Just because the crash of 2008 did not usher exactly the kind of depression experienced after the market crash of 1929 does not necessarily mean that we may not be heading that way anyway. How come? In essence, a depression is nothing more than a prolonged recession. How do you know you are in a depression? Simply, when economic growth remains minimal, when interest rates hit rock bottom, and when consumer spending all but disappears along with the credit supply. It is also quite depressing to know U.S. banks have about $1.3 trillion in cash, but are super reluctant to lend to the private sector, entrapped by a liquidity conundrum of their own making.

What causes a depression? Typically, a depression happens after one or more asset bubble explodes, while the credit supply implodes and dries out. In contrast, most recessions are the result of heightened inflationary pressures and overstocked manufacturing inventories. So, what do you think: are we repressed in a recession or depressed in a depression?

Consider one more argument that it may be the latter. Central banks all over the world, not just in the U.S., have dumped trillions of dollars into the global economy. With that much money in the global financial systems, world economic output should be tremendous. Yet it is not, far from it, which only proves that this is not just another recession and that it resembles more and more a bona fide depression.

All that is growing these days are the unemployment lines. True, there are no soup kitchens for the poor yet, but I suspect there wouldn’t be any just yet, as long as the government is mailing the checks each week for 99 weeks to the currently estimated over 10 million unemployed Americans. Whichever way you look at it, there is nothing simple or ordinary about this economic downturn.

How do things look in a depression? Things change. People change. How they perceive debt changes. How they behave in malls changes. Depressions leave much deeper scars than recessions. They leave people traumatized and take years to recover from, to forget foreclosures on beloved homes, to forget collection agencies’ calls, to forget the humiliation of not being able to provide for one’s family.

Perhaps this is why we are seeing home sales sliding to 15-year lows. Perhaps this is why bond markets are sounding every warning bell they have in their arsenal. Perhaps this is why yields on U.S. Treasuries have gone Japanese on us.

Here are some disturbing facts. The 1930s depression did not create declining economic output every quarter. In fact, during the first impact from 1929 to 1933, no more and no less than six quarters had produced increasing GDP data. On average, during these upturn quarters, the economic output growth rates were known to achieve eight percent on an annualized basis. However, since any growth, let alone an eight-percent GDP, was virtually unsustainable, no one in their right mind could declare the recession as over. Incidentally, stock markets flew into the stratosphere in the early 1930s, gaining 50% in the aftermath of the Great Crash simply because the confusing GDP data had lulled everyone into a beautiful illusion that the worst was over.

I’m tired of this emotional rollercoaster, too, of all the ups and downs, hopes inflating, hopes deflating. But if emotions are taken out of the equation and the equation viewed realistically, some harsh truths are undeniable. The Federal Reserve has cut the funds rate to zero, like Japan, and its balance sheet is in tatters. The U.S. budget deficit has swelled to nearly 10% expressed in relation to GDP, which is actually double the deficit vs. GDP ratio created during the 1930s, when Franklyn Delano Roosevelt was running the show. Finally, decades of easy money have left U.S. households, businesses and the government with $6.0 trillion of debt that has to be retired one way or another.

I’m risking the dubious honor of being called a “permabear.” But it is not as if I want to be über-pessimistic. Actually, on my off days, I’m quite an optimist, as well as a realist. Instead of looking for someone else to tell me if it’s raining outside right now, I prefer to open the window and see for myself. And the view from the window is telling me that there is no quick and easy way out and that I should read the market better within the still dismal macroeconomic context, not while blinded by short-lived stock market rallies.

I’ve used Japan as an example of what crippling asset and credit crises may leave in their wake. In Japan’s case, it is almost two decades’ worth of negligible or no economic growth. And now the conundrum — while the economy is breathing its shallow breaths, Japan’s currency is skyrocketing. While at face value it may seem like a good thing, the rising yen is spelling doom for Japan’s crucial export sector.

I don’t speak “car” well, but if I were to compare Japan, the world’s third largest economy, to a car, I would have to say that Japan’s economy has been driving in reverse for so long that it may have forgotten what it means to at least shift to “P.” And, as the fragile U.S. economy most likely is headed for the double-dip recession, dragging with it other world economies, kicking and screaming, things are not looking up for Japan. Quite the contrary.

Just like policymakers in the U.S. are contemplating adopting further stimulus measures, Japan went beyond the contemplation stage and went straight for expanding its $236-billion bank credit program by a third. And, as more money was pledged towards boosting the domestic demand, the currency markets had an unpleasant jolt when the yen started rising sharply against the U.S. dollar and euro. To illustrate, since April of this year, the yen has increased 12% against the U.S. dollar.

It is quite a paradox; Japan, with its red-hot, sky’s-the-limit currency and its sickly yellow, weak economy. Let’s just say there were quite a few FX traders and currency analysts scratching their heads recently. What most are also seeing is that the yen might be miles away from hitting the resistance level. At the same time, what the yen’s ascension leaves behind is a growing aversion to any risk-taking and further deterioration of trade imbalances.

What is the yen doing to Japan’s manufacturing sector? Well, it’s just killing it. According to a number of government-sponsored surveys, about 40% of Japanese manufacturers fear that, unless the yen stops rising, they might be forced to shift their production lines abroad where labor and facilities are cheaper at least.

Is there anything that can stop the yen? Not much, other than pulling together a massive government stimulus package together with similar in size and intention stimulus packages from other central banks. At the same time, I don’t see how that’s going to happen again!

What Japan has going for it? Luckily, the country has a few saving graces. For example, before the yen started its new rise to infamy, Japan had considerable trade surpluses and one of the highest domestic savings rates in the world. That made the country one of the few remaining providers of real capital in the world, not just printed paper money. As a result, during the recession of 2008/2009, Japan’s currency, along with the Swiss franc and the greenback, was considered a safe haven, to which many investors flocked. Even the Chinese have started diversifying away from U.S. bonds and have been stocking up on Japanese bonds.

What on earth is pushing the yen so high all of a sudden? Japan is getting older and fewer babies are born into that part of the world. At the same time, Japan is exporting more, because the domestic demand is shrinking. Adding to the pile is Japan’s hoarding of foreign assets, including bonds and equities, although recently Japan started repatriating some of the capital back into Japan.

It seems that the U.S. economy is heading towards another recession. There is no other way of describing what the erosion of confidence is doing to it. Although the first half of 2010 has been more than decent, a number of economic indicators are suggesting that the U.S. recovery has lost its luster, to say the least.

What is causing all this nervousness? Among the indicators from last week are orders for durable goods that barely moved in July by 0.3%, new home buys that dropped by 12% to the slowest annualized growth rate since recording commenced in 1963, and sales of existing homes that plummeted off a cliff by 27.2% to the lowest rate since 1999. Even more frightening was the number of 500,000 Americans asking for unemployment benefits just last week, although that probably explains what is happening to the home buying.

Without a shred of doubt anymore, the U.S. economic recovery has hit a major roadblock, which has left many economists and policymakers wonder about its sustainability without additional stimulus. Making things worse is the frail psyche of American consumers and investors who are still very much shaken by the crash of 2008.

The U.S. unemployment rate sits stubbornly at 9.5%. No wonder consumer confidence is hitting new lows week after week. No wonder also that businesses have little to no motivation to start hiring again or investing in new projects. And those who still have their jobs are hoarding cash and trying to replenish their net worth lost during the credit and financial crises of 2008 and 2009. Adding to the problem are lenders that are facing tighter regulatory conditions and, having learned their lesson, are again reluctant to lend, thus impeding new spending and investment.

What are policymakers to do? How can they stimulate consumer confidence without resorting to further stimulus?

On August 10, during the Federal Reserve’s Open Market Committee meeting, Ben Bernanke said that the Fed would continue with the measured buying of Treasuries to ward off any interest rate pressures. This represents a departure from the Fed’s previous plan to exit the debt market and start working on resuscitating its balance sheet. In fact, the Fed is likely to take quite a detour from quantitative easing, if the disappointing data keep on coming, which is also very likely.

From what I can tell, while nearly everyone is afraid of the double-dip recession, no one is willing to come out flat and say, “Yes, it is coming.” What we are hearing, however, are probabilities. Goldman Sachs, for example, puts the odds at 50%, while Nouriel Roubini, one of a handful of economists who actually predicted the crash of 2008, puts them at over 40%.

I don’t want to call out probability percentages either, simply because I don’t think that’s what the current economic funk is about. When surviving a credit-induced recession, the recovery is never easy. There are ups and there are downs, some more pronounced than others are. We just have to get used to the idea that economic output is going to be sluggish and moving at a snail’s pace for the next couple of years, if not more.

I like gold anytime; inflation, deflation, high interest rates, reduced interest rates, weak dollar, strong dollar. I like it for one simple reason — it is something very tangible and very valuable. Most investors, however, like to flock to it only when certain macroeconomic factors align, such as a rising price environment and volatile currencies, particularly the U.S. dollar.

Yet, one more piece of proof that the crash of 2008 has changed everything is that, almost two years later, with virtually no inflation in sight, investors’ infatuation with gold is returning. Even some of the world’s most famous hedge fund managers, such as George Soros and John Paulson, have fallen under gold’s spell. Judging by recent quarterly filings with the Securities and Exchange Commission (SEC), Soros Fund Management reportedly increased exposure to the SPDR Gold Shares exchange-traded fund (ETF) to nearly 13%, compared to a mere seven percent reported at the end of the first quarter.

Additionally, further rebalancing the hedge fund, Soros reduced the fund’s exposure to big names on the U.S. stock exchanges, such as Verizon, Pfizer and Wal-Mart Stores. In dollar terms, Soros Fund Management reduced exposure to North American equities by 42% quarter-over-quarter, from $8.8 billion to $5.1 million. As a result, the fund’s largest holding as of June 30, 2010, is the SPDR Gold ETF, with quarter-end market value of close to 600 million dollars.

Of course, there is speculation about why hedge fund managers all of a sudden would factor in gold and its related products. It always happens as hard cash is converted into gold bars. On one hand, the consequence is higher prices or the creation of an inflationary price environment. On the other hand, hedge funds are sounding the warning that a correction is on its way.

The fact that someone is investing in gold ETFs is not something that would raise a red flag. ETFs dedicated solely to bullion were introduced a few years back to make it easier for ordinary investors without adequate skills to invest in gold and diversify their portfolios. These days, regardless of whether you are an ordinary investor or a hedge fund, it is all about protecting your portfolio from sovereign debt explosions, volatile currencies, insanely huge budget deficits, etc. No wonder gold has again become the safe haven, even if there is no sign of inflation on anyone’s horizon yet.

True, jewelry demand is decreasing. But investment demand is picking up the pace, more than offsetting the shortfall from the decreasing demand for jewelry. This has prompted many analysts — and I have long agreed, too — to believe that gold’s upward price momentum is very likely to remain strong and trending upward for the next five years, if not more.

Note that, while the U.S. economy is currently operating under the dark cloud of deflation, the risk of higher inflation is also still very real. The amount of global government stimulus has reached gigantic proportions, which is very likely to start fuelling inflation, and sooner rather than later at that. Adding to the global fury hungry for more gold is the fact that the annual mine output has remained flat and/or trending lower for years now, signaling that the supply part of the equation is going to remain weak for years to come.

As a result, we are seeing gold price forecasts in the near term from $1,200 to $1,300 per ounce, almost without any effort. Note that, on Tuesday, gold futures for December delivery traded at $1,233.40 an ounce in New York. Perhaps even those optimistic forecasts are not optimistic enough and we could soon start seeing gold forecasts predicting prices of $1,500 to $2,000 an ounce again.

August is rolling on its final days and the air of September uncertainty is already here, depressing the markets, and feeling as if the winds of change are not likely to come anytime soon. Investors are again hoarding cash or flocking to the safety of bonds. Equity markets appear to be in a permanent red zone and no one is even mentioning recovery anymore, let alone cheering when a few positive data sprout here or there.

Last week, we learned about U.S. retail sales edging slightly higher in July, the first time in the past three months. The U.S. consumer confidence also rose somewhat, albeit beating analysts’ estimates by a narrow margin. After months of such lukewarm performance, most of the headlines celebrated little, except that the economic data published last week were not completely awful.

So, there is doom and gloom galore. As “The Wall Street Journal” survey of 53 economists summarized it, there are “too few jobs, too little wage income and too little consumer spending.” It seems we all have a good and realistic handle on the big picture, but little or no understanding of what is likely to happen next.

After the almost collapse of the global financial system less than two years ago, there have been many new “economic prophets,” forecasting everything and anything, from interest rates to equity prices to inflation to deflation. Their views are often as divergent as they could be. Yet, learning the hard way from recent history, a remarkable number of the prophets are likely to be wrong. I suppose having the information is not everything.

Perhaps it is time to acknowledge that the future cannot be predicted and that, these days, not even educated guesses are likely to cut it. Your throw of the dart at the board could be just as good as the throw of any of the smartest guys in the room.

If we were to give up on the economists, what about the politicians? It seems they are all talking the good talk. However, at some point, the survival instinct is going to kick in. Come election times, no one is going to preach absolute truth and nothing but the truth, because such truth is ugly and scary and can cost them votes. In the end, the government is more likely to succumb to the time-honored tradition when dealing with black holes on the balance sheet, which is to crank up the printing presses and inflate its way out of debt.

We have learned little from our history, it seems. Policy mistakes have happened, are happening, and will continue to happen. We’re reliving one of them right now, with world governments each going about spending reduction their own way, sometimes a misguided one. But that is the reality. If indeed the effort is there, as the need certainly is, to reduce government spending, then everyone, from consumers to investors to business, must understand that the recovery is likely to lose momentum, unemployment will remain high, and consumers will entrench themselves in the back rows.

At the same time, if governments plagued with sovereign debt continue straining their threadbare balance sheets with more spending, they are bound to get their rude awakening sooner rather than later. Just because the bond markets are keeping quiet about the budget deficits and ultra-low-interest-rate environments, it does not mean they will stay so indefinitely. Because, if and when the bond markets become unhappy, they will do so without a word of warning and will do so viciously. Just look what happened to the Greeks. They received no heads-up either.

New data coming out of the U.S. shows that the U.S. economy is deteriorating, if indeed it has ever reached the recovery stage. Yet, the Obama Administration and Republican Congress cannot overcome their standoff and finally decide on a unified front to deal with the economy.

Last week, a barrage of bad news hit the financial press. First came reports showing that more Americans have been laid off and were seeking unemployment benefits. Then came the news that mid-Atlantic states’ manufacturing had declined to the lowest levels this year. Finally, most North American markets took a beating. Adding to the general feeling of gloominess was the Congressional Budget Office (CBO), which came out to say that the recovery that allegedly started mid-2009 was wishy-washy at best.

CBO is non-partisan, so its predictions should have more credibility since it does not cater to anyone. Anyway, the CBO predicted that the U.S. economic output would grow only two percent between the fourth quarter of 2010 and the fourth quarter of 2011. As for the unemployment rate, it is expected to remain high at least until 2014, when it may drop to five percent, barring any serious withdrawals into a double-dip recession. Partisan or not, someone had to ring the wake up bell on the collective denial that government stimulus policies have worked and that private demand was gaining momentum.

Not too long ago, as the first quarter ended with a loud bang, the U.S. government and policymakers perceived such performance as proof that they had made the right moves in response to the crash of 2008. What happened in the months since unfortunately proved them wrong.

President Obama was the first to blink. Last week, he urged Republicans to stop blocking his bills just for the sake of blocking them. Currently on the electoral menu is the $30.0 billion that the Administration wants to give community banks and another $12.0 billion it wants to provide to small businesses in the form of tax cuts. But, with mid-term elections threatening to tilt the balance of power in Congress, Republicans have little incentive to work with the President. Why would they, when most Americans think it’s the President’s fault that the recovery is not going as well as everyone was hoping it would. Yet, what most seem to forget is that, without all levels of government working together, there will be no recovery.

“There will be plenty of time between now and November to play politics. But the small business owners I met this week, the ones that I’ve met with across the country this year, they don’t have time for political games. They’re not interested in what’s best for a political party,” said President Obama last week.

Republicans have ammunition in their own arsenal, too. Their main weapon is refusing measures that would further widen the budget deficit. And therein lies my own conundrum. I’m truly afraid of the budget deficit, predominantly its massive size. On the other hand, I understand that, once the road of aggressive economic stimulus was taken and both the old and new Administration, together with Congress, have agreed on it, I don’t see an easy way back or away from it. Still, what frightens me the most is the stalemate that leads to indecisiveness and ineffectiveness, the kind that is stalling things right now.

The reputation, if it could be called so, of oils sands has been more about exorbitant costs and a dirty carbon footprint than about being a vast source of fossil fuel and associated profits. It seems that researchers have found a way to resurrect oil sands and, by association, oil companies with such properties in their portfolios. Granted, although the “new” future for oil sands has been long in the making, it has not yet reached critical mass. Still, it appears a viable vision and one worth presenting to our readers.

The vision involves underground, slow burning, oxygen-fuelled fires forced upon a mixture of oil, water and sand at a toasty 500-600 degrees Celsius. As counterintuitive as it sounds, these underground fires, notwithstanding the invoked images of hell, could be the cheapest way out of the conundrum that the meaningful and economically viable exploitation of oils sands represents.

I was curious about these fires burning the oil sands to produce crude oil. In the lab environment, huge test tubes are used to recreate the closest possible analogue to the oil sands of northeastern Alberta. Fuelled by air, these slow-burning fires slowly move down the tube, but burning only about 10% of oil, yet creating enough heat and pressure to free most of the crude trapped in the sand without using dangerous chemicals, loads of water, vast amounts of natural gas, or ugly open pits. The only thing needed is air that is forced into the oil sands at high pressure.

Such a virtually negligible environmental footprint that this new technology of exploiting oil sands would leave behind represents a dramatic departure from how oil sands are currently harvested. In contrast, now visualize open-pit drilling, steam-assisted gravity drainage (SAGD) and all the pollution that such technology creates. First, SAGD requires vast amounts of natural gas to boil water into steam, which is then used to heat the bitumen to separate the oil from the sand.

Of course, if it were easy, underground fires would have been a solution already in full implementation. The problem with underground combustion is not liberating oil from sand, but rather how to bring that oil to the surface. The SAGD technology creates enough pressure to propel the separated oil to the surface, much in the same way that traditional oil drilling does. With slow-burning fires deep beneath the surface, there is no such anti-gravity catalyst.

Additionally, although the combustion method is very efficient economically, there are other downsides, such as that it burns the well completely out. As the fires burn the bitumen, they leave nothing in their wake. They are also difficult to control and it seems that the extracted oil is not always completely free from sand, so further refining may be required.

The good news is that many global players have shown interest in developing this technology and making better use of their oil sands properties. The bad news is that even more have abandoned their “combustion pursuits,” too, particularly major energy companies in the U.S. and Canada. Those left in the playing field are limited largely to Romania and India, while the entire world’s in situ combustion-produced oil is about 30,000 barrels per day (or the utterly irrelevant 0.00035% of total global production of crude).

Where the picture of oil sands is changing and what is keeping me interested are smaller energy players in North America that are trying to return to the in situ combustion-produced oil. As the COO of mid-sized, Calgary-based Petrobank Energy and Resources Ltd. put it, “This can play a very big role in the oil sands. It has the potential to replace SAGD. I think that’s what people are looking for: a technology that will enable them to produce from these difficult resources with better efficiency and less environmental impact.”

Here is the catalyst that may propel large players’ return to the combustion method. The main issue with the SAGD is the enormous usage of water and natural gas. According to some estimates, companies currently exploiting oil sands could use four times more water and natural gas by 2030 than today. In other words, they might find themselves without both! Whereas air is not likely to be in short supply for the foreseeable future.

The in situ combustion method has many powerful arguments on the financial side of it, too. It has been estimated that a combustion project may require up to 26% less money than the SAGD, because it is much easier to compress air than it is to buy natural gas. With savings like those, profits from combustion-extracted oil could be massive.

To be fair and not to get carried away by exciting technologies, I should say that the oil sands are notorious for slow acceptance of different ways of thinking. The SAGD was invented over 30 years ago. Yet, it was not until early this year that one of the major SAGD projects has scored the first significant payout in the entire sector. Understandably, after billions of dollars have been poured into SAGD, switching now to something different is bound to meet resistance. On the other hand, it appears the SAGD technology has an expiration date of its own, which is why skeptical minds could be prevailed upon to come around to combustion.

Most people like to be right. So do I, but not about predictions I made about a year ago about the economic environment that we find ourselves in these days. For months now, I’ve written in “Profit Confidential” about deflationary risks and my general lack of faith in the recovery. After the credit market first exploded and then collapsed on the tails of the asset bubble bursting, all I see in the near term is more volatility, albeit perhaps not as intense as the fourth quarter of 2008 was.

History shows that balance sheet recessions are anything but your plain vanilla kind of recessions. Typically, it can take between five and 10 years to transition to the next sustainable expansion cycle and marked bull market. And, on the road to sustainable recovery, the journey is laden with numerous setbacks.

I know I sound like another Dr. Doom, but I’m sure I’m seeing the same things you are — we haven’t progressed that much compared to a year ago, have we? What may obscure the big picture for many are the government spending-induced rallies in the equity markets. But not much has changed on the unemployment front and the gigantic deficit front. I’m afraid that the illusion of recovery is nothing more than an illustration of a typical philosophical loop humans are so prone to: wanting to believe that the market knows best when it is those believers who are the market.

By all means, since the March 2009 lows, the market has bounced and rallied nicely. But similar bounces and rallies occurred off the Great Depression lows in the 1930s. In early 1930, the equity markets gained close to 50% following the crash of 1929. A huge part of the euphoria must have been rooted in people’s overwhelming desire for the worst to be over. Yet, when we think of the 1930s rallies, the images typically conjured up are not those of joy and of profit-making, but those of despair and loss.

I agree that, while there are certain similarities, the Great Depression and the Great Recession are not entirely alike. What we are dealing with is perhaps more understandable if we transplant it into the context of the post WWII era, for example. Unwinding of the excesses created during the credit cycle on steroids that last nearly a decade is like moving mountains — nearly darn impossible.

The first lineup of baby boomers is retiring, leaving behind a lesser pool of people capable of buying obscenely expensive homes. The Fed is realizing that the U.S. is on track to follow in Japan’s footsteps right into a decade or more of severe deflation. The U.S. balance sheet is triple its normal size and heavily weighted down with the budget deficit of $1.44 trillion, representing approximately 10% of GDP. The number of officially unemployed persons has exceeded over 14 million, or 9.5%, while the unofficial number is much higher at over 25 million unemployed.

I believe that money can be made in any market, but I believe more in recognizing when the game has changed. We are operating in an entirely new context and the old rules of thumb most likely no longer apply. The lows we are currently seeing in many market segments are not the same lows we are accustomed to seeing when the economy hits the bottom. These lows could be disguised black holes, because there is simply too much debt polluting individual, corporate and government balance sheets. Don’t forget the deleveraging that has happened so far has just touched the tip of the iceberg. We are still years away from truly repairing our balance sheets, if this is possible at all.

I think that the stages of emotional recovery almost perfectly apply to the stages of economic recovery from the crash of 2008. We have survived the stage of confusion and agitation and in my opinion are now deeply in denial. If and when we emerge from the denial stage, we will likely spend the next little while angry and depressed before we accept the new reality. Once we accept the new norm, it will still be a while longer before we adjust to it.

Greece just cannot get itself out of international headlines. I’m not entirely sure I would care what goes on in Greece if the country were not one of 16 key ingredients in gluing together all the pieces of the eurozone’s puzzle, keeping the euro afloat and the global economy in the peace that it needs to convalesce.

Alas, according to the recent official estimates, of which the world learned only last week, Greece’s recession deepened in the second quarter. At the same time, the country is struggling under the austerity measures that the government is ramming down its throat hard and without mercy. The methods may be questionable, but appear commensurate with the calamity that the country is facing.

Compared to the first quarter of this year, Greece’s GDP dropped 1.5%, largely due to the fact that the government has turned off all taps and reduced spending to what seems below even the bare minimum. Additionally, comparing the recent quarter to the same period the prior year, Greece’s GDP nosedived even further by 3.5%.
Even taking into account 2010 changes in methods of calculating Greece’s GDP, we are still talking about a dent in the country’s economic output the size of the Grand Canyon.

Meanwhile, the unemployment rate hit 12% in June, increasing from the über-marginally better May number of 11.9%. However, compared to the second quarter of 2009, the decline of the unemployment rate is more tangible. At the end of June 2009, Greece’s unemployment was bad, but bearable at 8.5%. At the end of June 2010, it was 10 basis points shy of the high 10-year unemployment rate of 12.1% reported in February of this year. The most affected were young people. Almost one in three Greeks between the ages of 15 and 24 is unemployed. That translates into an unemployment rate in that age group of 32.5%, compared to the 25% reported in May 2010.

What started the avalanche was the sovereign debt iceberg that revealed all its ugliness when the new Socialist government revised the inherited budget deficit. It did not help that the new government had little to do with expensing through taxpayers’ accounts. The gap of 13.6% of GDP was difficult to swallow, prompting the government to introduce austerity measures that are supposed to narrow it to 8.1% by the end of 2010.

The whole world knows how profoundly Greeks hate living with their belts tightened and cushy, publicly funded benefits taken away.
But they can protest, strike and vandalize public property all they want. The fact remains that, to avoid going bankrupt in May, the Greek government had to make tough promises to its EU partners and the International Monetary Fund. The biggest promise involved austerity measures and cutting the budget deficit to 8.1% at any cost, which shocked so many Greeks out of generous salaries and pensions, while hiking personal taxes.

Wherever you look these days, headlines just keep contradicting one another. One says that more Americans have lost their jobs, while another is all excited about a new bull market in stocks. One product sells well, another doesn’t. First, lending is improving. Then, lending is at all-time lows. Which one is it: a recovery or a double-dip recession?

I wish there were more coherence in the financial media, but I understand why such a wide range of opinions and, ultimately, the inability, even among the smartest people in the world, to determine where the global economy and markets are going. Simply put, there is nothing normal about our world in the post-bursting of the credit and asset bubble environment.

Perhaps this is why clichés such as the “new normal” are so hot among economists and strategists. For example, four quarters after World War II ended, the U.S. real GDP was more than six percent (annualized). In contrast, today’s real GDP has barely expanded to 2.4%. Making things worse are economic forecast revisions and realizations that the crash of 2008 was even worse than we knew or expected it to be. According to the new statistics, today’s real GDP is actually one percent below its pre-recession peak.

We have 55 years worth of post-war data to reflect on. If this were a normal recovery, then two and a half years after the beginning of the recession, the economy should be peaking and breaking above the pre-recessionary high (GDP of eight percent). Well, that is clearly not happening! Additionally, real final sales as of June 30, 2010, came in at less than 1.3% on an annualized basis, which is only 0.1% higher than the rock bottom that the economy hit about a year ago. Now, real final sales typically expand to four percent on an annualized basis in the year or so after the recession is proclaimed over. The conclusion is simple: either this is the worst kind of recovery in recorded history, or not a recovery at all, but a prelude to a double-dip recession.

The same goes for the labor market, which is truly in a sorry state. Typically, 30 or so months after the economic recovery peaks, the U.S. payrolls would already show excesses of up to 1.1 million new jobs, or 2.3%. Today, however, the U.S. labor market is in a precarious position. Since peaking in December 2007, we are still 7.7 million jobs, or 5.6%, in the hole.

Wall Street has certainly been busy convincing us that everything is back to normal. Yet, none of the confidence gauges out there are showing that the convincing is working. For example, the University of Michigan consumer sentiment index for July is still sitting at rock bottom at 67.8. What was the average sentiment score during previous recessions? That number is 73.8. And, what is the average sentiment score during economic expansions? Well, that number is a whopping 90.9.

Not to be skewed by looking at only one market sentiment data provider, there is also the U.S. Conference Board consumer sentiment index, which was sitting in July at 50.4 on an annualized basis. The index average during recessions is 70.4 and 102 during expansions. There is also the National Federation of Independent/Small Business optimism sentiment index, which in June was 89 on an annual basis. However, the average during a recession was significantly higher at 91.9 and during an expansion at 100.2.

I don’t know about you, but the way all this looks to me is as if we have not yet resurfaced from the crash of 2008. What appears very clear is that the trough has started from a much lower point in the cycle than anyone initially believed, and that whatever progress was made subsequently was erroneously classified as a sign of recovery.

Top economists and policymakers in the U.S. say that they are focused on the domestic troubles, but I have a feeling these days that their minds are often wandering off thousands of miles away to the Far East, for example, towards a country that has been in an economic funk for two decades, the cause of which sounds awfully familiar to Americans. It all started with a real estate bubble, which first exploded and then created a huge financial crisis. It was retained within the country’s borders, but the havoc it wreaked surpassed the size of the initial impact.

Which country’s cautionary tale this is? Japan’s. How well does it translate to North America? Too well, I’m afraid.

As the recovery in the U.S. loses wind, more economic theorists are coming up with theses that the slower growth we are experiencing now in North America seems very much like an overture to the Japan-like economic melancholy, manifested through recurring recessions of various degrees, lackluster recoveries and, more importantly, an environment of declining prices.

Of course, this is not the outcome anyone was hoping for and it is receiving more and more attention. Particularly attuned to the changing mood is the bond market. For example, government bond yields are flashing signals at full blast that months, quarters and even years of slow growth are ahead of us. In the U.S., yields on two-year government notes decreased below 0.5% last week for the first time ever. The reason for the drop was more than disappointing U.S. unemployment numbers.

Again, a parallel with Japan could be drawn. Japan is very familiar with this “bond-yields-sinking” feeling, having to endure it for over 20 troublesome years. And, even after all that, the recent decline of Japan’s 10-year government bond yield below one percent to its seven-year low was doubly disappointing, at least to the country’s economists and policymakers. It must be fatiguing fighting something for so long with everything you’ve got and still seeing little to no results.

You could say that the Federal Reserve Chairman, Ben Bernanke, has been almost obsessed with Japan and what happened with the country’s economy. He publicly committed to “doing [in America] all the things I told the Bank of Japan to do.” And if the obsession before was to do everything humanly possible to avoid Japan’s mistake, the obsession these days is whether it will be enough to stave off disaster.

Here is what might be keeping Bernanke awake at night. First, just like the U.S., Japan also experienced huge peaks and lows, driven by super inflated values in the real estate market. When Japan’s real estate market imploded in the early 1990s, it more or less paralyzed the country’s banking system. Two decades later, it is still convalescing and still not looking peachy.

During mid-1990s, prices in Japan started falling precipitously and have been combating deflation ever since. Since that time up until last year, Japan has reverted into some recessionary form or another five times. In 2009, the country’s GDP, adjusted for inflation, was lower than in 2004.

I have to say, while parallels exist and are definitely scary, prices in the U.S. are still increasing, albeit barely. In June, core inflation increased 0.9% compared to June of last year. Still, the current price environment in the U.S. is among the lowest in the past four decades. The good news — for now — is the fact that prices are at least stable and there is still some chance for the economy to heal itself. But if the prices start declining more aggressively, the overall economy could start on a very unpredictable and unstable path.

Believe it or not, deflation, and not inflation, has the power to keep economists wide awake every night. What likely frightens them, as it frightens me, is the potential to get caught in a whirlwind downward spiral, caused by lack of demand, which, in turn, triggers declining prices because consumer spending has dried up and all everyone wants to do is put away money, depressing the economic activity even more.

Incidentally, Japans deflation did not follow this scenario. True, prices have declined in Japan, but not as much as it was expected. They have been declining by a modest one percent every year, pulling the country more through a low-grade fever than through a violent infection.

However, just because Japan did not end up with the worst-case scenario, it does not mean that it did not end up in very bad circumstances. While Japan is not likely to sink like Atlantis, it is not exactly a growth-producing machine either. This has created an uncomfortable situation for a country with significant personal savings rates and the unusual amount of social cohesion.

Japan’s most likely saving grace is the fact that there is still strong global demand for its products. It is a significant cushion providing Japan with the safety net the country needs. That cannot be said for U.S. exports, however. On the other hand, the U.S. response to the financial crisis was much faster and more aggressive than Japan’s. Additionally, although today’s bank lending is a far cry from the pre-2008 crash levels, U.S. banks are still lending, albeit anemically, while Japan’s seem to have gone on a permanent holiday.

How this story will play itself out in the U.S. remains to be seen. Making predictions about where the prices are going to go is impossible to make at this stage. The U.S. is dealing with a mountain of debt that will take a seriously long time to unwind, potentially at a price of losing an entire decade, perhaps two, like Japan.

Economic issues have a concrete impact on any country’s domestic policy. The problem is that world economies are so intertwined that their relationships and any issues arising from these relationships sometimes have an adverse impact on how governments formulate and implement policy. The U.S. policy has had its share of such adverse consequences, the most prominent being the country’s dependence on foreign oil and, more recently — and more importantly — its dependence on foreign debt financing.

According to the latest data posted on the U.S. National Debt Clock, foreigners own about $3.98 million of U.S. Treasuries. China and Japan own most of them, holding $900 billion and $795 billion, respectively. Year-over-year, foreign ownership of U.S. Treasuries rose almost 20%, faster than the U.S. government could issue them at a rate of 15.6%.

Why is the U.S. selling its debt faster than it can print it? The short answer is that domestic savings are so low they are almost non-existent. Relying on the statistics posted on the Debt Clock, average savings per every man, woman and child in America is a measly $1,058!

Expressed as a percentage of GDP, some 30 to 40 years ago Americans were saving between five percent and seven percent. In the past 20 years, that rate has dropped to somewhere between one percent and three percent; although, in the wake of the Great Recession, the savings rate has improved slightly. Still, unless interest rates start rising, Americans have no real reason to start saving more aggressively. And, given the Fed’s policy on interest rates, it is unlikely that we will see them going up anytime soon.

The picture of the U.S. overall savings is just as bad as that of Americans’ personal savings. Total savings of any country are comprised of consumer and corporate savings, plus government surpluses. In early 2009, just as the Great Recession came for its proverbial pound of flesh, U.S. total savings expressed as a percentage of GDP entered negative territory for the first time since 1952.

Why so much difficulty saving money? Why the accumulation of so much debt? Well, saving money in the U.S. is not a simple matter of having the will to save. It is primarily the consequence of the country’s overall inability to finance itself via domestic means. The U.S. government is currently operating with a monster of a budget deficit, the size of which has grown to $1.44 trillion at the latest count, or more than 10% of GDP. This also means that the government does not have enough money to finance itself, which is why it has to rely on foreigners to buy the Treasuries and pay for them with actual money.

There is no other way of putting it: dependence on foreign debt financing represents a serious economic and strategic risk for the U.S. According to the Congressional Budget Office, the U.S. will need to run the deficit until at least 2035, because the government savings rate is negative and foreign debt financing might be the only thing keeping it from bankruptcy.

What can make a dent in the U.S. reliance on foreign financing through debt? There are several ways, such as increasing the savings rate on all levels: consumer; corporate; and government. The government would also need to increase taxes and use that revenue to pay down the deficit. The U.S. government should also introduce aggressive austerity measures.

The alternative is grim. Being a long-term debt nation will start — and possibly already is — shaping U.S. policy. It could mean that our largest creditors could be in a position to tell us what to do and dictate what role we play on the international stage and how we conduct ourselves on that stage. That risk of being indebted as a nation to other nations was not lost on the Founding Fathers. It was Thomas Jefferson who said it that, “To preserve our independence, we must not let our rulers load us with perpetual debt. We must make our election between economy and liberty, or profusion and servitude. Our properties within our own territories should not be taxed or regulated by any power on earth but our own.”

For 43 years, GFMS, the world-renowned precious metals consultancy, has been publishing its gold survey, which is considered one of the most authoritative annual surveys of the gold market in the world. According to GFMS, gold and other precious metals predict further gains in investment and gold prices, building on the record-performing 2009. However, there are also concerns about the strength of the gold rally in the second half of 2010, considering that jewelry demand remains weak.

According to GFMS, in 2009, investment demand surpassed jewelry production for the first time since 1980. In effect, gold investments more than doubled last year to almost $60.0 billion, in part because of the declining U.S. dollar, but there were other powerful price-driving factors. Fears over quantitative easing — that is, fears over world central banks’ indiscriminate increase of money supply — played a significant role in gold investment activity in 2009. Additionally, mounting counterparty risks also contributed to gold’s upward momentum, rallying the gold price to record highs in early December of last year. In fact, it was during the closing months of 2009 that the complexity of overall investment reached a boiling point, particularly as buying of physical gold and gold exchange-traded funds (ETFs) rallied among ordinary investors and as more speculators focused on the futures market.

GFMS further added that 2009 to gold was more than just about investment activities. For example, the gold market had to address the issue of sharp declines in jewelry sales, which achieved record lows not seen in over two decades. The volumes that had peaked in 1997 have been almost cut in half in 2009, as the Great Recession in conjunction with an environment of still higher prices wreaked havoc on all kinds of consumer spending. 

At the same time, scrap metal supply rallied, piggybacking on elevated prices and panic-selling under the profound pressures of global economic trauma. As a result, the demand for scrap metal reached record highs in 2009, making up for almost 40% of the world’s total supply.

Based on its precious metals’ survey, the consultancy stated that the complex relationships of these forces were at their most dramatic in the first quarter of 2010, fuelled by strong forward momentum in precious metals’ prices during the fourth quarter of 2009. Furthermore, GFMS said that getting the real picture very much depended on having a thorough look at what was happening in the physical market. Meaning, as scrap metal demand skyrocketed in the first quarter of 2010 past not only jewelry demand, but also mine production, it should have not come as a surprise to anyone how investment activities managed to speed by the $1,200-per-gold-ounce mark as 2009 drew to its close.

In its latest survey of precious metals’ markets, GFMS also accounts for events that had transpired in the government sector, where net sales dropped a staggering 80%. This development is primarily attributable to lower sales by European central banks. GFMS also makes a mention of the importance of India’s purchase of 200 tons of gold from the International Monetary Fund (IMF), which gave a huge boost to the market and which has sent a clear signal that central banks’ attitude towards gold is on the cusp of dramatic change.

As a direct consequence of India’s IMF gold purchase, investors responded so bullishly in September that most mining companies still holding onto a hedge book immediately started unwinding their hedges. Unfortunately, there are still plenty of hedge books out there, totaling over 250 tons according to GFMS estimates. That much gold cannot be easily replicated with the outstanding books at year-end, regardless of how strong supply levels are from various markets. 

Having in mind that GFMS is forecasting higher mine output and minimal de-hedging in 2010, the implication could be that the consultancy has become somewhat bearish on gold. However, the message in the 43rd GFMS precious metals survey is that, while in the short-term, prices of precious metals, gold particularly, are likely to come under pressure, gold fundamentals are improving and investors have no good reason to start either minimizing or liquidating their gold exposure.

Looking ahead, upward price momentum for the remainder of 2010 is likely, because levels of investment activity are as strong as ever, in large measure because of exceedingly high levels of sovereign debt and the potentially long-term inflation threat looming in many markets. On the other hand, GFMS also warns that, since there are no immediate signs of where fresh investment is going to come from, nor are there macroeconomic factors out there strong enough to create another extraordinary upward price movement, the next rally in gold might take longer to materialize. According to GFMS, the precious metals market could be entering the end game now, although there might still be two years or more for it to develop. The only way to avoid a steep correction in the precious metals market and to bring it back into equilibrium would be to boost jewelry demand and to scale back the demand for scrap.

The housing market does not exist in a vacuum. It has always been connected — albeit not too strongly — to certain long-term macroeconomic trends, such as employment, for example. Nevertheless, the relationship has always been positively correlated. When more people have jobs, home prices tend to increase, because new household units are created more easily, all needing roofs over their heads. Of course, it all ties into the overall economy, because, as the economy grows and both individual and corporate earnings improve, the real estate market typically prospers.

Unfortunately, the reverse is also true, at least if the unemployment downtrend persists over more than just a few months. When people lose jobs, home prices decrease, because the demand is taken out of the equation. And, if the job loss is not stopped for more than a year, a percentage of those who lose their homes to bankruptcies and foreclosures increases to the critical point where there are more sellers than buyers, pushing home prices sharply down.

Many developed economies have gone through housing bubbles and housing busts. However, what is going on now is something much more dangerous. What we are about to experience is a prolonged down-spiral effect that might be irreparable.

I believe by now that it is clear that the recovery has stalled because it appears more fundamental economic weakness is ahead of us. While in the past couple of months, the U.S. economy has generated new jobs, there is something else to consider. By the end of the 2010 Census, the economy will have to endure the impact of an estimated 1.2 million lost jobs during the second half of this year. Even if not a single job is lost from June to December of this year, just to achieve the positive zero on the job creation front, the private sector would have to create on average 200,000 jobs per month (1.2 million/6 = 200,000) by December 31, 2010.

The rigid 200,000 job creation rate per month appears unsustainable. If the private sector falls short, which at this point seems highly likely, the economy will continue losing jobs and unemployment will continue to rise. Add the Gulf of Mexico oil disaster to the already dismal job situation, and we have a recipe for disastrous job losses on our hands. Although some temporary job creation may be associated with clean-up efforts, in the long term, the region is still very likely to suffer through huge unemployment rates for who knows how long.

How does unemployment tie in with the housing market? First, to qualify for a mortgage, a homebuyer must have a job. Second, that job should be sufficient to pay for a mortgage. If either or both of these requirements are not met, the homebuyer will not get the loan to buy his or her dream home. Additionally, if someone who already has a mortgage loses their job or if it suddenly does not pay enough, they will lose their house to foreclosure.

Furthermore, as fewer people are able to qualify or keep their mortgages, more houses remain unsold on the market, thus increasing the supply. As the supply rises, the demand for reasons already explained dwindles. Lower demand also means lower prices, as sellers become desperate and agree to sell homes below market value just to get out of their mortgages.

The erosion of employment and housing leads also to certain intangible “psycho-economic” consequences, as I call them. In the current environment of falling prices, it is good news when mortgages are at or near parity in value with the underlying home values. But, as the down-spiral effect gains momentum, we are seeing many homeowners struggle with owing more on their mortgages than equity owned in their homes. It is depressing to realize that one day you were wealthy and the next you’re thousands of dollars in the hole. Being perceived as poorer erodes consumer confidence and, eventually, it adversely impacts the country’s spending rate, slowing down an economic cycle in the process.

How can we stop this downward-spiral effect? This is easier to answer than it is to put into practice. The only way to stop the downward-spiral effect is to create more jobs that pay good money. Statistics shows that the sustainable job creation in the U.S. will start somewhere around two million new jobs in the private sector, not government, every year. That is the absolute bottom level needed to accommodate the overall population growth, as well as new people searching for jobs.

How long until we get there? At this point, it is anyone’s guess. We could be talking about a year, two years, perhaps longer. But, more importantly, it is not just the number that has to be achieved. For the job market to produce more income and for the housing market to heal, both will have to recover at approximately the same pace and cognizant of each other. Maintaining a positive correlation between the job and housing market has never been more important than it is now.

The economic boom lasted 15 years, give or take. And then the crash of 2007/2008 came, wiping out nearly all the gains, both individual and national. Now, after more than a decade of easy money, paper wealth and the all-consuming consumerism, only one question remains. Was 15 years of boom worth all the grief today?

One way to look at the world since the 1990s is to see it as a grand experiment, both economically and socially. From the economic point of view, the elasticity of cheap credit was expanded as far as it would go. Socially, that meant that even the essentially poor people could borrow money to buy a house on a vague hope their future earnings would miraculously improve compared to the present day.

We all know what happened when credit was no longer elastic. But if we were to do it again, how would we do it? Or would we even do it at all? Would we avoid the risk and decrease the gains to an extent, or would we roll with the gains and disregard the risks come rain or shine? To answer this question, perhaps the best gauge would be to compare the bottom line; that is, have we lost all the gains or are we at least at a positive zero?

The place to start is looking at the actual purchasing power of the poor and lower middle class. Typically, in developed economies, the poor and lower middle class account for about 20% of the population. The question that needs answering is: has that 20% really gained more bang for their buck and have they kept it? Let’s look at the two outliers on the earnings front after the 2008 crash — Canada and the United States.

Starting with the country that has probably weathered the Great Recession with the least amount of inconvenience, Canada, the answer to that question would be a definite yes. Statistically speaking, the net income of the bottom 20% earners in Canada has slightly decreased during the recession of the 1990s from about $21,000 to $19,000 (in inflation-adjusted present-day dollars). However, the reversal came around 1997, at which point the net income of bottom earners started increasing to almost $24,000. Additionally, the next class of earners in Canada saw their net incomes rise from $32,000 to $40,000 during the period from 1997 to 2008. Since the crash of 2008, the purchasing power of both groups of earners may have flattened, but essentially it has not fallen.

(Something similar has happened in the U.K., tracing Canada’s purchasing power progression up to the crash of 2008. But unlike Canada, incomes of the 20% bottom earners in the U.K. have actually fallen since then, while other earnings groups have been
adversely impacted, too.)

As far as the U.S. is concerned, the picture is completely different. The peak of prosperity for Americans came in year 2000, decreasing a bit after the tech bubble burst, but more or less regaining solid footing and upward momentum in the next few years. However, when the crash of 2008 happened, net incomes in the U.S. seem to have fallen into a bottomless pit, dropping all the way down to 1997 levels.

What these statistics tell me is that it all depended on the strength of infrastructure of the entire society, the way the society as a whole perceives risk and the systems of value that govern it. Just one small example of how different things could have been for the U.S. would be the recently introduced financial reform bill in the U.S. What Canada has had for decades — that is, rigidly regulated financial institutions — the U.S. is introducing only now. The prosperity in Canada may not have been as flashy and apparent as it was in the U.S. However, Canada did not lose its boom years’ gains. U.S. did; all of them.

I admit; I love it when President Obama feels on top of the world. Last week, he passed into law what is considered the most comprehensive overhaul of lending and high finance rules and regulations since the Great Depression. Its goal is simple. Wall Street should never again have the power to set off a recession. Or, as Obama put it, “Because of this law, the American people will never be asked again to foot the bill for Wall Street’s mistakes.”

The new law is complex, but Washington insisted it also be translated in pocketbook terms, giving emphasis to safeguards for borrowers against manipulative and dishonest lenders. The lawmakers claim that this historic piece of legislation will be “the strongest financial protection for consumers in the nation’s history.”

It came with the price, though. Obama has lost quite a bit of public support in the heated discussions leading to last week’s passing of the bill into law. Republicans also disagreed, viewing the bill as an unnecessary burden on small banks and small companies relying on banks’ help to keep their credit lines and doors open for business. Stifling this symbiotic relationship, the opposition argued, could cost the U.S. economy even more jobs.

Obama counteracted, stating, “Wall Street’s near collapse was a crisis born of a failure of responsibility from certain corners of Wall Street to the halls of power in Washington.”

Of course, Washington can drag this particular horse only halfway to the water. The financial sector and market regulators will have to go the rest of the distance by rewriting their own regulations to meet the requirements of the new law, which could open a whole other can of Wall Street lobbying worms. Even Obama is aware of the dangers ahead that could pull teeth right out of his financial reform bill. He warned, “Regulators will have to be vigilant.”

What has angered those opposing the bill? After billions of dollars have been poured into the financial systems at the height of the credit crisis to soothe the markets and provide at least an illusion of stability, at the same time the ordinary taxpayers failed to grasp why they would have to be the ones left paying the tab for big banks. Almost two years later, Obama’s new law gives financial institutions’ regulators the authority to liquidate weak firms, regardless of how big they are and how interconnected they might be.

“There will be no more tax-funded bailouts, period,” said Obama.

Bold words, by any account, although the bill leaves the little back door open. The Federal Deposit Insurance Corporation, for example, is allowed to borrow from the Treasury, in effect borrowing from the U.S. taxpayers, to help with costs of winding down a failing large financial firm. The good news is that large firms that remain standing will have to pay the Treasury back, not the taxpayers.

Of course, Wall Street spent some serious man hours poring over the huge bill, trying to find where it will hit and hurt the most. As I wrote on Monday, credit rating firms, for example, are not likely to allow issuers of securities backed by debt, like mortgages, to put their ratings into public offering documents. The reason lies in the provision of the law that allows aggrieved investors to sue rating agencies more easily. In other words, credit agencies will think twice before they rate something and post it for everyone to see. They can no longer escape unscathed if they rate something inadequately.

This is not where the law stops, far from it. It has also created within the Federal Reserve an independent and powerful consumer financial protection bureau, which will be responsible for writing and enforcing new regulations dealing with lending and credit practices in the U.S. The umbrella of this bureau will be large enough to capture obscure markets that have previously escaped regulatory oversight, such as subprime lending. Shadow economy no more. If there are firms or market segments threatening everyone else, it will no longer be difficult to simply dismantle them.

The bill has been pushed off the jumping board into delicate and unpredictable political waters, with many fractions hating it simply on face value, that it is being one of Obama’s swan songs. Republicans are howling about jobs and what this bill will potentially do to the labor market. Many business leaders believe that Washington is not listening to their woes. Ordinary Americans are losing faith in almost everything, including Obama’s policy initiatives.

I think the White House has been too aggressive in trying to make this law broadly appealing. I also think that such eagerness wasn’t necessary. Those who don’t understand the need for financial reform have learned absolutely nothing from the Great Recession. Financial reform is not about politics; it should transcend bipartisanship. What it is about is risk management and financial prudence, which is why I couldn’t care less which party has put it in place. Sure, I’m all for constructive criticism, but I haven’t seen much of that. What I’ve seen has mostly been vocal partisan parlance without any real supporting arguments. Yet, oddly, many critics of the bill managed to show up at the bill signing ceremony.

The new “Wall Street Reform and Consumer Protection Act” is a brick of a law at 2,300 pages. Being a mammoth, no wonder it had spawned a few unintended consequences, one being a just what is meant by credit agencies being held more responsible when providing their ratings. The panic was substantial to the point that the Securities and Exchange Commission had to act as a go-between, calming the markets and even invoking a reprieve of sorts from its own regulations.

For almost 80 years, credit rating agencies such as Standard & Poor’s and Moody’s have enjoyed a comfy and protective legislative cushion, whereby, if their ratings turned out to be completely off their rocker, the agencies couldn’t be sued. Nice, right? But the new financial reform legislation has taken that protective cover away in lieu of assigning the highest ratings to toxic assets that have both triggered and caused the Great Recession.

In other words, this means that credit rating agencies will be for the first time in history actually legally liable for their ratings. Trying to pull back the protective covers, S&P and Moody’s are now prohibiting their ratings from being used in offering documents, effectively creating a Catch-22 situation. Meaning, firms trying to raise capital by issuing debt backed by assets, such as mortgages or car loans, for example, can no longer disclose credit ratings of asset-backed securities, yet they are required to do so by other legislation.

The ripples already spread out last week. According to “The Wall Street Journal,” Ford’s financing unit has had to delay issuing bonds backed by its car loans because not a single credit rating agency showed up for the “ratings party.”

This is when Ben Bernanke had to step in, advising the SEC to deal with the situation as soon as possible. Bernanke’s concern is that all this pulling and tugging is placing undue pressures on the credit markets in an environment where it is still difficult for many companies to borrow money from distrustful lenders.

What the SEC did was issue a sort of an amnesty, but not to credit rating agencies. In last week’s statement, the SEC has allowed Ford to issue unrated asset-backed securities for a period of six months. The reprieve stems from the SEC guidelines addressing the distribution of asset-back securities under Regulation AB.

Meredith Cross, director of the SEC’s corporate finance division, stated, “Although there are currently few issuers in the registered asset-backed securities market, we understand from some issuers that they cannot currently obtain credit ratings in these Regulation AB filings. This action will provide issuers, rating agencies and other market participants with a transition period in order to implement changes to comply with the new statutory requirement, while still conducting registered AB offerings.”

It remains to be seen if this transition period will be sufficient to calm both debt and credit markets. But I’m not so concerned with issuers having difficulty peddling their asset-backed offerings. What I’m really concerned about are credit rating agencies. Don’t you find it curious how now, when their legal safety net has been removed, rating agencies are suddenly reluctant to do their jobs, which is to rate debt issues? Makes you wonder what they have been doing before.

We already have serious doubts about their rating methods and consider credit agencies to have gloriously boondoggled ratings of toxic assets. They were supposed to be one of the watchers. It seems that the watchers may have been asleep for eight decades with the public being none the wiser had it not been for the credit crisis. They are now awake and there are no doors and windows to protect them, which seems to be the reason they don’t want to be the watchers anymore. But what else are they good for, then?

Americans are surely, albeit unwillingly, reconciling themselves to the reality that the economic recovery is faltering. The second-quarter results of many bellwethers are pushing stock prices down, clearly questioning the strength and sustainability of the recovery that only few short months ago seemed like a near certainty.

Leading the stampede towards the exit sign are equity investors. But they have not been the only ones in retreat. Crude oil slid as well, as the sentiment swelled that the demand for fossil fuel from major economies is declining in tandem with economies slowing down, too.

The U.S. dollar has also declined, particularly against the yen, to its lowest level this year. Finally, yields are plummeting, too. For example, the yield on the U.S. two-year note has dropped under three percent, because more and more investors perceive economic growth as nothing more than a mirage. In turn, falling yields are forcing the Fed to keep interest rates at super-low levels longer than anyone would have expected or even liked to.

Additionally, the Labor Department recently announced that the U.S. consumer prices index that excludes energy and food costs increased more than expected, which calmed fears of deflation, but only to an extent. However, what is keeping investors on edge is the consumer sentiment, which again seems to be in virtual freefall. For example, the Thomson Reuters/University of Michigan index gauging consumer sentiment has dropped to 66.5 so far in July, which is the lowest level it has hit since August of last year.

It is precisely this chronic negative sentiment that is threatening to strangle the recovery. The government has no more money to throw into the economy to keep the demand up, at least artificially, until the real demand kicks in. Alas, the real demand has never materialized and the market is now shaking in fear, because angry voters and stressed out bondholders are effectively putting politicians off new stimulus.

The problem is that, aside from more stimuli and interest rates being low, the government really has no more ammunition in its arsenal to fight a fall back into the recession and to keep the recovery going at any pace, even a snail’s pace if need be. And that prospect is fuelling tension in many markets, because no one can see where economic growth will come from.

The longer this impasse drags on, the drearier the economic prospects become. To put things into perspective, deflation is currently perceived as a relatively minor threat. However, as economic conditions deteriorate, deflation, for example, could become nothing short of a clear and present danger.

07/21/10 — When economic bailouts were being handed out like candy to kids at Christmas, I had to speak against them, but mostly in the context of not seeing even a trace of planning for exit strategies. What kept me on edge was the fact that I could not see the reset of economic and financial activity before the recovery could grow roots for real. Knowing the reset would be unpleasant, I also feared the longer it took, the worse it would get.

Initially, what unsettled me was that the resetting would not happen anytime soon. Now I fear that, happening all at once and soon, the reset could actually create more harm than the crisis that has necessitated it. This is simply because all the fiscal and monetary cards have been played out to deal with all the craziness that followed the freaky fall of Lehman Brothers almost two years ago and none are left.

I mean it: I think there is virtually nothing left — either politically or economically — that could generate the badly needed multipliers and economic drivers. The bailouts have been handed out to the point of asphyxiating government finances. The costs of borrowing have nearly evaporated. Fiscal deficits have hit the stratosphere. All of which means that there is no more flexibility and, when there is no flexibility, there are no options.

This is how cycles work. Typically, recessions exist to purge excesses created by previous recoveries. However, the Great Recession did not purge all the excesses, if it had purged any at all. Consumers and governments are still struggling under mountains of debt. House prices in many regions are still higher than what real estate market fundamentals command. People are still driving ostentatious cars. The way it looks to me is that all that money really
did little, if anything, to reset the underlying infrastructure of the global economy.

This is why economies around the world are still vulnerable and still prone to speculative bubbles. There was no catharsis in the aftermath of the credit and financial crisis of 2008. There was no purging of excess. Efforts to bring forth the much-needed reforms have been
drowned in economic stimulus and its short-term results. Instead, we are now saddled with an economy addicted to reduced interest rates and excess money supply. Whichever way you look at it, this cannot end up well.

Make no mistake; before the economy untangles itself from this straightjacket, it has to reset itself. This has not happened in the past almost two years. Sure, it may seem so, because we have had a difficult ride, but what the global economy has gone through so far should not be equated with the resetting of the underlying structure. In other words, the Greater Recession could await us as early as 2011.

As if on cue, there is a precedent to this scenario. In 1980, first there was a mercifully short, yet very sharp recession that was also liquidity-induced, as was the Great Recession. The first bout lasted from January to July and it hit the interest-rate-sensitive sectors, such as the real estate and automobile industry, the hardest. Just like during the 2008/2009 recession, the months that followed saw interest rates plummet and liquidity taps fully turned on. It was only under the then Federal Reserve chairman Paul Volcker that liquidity was restrained, and in the nick of time, as well as at a steep price.

How did Volcker do it? He relied on “open market operations” to rein in credit, which first pushed interest rates down and led to the initial recessionary bite out of the U.S. economy. Volcker soon realized that, while liquidity in the short term was repaired, in the long term, things looked anything but rosy. Inflation had arrived and unemployment was swelling to a politically unpleasant size. To counteract that, Volcker tightened the money supply that pushed
interest rates significantly higher and effectively caused the severe recession of 1981-1982.

The economic situation of 2008-2010 is similar only to an extent and is much more complex, unfortunately. There is no detailed model to follow. Not even a similar, liquidity-induced recession of 1980 offers enough guidance. Are things beyond repair? I honestly don’t know,
but I do fear they are. I don’t know how world markets and economies can wean themselves off of reduced interest rates. I don’t know how consumers, business and governments can stop relying on debt and leverage. And, I don’t know how markets and economies are going to survive the bursting of the low-interest-rates bubble, which, let me make it very clear, will inevitably burst.

07/19/10 — The economic health picture in the U.S. is getting worse month after month. The choppy U.S. recovery has spawned many conversations at the Federal Reserve about potentially unleashing another emergency bailout. Such conversations are not exactly jiving with the recent G20 sentiment necessitating the pull-back from extraordinary measures implemented to fight the worst recession in a generation. However, recent evidence has the Fed worried that the country simply will not have enough momentum to turn the corner and might again spin out of control back into the recessionary down spiral.

For the time being, the Fed chairman Ben Bernanke has cut estimates for the U.S. GDP, realizing the country’s dismal labor market and sinking into the jaws of deflation could be permanently arresting economic growth. In addition, the Fed is keeping its main interest rate near zero for who knows how long.

On the balance of things, the Fed did not feel that the concern was sufficiently urgent to actually introduce new measures, at least not yet. However, simply talking about additional measures indicates that the U.S. central bank is worried about the recovery’s snail pace
and the limited impact that existing measures and policies have had on the labor market, consumer confidence, and the credit markets.

What additional measures exactly is the Fed discussing? Nothing we haven’t seen before. Potential additional measures could range from moderating market sentiment through wording of the announcements to keeping interest rates at absolute rock bottom for the near future. The wording from last week’s minutes, for example, went something along these lines: “[We] will consider whether further policy stimulus might become appropriate if the outlook were to worsen appreciably.” Furthermore, the Fed has openly acknowledged in the minutes that the outlook has already “softened” quite a bit.

As an unintentional preamble, only hours before the release of the FOMC minutes, three separate economic reports further proved just how soft the outlook really is. Retail sales continued to slide in the U.S. and that is reason all unto itself to worry about the economy,
because consumer spending is what fuels about 70% of it. Furthermore, import prices continue to spin down the toilet to lows not seen since early 2009. Finally, corporate inventories recorded their smallest gains last month, as companies prepared for months
and months of weak and weaker demand.

Opinion polls indicate that most Americans not only don’t believe that the economy is recovering, but they also believe that the economy has either reverted back into a recession or it has never left it. Perhaps the economy has started growing in 2010, but, as far as most Americans are concerned, not much has changed in their financial lives and future prospects. The growth/recovery is obviously still frail and it can easily be run off track, which is making consumers, investors and businesses equally nervous.

Aside from dismal domestic data, the European debt crisis has delivered punches of its own. In June, the eurozone’s problems have pushed the S&P 500 Index down over five percent. Coupled with the estimates that unemployment is going to stay high for a long period
of time, the Fed had little choice but to cut the 2010 GDP predictions from a range between 3.2% and 3.7% to a new range between 3.0% and 3.5%. Additionally, inflation forecasts were also cut to a new lower range between 1.0% and 1.1%, clearly signaling a period of prolonged deflationary price environment.

For the time being, the Fed is only monitoring the situation and weighing macroeconomic factors and their correlations. That also means that institutional investors are also going to step to the sidelines and adopt a “wait-and-see” strategy. With large buyers out of the playing field, I don’t see who will remain in the equity markets to keep the balance of buyers higher over the sellers. This will mean low trading volumes and sideways trading at best, likely resulting in disappointing equity market performance for the remainder of 2010.