Has Debt-Deflation Begun?

Today’s CPI data from the US Bureau of Labor Statistics reveals that consumer prices fell by 1 percent in the month of September. This is the steepest monthly fall in the index since January 1938, and comes after two previous monthly falls (of 0.4 and 0.14 percent). It is therefore possible that a debt-deflationary process is underway.

Monthly Change in US CPI since 1924

There is no doubt that we are in a debt-induced economic crisis; America may now have entered a deflationary crisis as well. The combination of the two is the motive force that sets in train a Depression, as Irving Fisher explained in 1933, in his academic paper “The Debt-Deflation Theory of Great Depressions” (Econometrica, 1933, Volume 1, pp. 337-357).

According to Fisher, the steps that lead from a debt crisis, to falling prices, and a Depression are:

“(1) Debt liquidation leads to distress selling and to

(2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes

(3) A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be

(4) A still greater fall in the net worths of business, precipitating bankruptcies and

(5) A like fall in profits, which in a “capitalistic,” that is, a private-profit society, leads the concerns which are running at a loss to make

(6) A reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to

(7) Pessimism and loss of confidence, which in turn lead to

(8) Hoarding and slowing down still more the velocity of circulation. The above eight changes cause

(9) Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.” (Econometrica, 1933, Volume 1, p. 342)

This process is starkly apparent in the US data. After 1930, everyone in the USA was trying to reduce debt–but the debt to GDP ratio rose nonetheless.

US Debt to GDP Ratio 1925-1935

The ratio rose because prices fell by up to 10 percent per annum, and real GDP also collapsed by as much as 13 percent in one year (the GDP data is yearly and therefore understates the steepness of the fall in output). Attempts by individuals to pay down their debts were swamped by prices and incomes that fell faster still. The phenomenon that, as he put it, “the more debtors pay, the more they owe”, deserves to be named “Fisher’s Paradox” in his honour.

Falling Prices and Falling Output

That train of events is now quite possibly unfolding in the USA right now–and from a level of debt that is twice as high (relative to its GDP) as it was in 1929.

America's modern debt bubble dwarfs the one that caused the Great Depression

Fisher’s explanation of how the Great Depression came about was one of the great, neglected contributions to economic theory. There are two reasons why it was neglected–one tragic, the other scandalous.

The tragedy was that, prior to the Great Depression, Fisher was the pre-eminent academic cheerleader for the boom of the Roaring Twenties, and he had also invested his fortune in margin-loan-financed stock purchases. His reputation was destroyed when, in the middle of the market crash, he made the following pronouncement (which was duly reported in the New York Times):

“Stock prices have reached what looks like a permanently high plateau.

I do not feel that there will soon, if ever, be a fifty or sixty point break below present levels, such as Mr. Babson has predicted. I expect to see the stock market a good deal higher than it is today within a few months.”

His fortune was destroyed by the margin calls that came with the collapse. Having made a tidy sum by inventing the Rolodex and selling it to the Rand Corporation, his paper worth (in 2000 dollar terms) was well over $100 million. He lost the lot and was only saved from bankruptcy by his wife’s sister’s wealth, and her forgiveness of his debts to her on her deathbed.

In a reverse of the old parable about “the boy who cried wolf”, Fisher’s accurate diagnosis of the causes of the Great Depression was tainted by his previous failure to see it coming, and by his misleading assurances to the public that there was nothing to worry about.

The scandal is that, after he dramatically revised his approach to economics and came up with a cogent explanation of the process that could cause a Depression, his work was ignored by the economics profession because it was incompatible with the concept of equilibrium. I will cover this issue in much more detail in my next Debtwatch Report in December, but here is a quick precis.

The dominant economic theory of the 1920s assumed that the economy was always in overall equilibrium, and would tend back to equilibrium from any disturbance. Fisher subscribed to this belief, and developed the application of this theory to finance.

In the early 1930s, chastened and effectively bankrupted, Fisher came to appreciate that a misguided belief in equilibrium was the reason he had failed to anticipate the Great Depression. He reasoned that, even if the economy did in fact tend towards equilibrium, in the real world “New disturbances are, humanly speaking, sure to occur, so that, in actual fact, any variable is almost always above or below the ideal equilibrium”.

The world therefore had to be analysed using disequilibrium thinking–and using this insight, he developed the debt-deflation analysis, in which he reasoned that the “two dominant factors” that cause a Depression are “over-indebtedness to start with and deflation following soon after”.

Following Fisher’s lead would thus have required the economics profession to abandon the practice it had developed–of analysing the economy as if it were always in equilibrium–and take on a new, challenging approach of modelling disequilibrium processes.

Faced with this choice, the economics profession did what it has always to date done–it obfuscated and bifurcated. The dominant majority of the profession ignored Fisher’s arguments, and stuck with the familiar tools of equilibium analysis; only a minority (most notably Hyman Minsky) heeded Fisher’s warning.

Today, economists trained in the majority tradition—who almost certainly didn’t study Fisher in their university courses, and who certainly didn’t follow his guidance in their economic analysis—continue to analyse the economy using models that presume it tends towards equilibrium.

Worse still, these models ignore completely the issue that Fisher emphasised was the most important one—the level of private debt. And economists who believe in them occupy all the official positions in Treasuries and Central Banks around the world. Politicians following their advice can be forgiven for not realising that they are being misled, because even those economists themselves don’t realise it (though they are beginning to appreciate this lesson the hard way–see Australia’s RBA Governor Glenn Stevens’s comment yesterday that the current financial crisis has taught Central Bankers that they “could have a more conservative attitude to debt build-up”.

The economic crisis we are now experiencing is in no small measure a product of that academic decision to ignore debt, and to model the economy as if it is always in equilibrium. Had economics instead followed Fisher’s lead, our economic managers would have been attuned to the dangers of excessive debt, and aware of the tendency for the economy to undergo bouts of debt-financed exuberance that drive it far from equilibrium–and potentially to the brink of a debt-deflation.

With the apparent development of a deflationary trend in America, we may now have taken the first step over that precipice.

Steve Keen

Recession Can Be Avoided

Can South America escape the wrath of the economic and financial storms that have their epicenter in the United States? Since the financial meltdown began in mid-September, the bond markets of most of the region (Brazil, Argentina, Colombia, Venezuela) have been hit, as well as most of their stock markets and a number of currencies. The steep drop in commodity prices in recent months has also reduced export and government revenue to a number of countries (Argentina, Brazil, Ecuador, Venezuela, Peru, Chile) where previously high prices of agricultural crops, minerals, and hydrocarbons has contributed to a growth spurt over the last few years. The old adage that "When America gets a cold, Latin America catches pneumonia" has been widely cited.

However, there is good reason to believe that South America, in particular, can weather this storm with minimal damage if it adopts the right macro-economic policies. First, these countries are not very much tied to the U.S. economy, which is in the midst of a deep recession. Exports from Brazil and Argentina to the United States, for example, are less than one percent of those countries' economies. Second, the financial institutions of these countries, for various reasons, did not buy the toxic mortgage-backed securities and other "troubled assets" that have tanked US and even European banks, nor did they engage in the kind of over-leveraging and other risky practices that have brought down the U.S. financial system.

So there is no reason to expect South America to face the kinds of economic troubles that currently plague the United States. However, South America is still linked to the world economy through trade and investment, and will be affected by the world slowdown. It will therefore need to pursue expansionary monetary and especially fiscal policies - just as the rich countries are doing - in order to maintain healthy economic growth.

China did this during the Asian economic crisis ten years ago, and maintained solid growth while its neighbors - Indonesia, South Korea, Thailand and others - suffered serious losses of output and employment and watched tens of millions sink into poverty. The Chinese temporarily changed their economic strategy and invested hundreds of billions of dollars in public works and infrastructure. They are responding similarly to the current crisis, deciding this week to increase spending on infrastructure, transportation, and social welfare programs over the next two years by $587 billion.

Developing countries face one constraint that the United States or Europe does not have when they choose to stimulate their economies: their currencies are not "hard" currencies that the rest of the world accepts, and so they must have enough foreign exchange to avoid a balance of payments crisis. Fortunately, South America is currently well situated: most of the region has large amounts of reserves. Bolivia, the poorest South American country, has more reserves relative to their economy than China does. But the region is still subject to irrational fears that can destabilize their financial systems. For example, none of these countries are going to default on their sovereign debt, yet most of their bond prices crashed and yields soared when the financial crisis began.

For this reason, South America could use a stabilization fund that countries could draw on in order guarantee financial stability. It would be very unlikely that such a fund would actually be used - its existence would negate the need to draw on it. Washington and its partners such as the UK are trying to raise money from the countries with large reserves, such as the oil-rich Gulf states. But they want any stabilization arrangements to go through the IMF.

This is too risky for South America, and it is unnecessary. The IMF badly mishandled the Asian crisis and its contagion a decade ago, causing major damage. They can do the same thing by imposing the wrong conditions on lending today, as well as by playing favorites among countries in need. (There is no reason to scold or criticize the Fund; its managers answer to the U.S. Treasury Department.)

South America should appeal directly to countries that have large amounts of excess foreign exchange reserves, such as China ($1900 billion), Russia ($556 billion ), Abu Dhabi (estimated $875 billion) and others for a stabilization fund that is outside of the IMF. The details are less important than that it should be established quickly. One of the worst things that the U.S. Treasury and IMF did during the Asian crisis was to force countries in the region to abandon their plans for a regional "Asian Monetary Fund" and then to delay the necessary balance of payments support until most of the economic damage had been done.

Of course, Washington will (and already is) use its political clout to muscle the excess-reserve countries into going through the IMF. But South America has some political clout of its own. Brazil is a major player on the world stage. Venezuela and Ecuador are members of OPEC, where much of the world's excess reserves are, and Venezuela is a major oil exporter. China is becoming a strategic partner in Latin America and is stepping up its investment there. Russia is also becoming more involved in the region.

On a separate track, the South American governments should also lobby the U.S. Treasury Department to prohibit onerous conditions from being attached to any IMF lending that takes place. The only legitimate purpose of the IMF providing balance of payments support is so that countries can avoid the harsh austerity and recession-deepening measures that might have to be implemented in the absence of foreign exchange credits. Lending that imposes contractionary conditions in a downturn is inexcusable. And inflation is not a serious threat right now, in the face of a global recession.

South America can grow right through this world recession, just as China will. Just as it is true for the rich countries, expansionary macroeconomic policies will be key. But some outside help for a balance of payments support fund could play an important role in making sure that this happens.

Global Meltdown: Worse Than the Great Depression?

It's a minority but growing view, including from 86-year old former Goldman Sachs chairman, John Whitehead, at the November 12 Reuters Global Finance Summit in New York. As disturbing evidence mounts, he said: "I think it would be worse than the depression. We're talking about reducing the credit of the United States of America, which is the backbone of the economic system. I see nothing but large increases in the deficit, all of which are serving to decrease the credit standing of America.

Before I go to sleep at night, I wonder if tomorrow is the day Moody's and S & P will announce a downgrade of US government bonds. Eventually (they'll) no longer be the triple-A credit that they've always been. I've always been a positive person and optimistic, but I don't see a solution here." Powerful words from a man who "want(s) to get people thinking about this, and realize (we're on) a road to disaster."

A subject writer, precious metals analyst, and Safe Money Report editor Larry Edelson also comments on. Most recently on November 13 in an article titled: "The G-20's Secret Debt Solution." He's quite dire in saying short-term fixes won't be discussed at its November 15 summit. A "far more fundamental fix is being (secretly) discussed - the possible revaluation of gold and the birth of an entirely new monetary system." It's a topic Edelson has spent much time on previously.

Given the speed and severity of the current crisis, he believes something big is planned and puts it this way: "If we can't print money fast enough to fend off another deflationary Great Depression, then let's change the value of the money." In other words, devalue it, but do it globally. "It would be a strategy designed to ease the burden of ALL debts - by simultaneously devaluing ALL currencies (or at least all that matter) and re-inflating ALL asset prices."

Edelson thinks G-20 officials will discuss this seriously. Essentially, the idea of "a new financial order that includes new monetary units that (will help) wipe clean the world's debt ledgers." At best, it will be a tough sell given that the US, by far, is the world's largest debtor and the one most in need of help. The urgency for all others is that if America sinks, it'll drag down all world economies with it, so it's possible some kind of solution will be arranged. But it's not assured, nor can it be ruled out that the summit will be stalemated as every nation has its own concerns and its own constituency to serve.

Edelson believes that key US officials, including Fed chairman Bernanke, Treasury secretary Paulson, and president-elect Obama back the idea, and (most but not all) key world central bankers and politicians agree that a new monetary system is needed.

Consider a historical precedent at a previous dire time - the Great Depression. In April 1933, Roosevelt issued Executive Order (EO) 6102 that stated:

....a "national emergency still continues to exist (and) by virtue of the authority vested in me....(I) do hereby prohibit the hoarding of gold coin, gold bullion, and gold certificates within the continental United States by individuals, partnerships, associations and corporations...."

The EO required the delivery on or before May 1, 1933 "to a Federal Reserve Bank or a branch or agency thereof" all such holdings other than amounts used in industry, profession or art and other listed exceptions. Failure to comply carried a fine up to $10,000 (adjusted for inflation today would be 16 times or more that amount), up to 10 years in prison or both. This EO is called the Gold Confiscation (act) of 1933. It's price at the time was $20.67 an ounce. Shortly thereafter, it was raised to $35 an ounce for an effective US dollar 41% devaluation.

What Edelson is suggesting is that world economies together will do the same thing - "a simultaneous and universal currency devaluation" without confiscating gold. They don't have to and instead can "raise the current official central bank price from its booked ($42.22) value an ounce - to a price that monitizes a large enough portion of the world's outstanding debts."

If this happens, debts will be reduced to a fraction of re-inflated asset prices "led higher by the gold price." Further, Edelson believes, in place of the dollar as a reserve currency, "three new monetary units of exchange (will emerge) with equal reserve status" - a new dollar, euro and "a new pan-Asian currency" with the Chinese yuan likely surviving and linked to a basket of the other three.

With devaluation, new currencies will be worth less than the old ones by a considerable amount. For example, "10 new units of money (may then equal) one old dollar or euro." They'll have new names as well, and new "regulations and programs would be designed and implemented to ease the transition to a new monetary system" - if it happens and it's by no means assured.

But if it does, central banks and governments would run things along with the IMF that's had contingency plans for such an eventuality since it was established in 1944. According to Edelson, a new monetary system will include the following:

(1) A new fixed-rate currency regime

Once the price of gold is increased and new currencies introduced, "a new fixed exchange rate system" will be introduced. The floating one and old currencies will be eliminated to reduce market volatility.

(2) New compensatory measures for savers

They'll be introduced as an inducement and to protect against further devaluation. For example, a possible "one-time windfall tax-free deposit could be issued directly to individual accounts or to employer-sponsored pensions, to IRAs, or Social Security accounts." Something like a tax rebate. At the same time, income taxes may be raised to cover the cost or perhaps some kind of global sales tax instead.

(3) Additional programs to protect lenders and creditors

They'll get top priority over individuals but with a currency worth far less than before. So programs will be needed (like tax help) to help them offset the losses that will be considerable.

Can this work? Edelson thinks so as hard as the medicine would be to swallow. Also, it's not a recipe for high growth rates or improved returns on investments the way it was in the great bull market now ended.

Another issue is what gold price would be legislated to reflate world economies. Who can say, but here are some possibilities Edelson sees, and note the dramatic effect on the precious metal if he's right:

-- if 100% of public and private sector debt is monetized, "the official government price of gold would have to be raised to about $53,000 per ounce;"

-- at 50% monitization, gold would be $26,500 an ounce;

-- at 20%, it would be $10,600 an ounce; and

-- at 10%, it would be $5300 an ounce.

The lowest figure isn't outlandish in light of historical precedent. Gold hit $850 an ounce in 1980. In CPI inflation-adjusted terms, around $2300 an ounce would equal it today. But if the government hadn't cooked the CPI calculation to keep it low, the number would be about $6250 an ounce. So if a devaluation occurs, perhaps even $10,600 might not seem unusual.

Edelson bases his numbers on US debt only because this country is the world's largest debtor and at "the epicenter of the crisis." He won't be surprised if "the G-20 monetize(s) at least 20% of the US debt markets." If so, he sees gold at over $10,000 an ounce along with currency devaluations "by a factor of at least 12 to 1, meaning it would take 12 new dollars or euros to equal 1 old dollar or euro."

A gold standard isn't needed because central banks need only monitize and reduce their debt burdens "via inflating asset prices in fiat money terms." The obvious question is what to do if he's right. Think gold, and in his judgment, make it "as much as 25% of your investable funds." He's not alone recommending this, including others who believe America is insolvent, will simply default on its debt, perhaps create a new currency as Edelson believes, and do it sooner than most people imagine. Next year perhaps because conditions are so dire and deteriorating fast.

Macro data keep confirmng it. The latest on November 13 with initial unemployment claims at 516,000 or the highest since September 2001. Continuing claims are at the highest level since 1983. For the week ending November 1, the seasonally adjusted insured unemployment advance number was 3,897,000 or an increase of 65,000 from the preceding week.

Crucial to understand is that these figures are grossly understated given the numbers of discouraged workers, part-time and occasional ones, and other ways the government cooks the books to soften or otherwise alter all types of "official" data. None of it, including GDP, inflation, and the rest is reliable. For unemployment, a good rule of thumb is to double the announced figures, so the Labor Department's reported 6.5% is, in fact, around 13% and rising.

In addition, housing continues to deteriorate. Large builder Toll Brothers president, Bob Toll, says "These are bad times if there ever were" any. Along with declining prices and rising foreclosures, it shows in new mortgage application figures - down 40% from a year earlier and no evident leveling off signs.

Still more bad news on November 14 with the Commerce Department reporting October retail sales plunging a record 2.8% after falling the previous three months. Even excluding a 5.5% drop in auto purchases, they fell a record 2.2% with lower gasoline prices accounting for much of the drop. Nonetheless, numbers were down across the board, and August and September figures were revised lower signaling a poor holiday shopping season and very bleak Q 4 that's certain to continue into the new year.

Some observers believe that these and other data lie behind Paulson abandoning his toxic asset purchase plan to give more to "nonbank financial institutions, like insurers and speciality-finance companies" as well as to "Shift Focus in (the) Credit Bailout to the Consumer," according to The New York Times. Others see the Treasury in disarray and still others think the original plan was a head fake, and all along Paulson had other things in mind and will gradually unveil them. They'll offer little for beleaguered households if anything at all.

Details on his newest plan are vague, but apparently consumers won't directly benefit. Around $50 billion will be for a new loan facility to help companies issuing credit cards, making student loans and financing car purchases. It means maxed out households won't be able to borrow because they're already overextended, and lenders will only do business with good credit risks.

Nonetheless, this is the latest twist in what some critics call making Treasury policy on the fly. First toxic asset purchases, then bank recapitalizations and various other handouts, and now the vague outlines of a new plan just announced. Tomorrow something else in the wake of the G-20 November 15 summit.

Its official 47-action items statement (drafted well in advance of the meeting) was in the usual type political-speak. According to The New York Times, "leaders of 20 countries agreed Saturday to work together to revive their economies, but they put off thornier decisions about how to overhaul financial regulations until next year (when it plans) its next meeting for April 30, 101 days after (Obama) is sworn into office." Whatever is finally agreed on, this much for certain is clear. Unchanged Washington/Wall Street dominance is planned along with putting the IMF in charge of global "neoliberalizing" with all its destructive fallout.

A Long-Term View on the Depression

It's from noted sociologist, social scientist and world-systems analyst Immanuel Wallerstein, now a Senior Research Scholar at Yale where he covers world-systems in three ways:

-- the historical development of the modern world-system;

-- the contemporary crisis of modern world-economy capitalism; and

-- structures and knowledge.

He's authored numerous books and writes regular commentaries on major world and national topics. A recent October 15 one is titled "The Depression: A Long-Term View."

It's started in his view. We're "at the beginning of a full-blown worldwide depression with extensive unemployment almost everywhere. It may take the form of a classic nominal deflation (or less likely) a runaway inflation, which is simply another way in which values deflate." What caused it, he asks? Derivatives? Subprime mortgages? Oil speculators? It's a "blame game of no real importance."

Understanding it calls for far more revealing factors, such as "medium-term cyclical swings (and) long-term structural trends." Over several hundred years at least, he describes two major ones. "One is the so-called Kondratieff cycles that historically" lasted 50 - 60 years. The other is called "hegemonic cycles" that are much fewer in number but last far longer.

America contended for hegemony as early as 1873, achieved it fully in 1945, and has been declining since the 1970s. "George W. Bush's follies have transformed a slow decline into a precipitate one. And as of now, we are past any semblance of US hegemony. We have entered, as normally happens, a multipolar world. The United States remains a strong power, perhaps still the strongest, but it will continue to decline relative to other powers in the decades to come." Nothing can change this.

Kondratieff cycles are timed differently. Its last B-phase ended in 1945, followed by "the strongest A-phase upturn in the history of the modern world-system." It peaked around 1967 - 73, and headed down. "This B-phase has gone on much longer than previous (ones) and we are still in it."

Its characteristics are as follows:

-- "profit rates from productive activities go down, especially in those types of production that have been most profitable;"

-- it directs capitalists to financialization and speculation for higher returns; and

-- "productive activities, in order not to become too unprofitable, tend to move from core zones (like America) to (lower cost) parts of the world-system."

Speculative bubbles are profitable while inflating, but they always burst. "If one asks why this Kondratieff B-phase has lasted so long, it is because the powers that be (the Treasury, Fed, IMF, and western European and Japanese collaborators) have intervened in the market regularly and importantly" to shore it up at times of economic disruptions - 1987, the 1989 S & L crisis, 1997 Asian contagion, 1998 Long Term Capital Management debacle, the 2001 - 2002 corporate scandal period, and more than ever today with big unanswered questions whether this time it will work.

It doesn't matter because we've reached the limits of what can be done - "as Henry Paulson and Ben Bernanke are learning to their chagrin and probably amazement. This time, it will not be so easy, probably impossible, to avert the worst."

In earlier depressions, innovations and quasi-monopolies helped world economies recover. In the late 1930s, WW II played the major role. Today things are different and "may interfere with this nice cyclical pattern that has sustained the capitalist system for some 500 years." They're new structural trends, according to Wallerstein. "The problem with all structural equilibria of all systems, is that over time the curves tend to move far from equilibrium (and it's) impossible to bring them back."

What happened this time? It's "because over 500 years the three basic costs of capitalist production - personnel, inputs, and taxation - have steadily risen as a percentage of possible sales price (so) today (it's) impossible to obtain the large profits" that previously were the "basis of significant capital accumulation." It's the result of capitalism working so well that it finally "undermined the basis of future accumulation."

At this point, the system "bifurcates." The immediate consequence is high chaotic turbulence (now ongoing) and will continue....for perhaps another 20 - 50 years. From the chaos "one of two alternate and very different paths" will emerge.

The present system won't survive. A new one will replace it. It will not be capitalism as we know it, but may be far worse or far better (more democratic and egalitarian). Determining the outcome is "the major worldwide political struggle of our times."

In the short-term, we're moving into a "protectionist world (forget about so-called globalization)." Governments are getting more into production - even in America and Britain. We're also moving more into "populist government-led redistribution," either in a left-of-center social democratic form or a far right authoritarian one. "And we are moving into acute social conflict within states, as everyone competes over the smaller pie. In the short-run, it is not, by and large, a pretty picture."

A Brief Summary of Nouriel Roubini's Latest Views

As of November 11, he says "the US will experience its most severe recession since WW II, much worse and longer and deeper than even (in) 1974 - 75 and 1980 - 82." It'll last through 2009 and cause a "cumulative GDP drop of over 4%." Unemployment will likely reach 9%. The US consumer is debt burdened, saving less and faltering: "this will be the worst consumer recession in decades."

A V-shaped recovery "is out the window." In prospect is either a U-shaped 18 - 24 months recession or a worse multi-year L-shaped one similar to what Japan experienced in the 1990s. Economist Michael Hudson sees an L-shaped depression ahead, more severe than what Roubini forecasts who doesn't rule out something worse than he imagines.

As a result, president-elect Obama "will inherit an economic and financial mess worse than anything the US has faced in decades:" the worst recession in 50 years;" the worst financial and banking crisis since the 1930s; a massive fiscal deficit; a huge current account one; "a financial system that is in a severe crisis and where deleveraging is still occurring at a very rapid pace," thus making the credit crunch worse; a household sector in disarray with millions insolvent and forclosures rising; the risk of serious deflation; a liquidity trap for the Fed as well; and "the risk of a severe debt deflation as the real value of nominal liabilities will rise given price deflation while the value of financial assets is still plunging."

Worse still, this is happening globally, even in mighty China that could see its market peak 12% growth rate plunge to 6% for a "hard landing." Emerging economies will be very hard hit, and advanced ones "will face stag-deflation (stagnation/recession and deflation)."

In countries like the US, Japan and possibly others, interest rates may reach zero with serious potential consequences if it happens. "Zero-bound on interest rates implies the risk of a liquidity trap where money and bonds become perfectly substitutable, where real interest rates become high and rising thus further pushing down aggregate demand, and where money fund returns cannot even cover their management costs."

Deflation also affects debt. At nominal values it will rise and thus increase its real burden. As for monetary policy, no matter how aggressive it gets, it will be "pushing on a string given the glut of global aggregate supply relative to demand (plus) a very severe credit crunch."

With this in mind, projected 2009 earnings are "delusional" and will have to be lowered sharply. As a result, view equity rallies as sucker rally bear traps, and Roubini has a cartoon to explain them:

-- top graphic: broker saying "I've got a stock here that could really EXCEL"....really excel someone asks?..another asks "EXCEL?"...still another thinks "SELL," then everyone yells "SELL;"

-- bottom graphic: everyone yelling "SELL"....one voice saying "This is madness! I can't take anymore, goodbye!" Good bye, someone asks? Buy? - asks another, and then everyone yells BUY!!

Michel Chossudovsky, Ellen Brown and others explain what's really going on. It's not pretty or what Wall Street wants investors to know. That markets are heavily manipulated. Speculation drives them up and down, and very visible (insider) hands profit hugely in either direction.

Chossodovsky: "With foreknowledge and inside information, a collapse in market values constitutes a lucrative and money-spinning opportunity, for a select category of powerful speculators who have the ability to manipulate the market in the appropriate direction at the appropriate price" - and he explains the various ways how.

Brown on the "Plunge Protection Team (PPT): it's "the group set up under President Reagan to maintain market 'stability (profitable instability also) by manipulating markets behind the scenes."

In other words, financial markets are rigged. "Free" ones don't exist except in the mind's eye of the innocent. They represent no collective wisdom other than the speculators who manipulate it for profit.

Brown: "In a rigged pseudo-capitalist economy, investors are easily separated from their money because they expect the market to follow 'free market principles' based on 'supply and demand.' They are seduced into 'pump and dump schemes" and fleeced.

In today's market climate, trusting in Adam Smith's "invisible hand" is a very hazardous exercise. Brown again: "The market today is indeed controlled by an invisible hand, but it is not necessarily serving the interests of small investors."

Paul Krugman on A Possible Depression

He doesn't expect one, but he's worried at a time when we're "well into the realm of what (he calls) depression economics." He means "a state of affairs like that of the 1930s in which the usual tools of economic policy - above all, the Federal Reserve's ability to pump up the economy by cutting interest rates - have lost all traction. When depression economics prevails, the usual rules of economic policy no longer apply: virtue becomes vice, caution is risky and prudence is folly."

He cites one piece of macro data, among many others, as an example - new unemployment insurance claims (mentioned above) that are high, rising, but not unusual in recessionary times. Standard policy is to cut the fed funds rate, but today doing it is "meaningless." It's officially at 1%, but it's "averaged less than 0.3 percent in recent days," so there's nothing left to cut.

Krugman suggests a huge $600 billion stimulus package, but even that could fall far short, especially if it causes as much destabilization as the Paulson bailout schemes - designed to wreck the economy, not heal it, so powerful interests can grow more powerful and do it with taxpayer dollars.

New Programs for Old Add Up to Same Old, Same Old

Shifting focus to bailing out consumers was covered above and explained as a way to help companies, not households. It's more Bush administration deception that will continue seamlessly under Obama, and just look at his major Wall Street contributors for proof. He fully supports aiding them at a time one observer calls the Treasury "privatized," and it's no secret that it's being looted.

Then there's (supposed) mortgage aid for beleaguered homeowners that falls way short of helping them. Quite the opposite in fact. The newly announced plan is more old than new and only to keep under water owners from deserting their properties and renting. The idea is for lower rates, extended loan terms, lower payments, and adding unpaid balances to principal. It's called negative amortization - when monthly payments are less than the full interest amount due. The interest accrues and principal balances increase, only putting off an eventual day of reckoning for a later time when prices of homes will be lower and owners even less able to afford them.

In others words, the solution is worse than the problem. It will sink owners more under water than at present, delay their defaulting for a later time, turn owners into levered renters, drive them deeper into debt, ensure continued foreclosures for many years to come, and end the dream of home ownership for millions. It will also discourage millions more from wanting one.

And there's more to this ugly plan. There's a catch. It focuses on loans Fannie and Freddie own or guarantee. They dominate half the mortgage market and have about 20% of delinquent loans, so far. Even FDIC chairman, Sheila Bair, is critical saying the plan "falls short of what is needed to achieve wide-scale modifications of distressed mortgages." She wants some TARP money for "fixing the front-end problem: too many unaffordable home loans," but what's needed is an entirely new plan.

One designed to work. With affordable monthly payments, principal balances reduced, and lenders required to eat losses on deceptive loans they never should have made in the first place. The proposed plan is designed to fail, and it's typical of how Washington operates. It was announced by the Federal Housing Finance Agency (FHFA), the same one that seized Fannie and Freddie in September.

On November 13, FDIC officials unveiled their own plan that improves on FHFA's but not enough. It's only for 1.5 million homeowners facing foreclosure in 2009. Its cost is an estimated $24.4 billion, and even so Henry Paulson opposes it because it taps a small portion of his TARP money.

Borrowers who've missed at least two monthly payments will be eligible for a reduced amount - at no more than 31% of their monthly income compared to the 28% of the pre-tax amount lenders once deemed affordable.

In exchange, mortgage companies will be guaranteed that if borrowers fall behind on their payments and they lose money, Washington will cover half of their loss in most cases. The plan's estimated cost is based on the assumption that only one in three borrowers with modified payments will be unable to make them. Currently, nearly half of borrowers under such plans default, so it's doubtful FDIC's plan will work, especially with home prices still falling and likely to bottom well below current values.

Nonetheless, leading congressional Democrats are supportive, and Senate Banking Committee chairman, Chris Dodd, said he'll introduce legislation to let bankruptcy courts modify mortgage loans. It's something consumer advocates want badly and the banking industry strongly opposes. It remains to be seen what kind of new law passes (if any), and despite expressing support for one during his campaign, rest assured that Obama will do nothing to harm his core constituency - his powerful Wall Street backers.

He'll likely let banks set their own terms for their own benefit to the detriment of homeowners. The way it usually works in the end. Further, arrangements announced, in place or planned can't stop foreclosures from rising. Increasing unemployment will intensify the problem. Many borrowers overstated their incomes and can't even handle reduced payments. Others were speculators on second homes and don't qualify.

In addition, home prices keep falling with no end of it in sight. Growing millions of owners are under water owing far more than their properties are worth and assuring many will default and simply rent - for less than they're now paying.

Further, securitizing mortgages complicates who owns them. Except for Fannie and Freddie, they're not your local bank or S & L in most cases, but foreign investors, hedge funds, and all sorts of other non-traditional mortgage paper holders. Usually ones homeowners can't meet with face-to-face, and if they could would be rebuffed. "Servicers" won't modify loan terms because doing so lowers their value for investors and likely would invite lawsuits.

It's another wrinkle in a complicated situation with homeowners at the bottom of the food chain being squeezed, short of major government help not forthcoming or likely in the new year. For them and most others, trouble is baked in their cake that they're now being force-fed to eat.

In greater portions after the Office of the Comptroller of the Currency refused to let lenders forgive large amounts of credit card debt. As much as 40% for consumers who don't qualify for existing repayment plans.

A rare financial industry and Consumer Federation of America alliance asked the Treasury Department for help on October 29 for very logical reasons. Consumers need it as well as credit card lenders for a way to mitigate growing losses - by assuming small in lieu of total ones and getting extended write-off periods.

But consider how over-indebted individuals may react if they're smart. Why pay anything when it's simpler to default and walk away. For those strapped enough, it's what growing numbers are choosing and the reason lenders like JP Morgan Chase, Citigroup, and Bank of America (already reeling from bad mortgage debt) are concerned enough to seek relief.

Instead, they should be held accountable for their fraud. For destroying savings, pensions, and for growing millions their homes and futures. For charging usurious interest and late charges on credit card balances. For gaming the system for decades but now out of their food source. Instead of help, have them give back and make it on their own, or step aside, be nationalized, and turn them into a public utility, on a level playing field, to serve the greater good for everyone.

Their due reward for what Paul Craig Roberts calls "unregulated banksters and Wall Street criminals, greedy CEOs, and a no-think economics profession (for having) destroyed America's economy," and now wanting to be saved from their own transgressions. Rebalance the tax code instead, make it progressive, and soak the rich, not the poor. It was the original idea in the first place at a time low income earners paid nothing. Today they're overburdened, overtaxed, out of work, and out of hope during the most serious disruption in our history.

They're not offered part of the latest bank handout that's little more than naked theft on top of all of it earlier. This time with another $140 billion windfall that was in a September 30 Treasury Department memo. According to tax experts, it overstepped its authority by overturning section 382 of a 1986 law curtailing the outlandish corporate gaming of the tax system. It nets Wells Fargo $25 billion for its Wachovia takeover and PNC bank $5.1 billion in acquiring National City. Future acquisitions will enjoy similar benefits with taxpayers getting the bill.

This also helps big banks acquire smaller ones, concentrate more power in their hands, and head them closer to near-monopoly control over the entire financial system. A privatized Treasury indeed - with bipartisan support and by the new president-elect.

His new Treasury secretary will maintain the status quo or even sweeten it at a time when ordinary households are in deep distress with little help in prospect beyond measures too inadequate to matter.

According to the New York and London-based CreditSights research firm, it's $5 trillion and counting for fraudsters and bare crumbs for the public. At a time economies are sinking into recession, unemployment and poverty rising, and mayor Richard Daley of this writer's Chicago warning of "huge" layoffs to come.

He compared now to the 1930s and said: "We never experienced anything like this except (for those) people who came from the Depression. When you have that many layoffs early (referring to the city's and what corporate heads tell him) - and they're telling me this is only the beginning of their layoffs - that is very frightening."

Daley warned that local governments could face bankruptcy at a time Chicago-based Challenger, Grey & Christmas outplacement consultant reported that US job cuts reached a five-year high in their latest numbers and are rising across the board.

It's just as bad for Illinois (and other states) according to Bloomberg. The state "is $4 billion behind in paying bills to its suppliers of goods and services," Comptroller Dan Hynes said. "Vendors face a 12 week delay in getting paid, and the wait may extend to 20 weeks" as conditions deteriorate further. "The unprecedented backlog of bills might grow to $5 billion by March. To call this an imminent crisis is an understatement," and it's affecting all state services. In other states as well across the country.

Even the mighty New York Times is hurting. It's fallen on hard times and may be a metaphor for the country. In 2002, its stock price hit nearly $53 a share and is now below $7.50 (as of November 14), down about 86%. It also owes lenders around $400 million by next May, has a mere $46 million on hand, and it needs all of it and more for operating expenses at a time one observer suggests that the Grey Lady may need to change its slogan to "Less News and Less Money To Print It."

Maybe none according to its publisher Arthur Sulzberger Jr. months back at the Davos, Switzerland World Economic Forum. He said "I really don't know whether we'll be printing The Times in five years, and you know what? I don't care either" because the paper is emphasizing internet news and doubled its online readership to 1.5 million.

Well and good but it hasn't enough online advertising to make up for what it's losing in print, and given today's climate, it may run out of time to make up the shortfall and stay viable. That may prove the epitaph for growing numbers of venerable (and now vulnerable) American and global companies at perhaps the most challenging time in their histories.

A Final Comment

How did it come to this in the first place? In a word: out-of-control excess yields even greater payback, and the only cure for bubbles (according to noted economist Kurt Richebacher) is to prevent them from developing.

The ones now deflating are unprecedented in their size and severity. No amount of policy making magic will easily fix them. America and world economies face a long, painful period ahead, likely more than at any other time in history with no clear idea what will emerge in the end. As one observer puts it: "All we know is that nobody knows."

What's known in the shorter term is what Michel Chossudovsky observes: "The financial crisis is deepening, with the risk of seriously disrupting the system of international payments. (This time) is far more serious than the Great Depression. All major sectors of the global economy are affected (and TARP and related schemes are) not a 'solution' to the crisis but the 'cause' of further collapse" - by design.

So what long-term lessons will be learned when the dust finally settles? According to money manager and market strategist Jeremy Grantham: "absolutely nothing" or put another way - those who don't heed the lessons of the past are condemned to repeat them.

Policy makers won't change. "Free-market" fundamentalism won't be tamed, and nothing in sight promises deliverance to a caring, progressive new world. Before whatever comes out of this in the end, plenty of pain will precede it, then past sins will repeat, and we'll go through the whole cycle again - if we make it through this one.

The Real Goal of Israel's Blockade of Gaza

The latest tightening of Israel’s chokehold on Gaza – ending all supplies into the Strip for more than a week – has produced immediate and shocking consequences for Gaza’s 1.5 million inhabitants.

The refusal to allow in fuel has forced the shutting down of Gaza’s only power station, creating a blackout that pushed Palestinians bearing candles on to the streets in protest last week. A water and sanitation crisis are expected to follow.

And on Thursday, the United Nations announced it had run out of the food essentials it supplies to 750,000 desperately needy Gazans. “This has become a blockade against the United Nations itself,” a spokesman said.

In a further blow, Israel’s large Bank Hapoalim said it would refuse all transactions with Gaza by the end of the month, effectively imposing a financial blockade on an economy dependent on the Israeli shekel. Other banks are planning to follow suit, forced into a corner by Israel’s declaration in Sept 2007 of Gaza as an “enemy entity”.

There are likely to be few witnesses to Gaza’s descent into a dark and hungry winter. In the past week, all journalists were refused access to Gaza, as were a group of senior European diplomats. Days earlier, dozens of academics and doctors due to attend a conference to assess the damage done to Gazans’ mental health were also turned back.

Israel has blamed the latest restrictions of aid and fuel to Gaza on Hamas’s violation of a five-month ceasefire by launching rockets out of the Strip. But Israel had a hand in shattering the agreement: as the world was distracted by the US presidential elections, the army invaded Gaza, killing six Palestinians and provoking the rocket fire.

The humanitarian catastrophe gripping Gaza is largely unrelated to the latest tit-for-tat strikes between Hamas and Israel. Nearly a year ago, Karen Koning AbuZayd, commissioner-general of the UN’s refugee agency, warned: “Gaza is on the threshold of becoming the first territory to be intentionally reduced to a state of abject destitution”.

She blamed Gaza’s strangulation directly on Israel, but also cited the international community as accomplice. Together they began blocking aid in early 2006, following the election of Hamas to head the Palestinian Authority (PA).

The US and Europe agreed to the measure on the principle that it would force the people of Gaza to rethink their support for Hamas. The logic was supposedly similar to the one that drove the sanctions applied to Iraq under Saddam Hussein through the 1990s: if Gaza’s civilians suffered enough, they would rise up against Hamas and install new leaders acceptable to Israel and the West.

As Ms AbuZayd said, that moment marked the beginning of the international community’s complicity in a policy of collective punishment of Gaza, despite the fact that the Fourth Geneva Convention classifies such treatment of civilians as a war crime.

The blockade has been pursued relentlessly since, even if the desired outcome has been no more achieved in Gaza than it was in Iraq. Instead, Hamas entrenched its control and cemented the Strip’s physical separation from the Fatah-dominated West Bank.

Far from reconsidering its policy, Israel’s leadership has responded by turning the screw ever tighter – to the point where Gazan society is now on the verge of collapse.

In truth, however, the growing catastrophe being unleashed on Gaza is only indirectly related to Hamas’s rise to power and the rocket attacks.

Of more concern to Israel is what each of these developments represents: a refusal on the part of Gazans to abandon their resistance to Israel’s continuing occupation. Both provide Israel with a pretext for casting aside the protections offered to Gaza’s civilians under international law to make them submit.

With embarrassing timing, the Israeli media revealed at the weekend that one of the first acts of Ismail Haniyeh, the Hamas prime minister elected in 2006, was to send a message to the Bush White House offering a long-term truce in return for an end to Israeli occupation. His offer was not even acknowledged.

Instead, according to the daily Jerusalem Post, Israeli policymakers have sought to reinforce the impression that “it would be pointless for Israel to topple Hamas because the population [of Gaza] is Hamas”. On this thinking, collective punishment is warranted because there are no true civilians in Gaza. Israel is at war with every single man, woman and child.

In an indication of how widely this view is shared, the cabinet discussed last week a new strategy to obliterate Gazan villages in an attempt to stop the rocket launches, in an echo of discredited Israeli tactics used in south Lebanon in its war of 2006. The inhabitants would be given warning before indiscriminate shelling began.

In fact, Israel’s desire to seal off Gaza and terrorise its civilian population predates even Hamas’s election victory. It can be dated to Ariel Sharon’s disengagement of summer 2005, when Fatah’s rule of the PA was unchallenged.

An indication of the kind of isolation Mr Sharon preferred for Gaza was revealed shortly after the pull-out, in Dec 2005, when his officials first proposed cutting off electricity to the Strip.

The policy was not implemented, the local media pointed out at the time, both because officials suspected the violation of international law would be rejected by other nations and because it was feared that such a move would damage Fatah’s chances of winning the elections the following month.

With the vote over, however, Israel had the excuse it needed to begin severing its responsibility for the civilian population. It recast its relationship with Gaza from one of occupation to one of hostile parties at war. A policy of collective punishment that was considered transparently illegal in late 2005 has today become Israel’s standard operating procedure.

Increasingly strident talk from officials, culminating in February in the deputy defence minister Matan Vilnai’s infamous remark about creating a “shoah”, or Holocaust, in Gaza, has been matched by Israeli measures. The military bombed Gaza’s electricity plant in June 2006, and has been incrementally cutting fuel supplies ever since. In January, Mr Vilnai argued that Israel should cut off “all responsibility” for Gaza and two months later Israel signed a deal with Egypt for it to build a power station for Gaza in Sinai.

All of these moves are designed with the same purpose in mind: persuading the world that Israel’s occupation of Gaza is over and that Israel can therefore ignore the laws of occupation and use unremitting force against Gaza.

Cabinet ministers have been queuing up to express such sentiments. Ehud Olmert, for example, has declared that Gazans should not be allowed to “live normal lives”; Avi Dichter believes punishment should be inflicted “irrespective of the cost to the Palestinians”; Meir Sheetrit has urged that Israel should “decide on a neighbourhood in Gaza and level it” – the policy discussed by ministers last week.

In concert, Israel has turned a relative blind eye to the growing smuggling trade through Gaza’s tunnels to Egypt. Gazans’ material welfare is falling more heavily on Egyptian shoulders by the day.

The question remains: what does Israel expect the response of Gazans to be to their immiseration and ever greater insecurity in the face of Israeli military reprisals?

Eyal Sarraj, the head of Gaza’s Community Mental Health Programme, said this year that Israel’s long-term goal was to force Egypt to end the controls along its short border with the Strip. Once the border was open, he warned, “Wait for the exodus.”

Jonathan Cook is a writer and journalist based in Nazareth, Israel. His latest books are “Israel and the Clash of Civilisations: Iraq, Iran and the Plan to Remake the Middle East” (Pluto Press) and “Disappearing Palestine: Israel's Experiments in Human Despair” (Zed Books). His website is www.jkcook.net.

A version of this article originally appeared in The National (www.thenational.ae), published in Abu Dhabi.