the Social Security and Medicare Trust Funds exist purely
    for accounting purposes: to keep track of surpluses and deficits in
    the inflow and outflow of money. The accumulated Social Security
    surplus actually consists of paper certificates (non-negotiable bonds)
    kept in a filing cabinet in a government office in West Virginia.
    These bonds cannot be sold on Wall Street or to foreign investors.
    They can only be returned to the Treasury. In essence, they are little
    more than IOUs the government writes to itself.

    200T in derivatives in banks

    Not including derivatives; 101T. including it, 301T

    Can't really pay it off anytime soon….

    2.3T budget deficit this year. 10T in the next 10 years.

  8. Greg Hall

    “I’m saying that debt is the actual cause of the disease and and the cause in the American case is pretty close to 1.5 to 2 times as bad as the Great Depression. So, I think it’s going to be… we’ll be lucky to come out of things as well as the Great Depression. We’ll certainly come out worse than 1990. People who believe we’re going to stop at less than double digit rates of unemployment are, I think, deluding themselves.” –Steve Keen

  9. Greg

    Excellent synopsis that we will unfortunately never see in prime time.

    The best thing Obama has done is to start talking positively which coincided with him getting what he wanted out of Congress. If he would of took this attitude from the beginning then losses would have been more gradual, but then he wouldn’t have been able to scare taxpayers into giving him a blank check which is what he now has with the Fed.

  10. Anonymous

    The banks only function at this point because government guarantees have been layered over what everybody knows are unkeepable promises.
    To see what happens when the government tries to unwind from this, we need only look back at 1937.

  11. gronk

    But, if the only way for the banks to get out of this mess is by earning shitloads of money, what is going to stop them from doing so when we are out of this mess?

  12. asphaltjesus

    1. This ‘end of the U.S.’ talk is doomsaying nonsense. If more of the disinterested voter bloc were involved, our government would act quite differently.

    2. One of the underlying ideas supporting the piece is the controversial notion that deficits matter. While deficits are not immaterial, I would argue there is *far* more room for the U.S. to run deficits. Reagan did it without consequences, GWB did it without consequences, Obama can too.

  13. retread


    I suggest you bone up on economic history. The financial crises are the result of excess indebtedness. The Reagan overstimulation and lax regulation lead to the S&L crisis, and while we discount it now, it was plenty scary at the time. And if you read the 1987 crash, the Merc was with 3 minutes of not opening when it got a loan from Chase. Had the Merc not opened, the NYSE probably would have failed.

    The Reagan deficits also lead to the Plaza accord, which was a big part of Japan's undoing.

    And no consequences of GWB? Have you looked at what is happening in the economy now? The worst crisis since the Depression, possibly even worse since we aren't through it yet, and you label it no consequences?

  14. K Ackermann

    @asphaltjesus – The end of the US has already happened, IMO.

    You have to look at what we did after invading Iraq to see what the new US is all about.

    Shipping containers filled with cash were emptied out without account.

    Bremer decimates the public sector by firing the 500,000 people who knew anything about the country.

    Unemployment was 68%, but the Pentagon nixed the hire-Iraqis-first clause for reconstruction contracts. As a consequence, the country was flooded with people hired to work for a bowl of rice a day, all while unemployed Iraqi’s looked on.

    Clean water disappeared, and electricity got down to two hours a day. Malnutrition actually becaume a problem at one point.

    The reconstruction money slowly evaporated, with the excuse that it was going to security. Betchel got every dime for only building 6 of the 65 schools they were contracted to build, and 5 of the 6 were not fit to occupy.

    Cost-plus contracts were sub-contracted 5 and 6 times around, with each contractor adding the cost of the full job.

    Around 655,000 Iraqi’s were killed, and life sucked for the rest of them.

    It didn’t matter one lick to the visionaries and leaders of the new US. They have not yet had to press violence on the US citizens as they shipped our jobs overseas, because credit was available to buy all the cheap crap.

    The orgiastic feeding at the pig trough has been interrupted by this economic crisis, and the bankers became enraged. They insisted, and got, trillions of dollars of our money that they view as rightfully theirs.

    They already have our 401k’s. They already sold us houses we can’t afford. They have all our information. They own the government.

    Your well-being is of absolutely no concern to them. They would like you to have a pension and have medical care, and if you can find it, then good for you. But realize the goal is to get the cost of labor to zero.

    This is America.

  15. ex VRWC

    There is only way for banks to earn a lot of money. That is to lend. There is no other way. The big thing that these macroeconomists gloss over is that lending is not stopped due to a credit freeze. Lending is stopped because credit demand has collapsed. And credit demand has collapsed because consumers and businesses were overleveraged. And their investments in 401K’s their homes, and their pensions have collapsed.

    Therefore credit demand will not return anytime soon. Therefore the banks will have no way to make money. Therefore their insolvency will be exposed sooner. ANd we will have saddles generations with their bad debts in the meantime.

    So, even the ‘positive’ scenario this author outlines is, in fact, unrealistic and will not happen. The sooner we adjust to this new reality and move on to more positive steps the better.

  16. mmckinl

    We’re going Japanese dear friends, that is, if they can manage it …

    Banks won’t be re-capitalized, debt will sit on our chest like a 500lb gorilla …

    New full employment will be 10% unemployment, that is, the official figure … budget deficits will pass a trillion for years and years … social programs will be severely cut …

    But hey, we saved the bankers!

  17. EDC


    Where… I don’t see it, all i see and hear are things getting worse. Yes the speed of worse isn’t as fast but there is no floor in sight.

    Don’t confuse change in the prices of stock as recovery. Yes, this will change social mood some and people will spend a little more but what has changed since July/August 2008? Any improvements?

    To even call this a shaky foundation is absurd. Shaky foundation is what we had after the 2003 recession because our growth was fueled paper shuffling.

    Again, this is nothing more than a slight paradigm shift in mood that has lifted stock prices. . .

    We are going by way of Japan and if we are lucky it will only be that bad.

  18. Edwardo


    “The big thing that these macroeconomists gloss over is that lending is not stopped due to a credit freeze. Lending is stopped because credit demand has collapsed. And credit demand has collapsed because consumers and businesses were overleveraged. And their investments in 401K’s their homes, and their pensions have collapsed.”

    And what is the Fed achieving by making the cost of money cheaper (or trying to) all along the curve? What is the net effect of creating more debt in a nation where the marginal utility of debt has been below zero as of 2006?

    I’m so glad you asked.

  19. Avl Guy

    A bit of history from 1973-1984 could help guide not so much "what" to conclude" but rather, "HOW" to think through complex economic and global forces that shape-shift across years.
    There’s too much linear thinking. We must do better than simplistic linear assumptions that all which happens tomorrow will move in a direction and velocity from the trajectory from we see today. . This post and many others display that type of analysis.
    1973 -1982 was an educational cautionary tale in non-linear events: circular and curved trends, inflection points, and surprises abounded.
    Those 9 years saw 3 official recessions begin and end.
    During those 9 years, we had 2 recoveries that sputtered (the 3rd recovery laid the groundwork for much of today’s debt crisis)
    We also had 2 energy price shocks, multiple bouts of double-digit unemployment and interest rates, and also stagflation.
    The complexities were due to the fact that the US was undergoing a structural economic transformation…and not merely multiple downturns. Thus we saw a massive migration of workers and households from the rust belt to the sun belt and the destruction of the US mfg base as part of the transformation.

    There's compelling evidence from the Deleveraging and the Debt Unwind, still unfolding in the US and overseas in 2009, that GDP models driven 70% by consumer spending will remain subject to debt unwind because global forces do not allow wages to rise enough to sustain consumer spending (as 70% of GDP) without households incurring more and more debt.
    Now that HH debt is at 350% of GDP, the model is inherently unstable and unworkable. Yet there is no replacement economic model or system.
    We are stuck in an economic transformation away from high HH debt levels and this away from GDPs 70% driven by consumer debt…with no destination known.
    There will be no recovery amidst such instability.
    The irony is that 1982 saw the end of the 3rd recession of that trifecta and beginning of a 25-yr secular bull market whose collapse is a feature of the current structural economic transformation. Job growth lagged for 2 years but resumed in 1984 and marked the beginning of the Service Economy GDP model whose debt-dependency led to its stalling and likely demise 24 years later during today’s structural economic transformation.
    These are two of many key links between the transformation of 1973-1984 and the one unfolding today.
    Politically, the US electorate cycled thru 4 presidents the last go round: Nixon, Ford, Carter and latched onto Reagan and his supply-side experiment with hi deficits. Reagan did not campaign on ushering in a service-based economy; it was not planned.
    Why 4 presidents? Oddly, each President saw “green shoots’ of short-lived recoveries whose lack of sustainability made the electorate intolerant of political miss-haps and stupidity. Nixon, Ford & Carter had little wriggle room for political miss-steps and were booted from office in succession..
    Contrast that to voters’ mind-boggling tolerance for political shenanigans, during the comforting 25-year economic boom, by Reagan (Iran-Contra), Clinton (Lewinski) and Bush II. (Iraq in 1st term).

    That is why a sustained recovery could be POST-Obama, after he is not re-elected. A Post-Obama world needs to be put on the table rather than narrowing the discussion to 4-8 years of Obama; 8 years of Obama is not a given despite the dissaray in the GOP in 2009.

  20. mmckinl

    Edwardo said…
    And what is the Fed achieving by making the cost of money cheaper (or trying to) all along the curve? What is the net effect of creating more debt in a nation where the marginal utility of debt has been below zero as of 2006?

    I’m so glad you asked.


    Read the financialsense post. He is exactly correct in the idea of the “marginal productivity of debt”. I posted on this over two years ago. I called it a GDP debt spiral …

    What the poster does not get is that a gold standard is NOT the answer. Gold has no intrinsic value.

    The value of money in a given system is two fold.

    The first is to pay taxes. Non payment of taxes leads to threat of forfeiture of property and indeed liberty. The government has gone one step further and made all debt payable only in the official currency.

    The second value of money is the production of the system divided by the currency available.

    Indeed the colonists in Pennsylvania had a ingenious fiat currency system:

    “Adam Smith wrote of the Pennsylvania currency in his famed 1776 work The Wealth of Nations:
    The government of Pennsylvania, without amassing any [gold or silver], invented a method of lending, not money indeed, but what is equivalent to money to its subjects. [It advanced] to private people at interest, upon [land as collateral], paper bills of credit…made transferable from hand to hand like bank notes, and declared by act of assembly to be legal tender in all payments…[the system] went a considerable way toward defraying the annual expense…of that…government [low taxes]. [Pennsylvania’s] paper currency…is said never to have sunk below the value of gold and silver which was current in the colony before the…issue of paper money.” wiki

    Ben Franklin wrote this about Colonial currency and the Revolution :

    Benjamin Franklin helped create the Pennsylvania Scrip, and in his autobiography he wrote of this currency:
    The utility of this currency became by time and experience so evident as never afterwards to be much disputed
    Franklin believed the shutting down of this paper money by Parliament in 1764 was the principal cause of the American Revolution, as did many other prominent Americans. Peter Cooper, founder of Cooper Union College, Vice-President of the New York Board of Currency, US Presidential Candidate in 1876, and one-time colleague of Secretary of the Treasury Albert Gallatin said in his 1883 book Ideas for a Science of Good Government:
    After Franklin had explained…to the British Government as the real cause of prosperity, they immediately passed laws, forbidding the payment of taxes in that money. This produced such great inconvenience and misery to the people, that it was the principal cause of the Revolution. A far greater reason for a general uprising, than the Tea and Stamp Act, was the taking away of the paper money.” wiki

  21. Anonymous

    Script is in vogue again in quite a few cities and states, read the link….

    Notice that it works very well locally but still based on the Federal Reserve Note for conversion.

    Gold price (at times silver also) reflects failing paper currency confidence. And the main reason for that is you can’t counterfeit gold or print it.

    Early America didn’t have the problems of being the world’s reserve currency, England did. You saw what happened when a central bank tried to force its will on a underling.

    The US is beginning to suffer the same fate now.

  22. Anonymous

    Script = Scrip,temporary substitute for money, securities, or other valuable claims. Business enterprises and municipalities have at times, especially when short of cash, paid employees in scrip, and communities have facilitated trade by using it. Various devices have made it acceptable, e.g., a store that would receive it in exchange for goods. The term scrip has also been applied to money of fractional denominations, and to gift certificates and the like that can be used to pay for purchases from stores, restaurants, and other businesses.

  23. Richard Kline

    Niels Jensen as cited by Edward Harrison: “Manufacturers always overreact. Come Q3 or Q4, they will suddenly sit up and realise that inventories have fallen too much and that they need to produce more. There is no reason to believe that this recession will be any different.”

    The ‘inventory recovery’ meme is going the rounds this last month, even in very high places. It is a wish that is highly likely to be dashed, and its purbeyance is indicative that the analyses behind it are not well thought out in relation to our present context. [I’m not taking a swing at Niels Jensen; many others say exactly the same thing.] I have spoken before in comments here at NC regarding why we are unlikely to get an inventory bounce of any significance, to wit that credit intermediation is so impaired in the US at least that we are likely to have an insufficiency of largescale working credit in the core of the real economy to _finance_ such a rebuild.

    But I’ll raise a second issue now also contra the contention cited above: there is no reason whatsoever to presume _in the present context_ that inventories will be rebuilt to their ‘normal’ levels pre-Sep 08 when demand collapse hit the real economy a stiff one in the face and shattered all the bones of the latter below the eyes. Yes, it is not only a truism but true that manufacturers all but always overreact on the downside, and plunge production below carrying capacity. Yes, in a ‘normal recession,’ this means that inventories dip far enough to generate a production bounce. We have the New Normal, folks; didn’t yah get the memo? Does anyone think that, say, the auto industry in the US is going to get a bounce in the back half of 09? Where is the consumer finance to _buy_ their product, even from those who stay in business? Is the airline industry going to realize that ‘they aren’t buying enough platforms’ and go to Boeing hat in hand for an increase? Demand for commercial re inventory will recover in the face of an ‘undershoot?’ Hah, I say HAH on that one: there is no undershoot as long as anyone’s breaking ground on a single project anywhere; or another way, commecial re hasn’t contracted enough to put us into ‘undershoot’ potential space given the ridiculous and speculative oversupply of same in Top Twenty markets.

    For some products, yes manufacturing is sure to undershoot _replacement level_ demand in the real economy, and that in principle would produce an inventory bounce. We will see very little of this in consumer-destined production in my view, though. As mentioned in comments, a large portion of the American consumerocracy has taken huge hits to their demand capacity; unemployment hits some; portfolio loss others; neg home equity others; then there are the Joes and Janes living on plastic limits who now have to find a way to pay down their Blessed Little Ulcers. Some have all of these conditions and are thus dipped in shite and set afire as exemplary cautionary offerins to Mammon for the view of all. But there is no credible scenario for a bounce in consumer demand in 09, not when many are desperately hoping to dodge the pink slip pounce. And if replacement demand is touched in most areas for the US, how, pray tell, is that stimulative for _US industrial production_ given that the elastic portion there is manufactured offshore in the main? China, Mexico, Japan, Taiwan, the EU: they may get a consumer bouncelet; I doubt it, but even if so that is not something that will directly impact US GDP.

    The inventory recovery scenario thus rest entirely on real production undershooting replacement level business demand. At the same time that said replacement level is getting whacked down big time from where it was indexed even six months ago. Most businesses would love to shrink their cost bases even if that means contraction. They have demand collapse at the sales window, all of them and most would be legitimately concerned that they haven’t built down _enough_ as of April 09. Yes, a bit of demand recovery for business manufactures _offshore_ would help the US a whole bunch. Which was why Prez O and crew went to the G-20 Flopfest and implored the rest of the world to soak their tax bases for the good of our country. And what was the outcome? FOAD. Hence, no demand pull there should be assumed in a realistic scenario in 09. Maybe in 10, maybe not.

    The inventory bounce meme of the present is an instance of inaccurate historical analogy in my view. We aren’t in a recession. Conditions of recessionary undershoot do not apply therefore. Match the story to the context and it strikes me as nothing but a pipe meme. And consider: If BO and Larry kill GM through a combination of arrogance, incompetence, and class ideology (one belongs, the other is a wannabe), we have an excellent chance to go flat over the cliff in the real economy as opposed to tumbling down a long, long scree of rock and cactus. Oh and the notion that the stock market is looking at anything but visions of the sugarplums they think they deserve is also not well reasoned.

    [This is not an indirect criticism of your post, EH. I agree with the general tenor of your remarks.]

  24. Anonymous

    While I can see that banks ought to be making money on new loans when looking at the interest rate they charge and the cost of borrowing from the FED, we need to take into account lower volumes of loans and the fact that at some point the FED will have to retreat from the market. That some sort of bank recovery is engineered seems likely considering the amount of resources being thrown at it, however I don’t expect credit usage to pick up in the way decision makers would like. The over leveraged have been hit and are unlikely to venture back into the leveraged world to the same extent.
    Working in a company that belongs to a sector which traditionally does well during recessions I believe that earnings may not be up to expectations. My guess is earnings will be close to 50 percent down at this point and close to non existent this time next year for the average firm. There is a real risk that banks go one way along with their stocks and the rest of the economy goes the other.

  25. Richard Kline

    Why should one conclude that the US economy is in a depressionary situation rather than a recessionary one, should it be asked? (It should, so I’ll talk to myself here.)

    —Most domestic financial actors except, surprisingly, domestic manufacturing (except where drugged, tied up, and raped by LBO and PE) are massively endebted, indeed at levels which approach or exceed historical extremes. While demand and profits have collapsed, these debts remain. : (

    —This debt was used to speculate in assets, leading to bubble values in most all asset classes. Those assets are reverting to historical trend norms, but this has leads to capital and price destruction from speculative highs out of proportion to ‘recessionary’ conditions.

    —Speculative bubbles and grotesque excesses of credit creation were enabled by governmental misfeasance, malfeasence, and nonfeasance, to quote the famous phrase. Nothing, nothing at all, has been done to correct this corrupt failure of governance; faces were changed but the suits remain the same. Government intervention in the economy is imperative for recovery, but such interventions as we have yet seen are either grossly inadequate or directly contributory to a continuance of the problem.

    —International demand and credit flows in the ‘developed’ economy are severely impaired. There will be no engine to drive recovery, and indeed many critical bridges are washed out.

    There are two further factors which fit a depressionary situation which are not yet fully in effect. The groundwork for both is laid, but their full effect is not yet evidenced.

    —Unemployment at headline levels which self-reinforce national-scale demand collapse. 15% minimum, really for our day and age, though 20% comes nearer historical extremes. May not happen, but we wouldn’t see it until well into 2010 in any reasonable case.

    —Currency collapse, or the semi-collapse of quasi-default on sovereign or semi-sovereign obligations. At the point we have too much Fedbucks and too little demand, our public paper goes crumpled and flaky. Exactly how this plays depends very much on what other major sovereign actors decide on as the outcome. We have a good chance getting better for something like this, though.

    If we get all six consitions, no one will doubt that this is a Depression. For know, the government and the psychobulls talk about a bump in their roadmaps. . . . That was the taxpayer, that bump they just ran over.

  26. Lori

    I think you are correct…

    $1.14 quadrillion get a load of this!

    No, that’s not a made up word. A quadrillion is one thousand trillion dollars. Not $4 trillion, but $1000 trillion – and change.

    Here’s the breakdown, according to the International Bank of Settlements, which acts as banker for the world’s central banks:

    1) Listed credit derivatives stood at USD 548 trillion;
    2. The Over-The-Counter (OTC) derivatives stood in notional or face value at USD 596 trillion and included:
    a. Interest Rate Derivatives at about USD 393 + Trillion;
    b. Credit Default Swaps at about USD 58 + trillion
    c. Foreign exchange derivatives at about USD 56 + trillion;
    d. Commodity Derivatives at about USD 9 trillion;
    e. Equity Linked Derivatives at about USD 8.5 trillion; and
    f. Unallocated Derivatives at about USD 71+ trillion.
    World derivative debt is $1.14 Quadrillion USD. For the US banks share of that see Table 1, page 22 of 33 at

    Why does obama leave it continue?

  27. Mike

    Uh, just one thing you’re missing with this post. And that is, why should bank shares go up? The market is currently “flipping” bank shares like flipping homes. It’s just illogical to assume that banks will acquire capital through shares when the MARKET doesn’t even know what’s on their books.

    The system is based on trust, and that trust is basically gone. It’s really that simple. Until transparency and justice return, the economy will continue to melt away as producers continue to get crowded out. And no amount of propaganda or “green shoots” will change that fact.

    One of these days, the dollar will have to be backed by REAL production again. The sooner the better.

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