California's unemployment insurance fund

I've been tracking the California unemployment insurance fund for a couple of years. The fund ran out of money at the end of 2008. Since then, it has been insolvent and borrowing from the federal government to pay unemployment claims. The fund appeared to bottom at -$11.08 billion in April, 2011 and has since recovered to -$8.7 billion in August, 2011. Under the original agreement with the federal government, the state was supposed to start paying interest on borrowed funds in January, 2011, but that was deferred until September, 2011.

The first interest payment of $303 million was paid last month. The LA Times covered the unfolding disaster.

It will have to pony up at least a half-billion dollars in 2012 and even more in coming years. The state, which already is struggling to close a massive budget deficit, probably will be forced to make even deeper cuts to schools, law enforcement and other basic services. In the meantime, California employers in January will be hit with a mandatory surcharge of about $25 per employee to begin paying down the principal on the federal loan.

Surcharges for each employee are likely to slow hiring in an already weak employment environment. California is not the only state with an insolvent UI insurance fund. President Obama is proposing further suspensions of interest owed to the federal government and surcharges from the federal government on employers. There is a deep hole to fill to pay for all of the unemployment benefits paid out over the last few years that will be a drag on employers for many years into the future.

Side note: When I started my first business in 1993, I was surprised to learn that I had to pay unemployment insurance on myself as the single employee in my company. I remember talking to the state UI office to confirm that I could collect unemployment insurance if I laid myself off. It never came to that, thankfully.

Mean vs Median unemployment

source: St. Louis Fed (UEMPMEAN, UEMPMED)

The mean duration of unemployment set another new record in September of 40.5 weeks. The median has been in a tight range the last few months, but inched up in September to 22.2 weeks. While the median has dropped from the peak, it is still at levels much worse than the 1980s recessions and worse than any recession since tracking started in the 1960s.

The story is with the still rising mean. There are millions of people who want to work but had their livelihood destroyed in the 2008 recession. Many may never be employed again -- have become unemployable. Their long term benefits may have run out and they may be stuck trying to get by until they can collect Social Security. It cries out for a new Work Progress Administration. In general, I am not in favor of Keynesian policies, as practiced by D.C. (as opposed to my understanding of the original idea). However, in this case, I think it makes sense. An equivalent funding of a new WPA using the same percent of GDP as in 1939 would cost about 1 trillion a year. The devil would be in the details of executing such a program without horrific waste.

Another look at money supply vs gold

Money Supply vs. Gold Price

I've added the Monetary Base (M0) to the charts. While the M1 and M2 charts show that the gold price has been increasing faster than the money supply, the opposite is shown in the monetary base, which has grown almost 4 times as fast as the gold price since the early 1980s. The Fed has been using the monetary base to execute two QE programs, purchasing well over two trillion dollars worth of MBS, ABS, and treasury bonds. Most of that new cash has ended up back at the Fed in the form of excess reserves, paying 0.25% interest to the banks that keep it there. If there was demand for that money as bank loans in the economy, it could create at least 18 trillion new dollars. Of course, there aren't a lot of credit worthy borrowers who want to take out new loans, and the banks need provisions for ongoing real estate loan losses. That inert money is likely to stay at the Fed until the real economy starts to improve, but the monetary base level is unusual and disturbing.

St. Louis Fed Financial Stress Index

This index is relatively new and is similar to the longer running Kansas City Fed financial stress index. Both have been rising lately, but are not even close to the stress shown in 2008.

The St. Louis FSI is built from the following 18 weekly data series:

Interest Rates:

• Effective federal funds rate
• 2-year Treasury
• 10-year Treasury
• 30-year Treasury
• Baa-rated corporate
• Merrill Lynch High-Yield Corporate Master II Index
• Merrill Lynch Asset-Backed Master BBB-rated

Yield Spreads:

• Yield curve: 10-year Treasury minus 3-month Treasury
• Corporate Baa-rated bond minus 10-year Treasury
• Merrill Lynch High-Yield Corporate Master II Index minus 10-year Treasury
• 3-month London Interbank Offering Rate–Overnight Index Swap (LIBOR-OIS) spread
• 3-month Treasury-Eurodollar (TED) spread
• 3-month commercial paper minus 3-month Treasury bill

Other Indicators:

• J.P. Morgan Emerging Markets Bond Index Plus
• Chicago Board Options Exchange Market Volatility Index (VIX)
• Merrill Lynch Bond Market Volatility Index (1-month)
• 10-year nominal Treasury yield minus 10-year Treasury Inflation Protected Security yield (breakeven inflation rate)
• Vanguard Financials Exchange-Traded Fund (equities)

I've added the FSI to the link list as a useful indicator to watch.

Punch the clown

While reading an Illusion of Prosperity post on Oil and Wages, I was going to comment on how it was unsportsmanlike to beat up on Anthony Mirhaydari at MSN Money and his questionable ideas. I mean, how hard is it to punch a clown?

After reading the article, I decided instead to join in the clown punching fun. Here is what he wrote about the crisis in Europe on October 5, 2011:

As for Europe, leaders continue to make progress toward a definitive solution.

Maybe he is in on the latest weekly emergency meeting, but I have yet to see any progress toward a solution. I see lots of emergency meetings, lots of plans to make plans, lots of ideas tossed out by ministers who don't have the authority to do anything, but no solution. Wasn't this problem solved in the summer of 2010? No. Wasn't it solved by a second Greece bailout in July? No. Does Mr. Mirhaydari know that Dexia, a 500 billion dollar bank is being dismantled by the French and Belgium governments this weekend? No. How about that Italy and Spain were both downgraded two days after his article, or that Belgium is now under downgrade watch due to the Dexia bailout. Banks all across the EU were downgraded in the last few days because there is no solution forthcoming.

The Greek Cabinet approved a new budget with tough austerity measures -- including mass layoffs of public sector workers -- designed to return the country to a primary budget surplus (before interest payments), a necessary first step toward restoring fiscal sustainability.

Greece has been approving austerity measures for a year and a half resulting in a lower GDP and bigger budget deficits. They haven't hit a single target since they entered their death spiral. And as mentioned, they can't meet their budget even if they stopped making all interest payments on their bonds tomorrow. They are beyond bankrupt. How have things changed?

As for Greece's saviors, only Slovakia and the Netherlands need to approve the so-called "July 21" changes to the eurozone bailout fund -- which will give the fund more strength and flexibility. Moreover, ratification of the July 21 agreement is needed before European leaders can push ahead with plans to leverage up the bailout fund with private capital with the help of the European Central Bank, a plan that should be the final nail in the coffin of the crisis.

The latest from Slovakia is that the ruling party is against approving the EFSF, but negotiations are ongoing. It could pass, but lets not count the chickens before they hatch. Even if it is approved, they seems to be no taste in Germany for leveraging it up. It really makes no sense for bankrupt countries to borrow from each other, with leverage, to pay off the bonds they can't afford to pay. The whole thing is a circular cesspool.

Whew, clown punching can be exhausting.

S&P 500 vs. Net Capital Inflow (Z1)

The 2nd quarter of 2011 showed a shocking drop in net capital inflow from the Treasury Department Flow of Funds (Z1). The drop was from 478 billion to 2 billion, a net change of -476 billion or almost half a trillion dollars that fled the US. The last time a drop like that happened was the 2nd quarter of 2008 when the net change was -475 billion. Does S&P history rhyme? We are about to find out.

Steve Jobs RIP

Steve Jobs RIP

A Decade of Rough Sledding

CNN has an article called "Face it, tough times are ahead".

President Obama has repeatedly stated, "We are tougher than the times we live in." Although the president may not have intended to signal a whole new approach to our future, the line has Churchillian implications. Speaking of tough times, he could call on Americans to recognize we face at least a decade of rough sledding, ask us to face the challenges and express confidence that we shall prevail.

The problem with asking Americans to suck it up is that the government is really asking the weak, poor, and least connected to suck it up, shoving the burden of the crimes and mistakes of the financial elite onto everyone else. It won't work. This is not an external enemy that bombed us at Pearl Harbor. These are the white collar confidence men running the banks, insurance companies, and the Federal Reserve. Today, I watched Bernanke give the nod to usurious 30% interest rates charged by banks when asked point blank by the Honorable Senator Bernie Sanders. He doesn't see any problem loaning banks money at 0.25% so they can turn around and lend it to consumers at 30%.

Harvard economist Kenneth Rogoff argues that intentionally inflating the dollar is the "the only practical way to shorten the coming period of painful deleveraging and slow growth."

If only it were so easy. Inflation is a disjointed, asymmetric process. Those with first access to new money spend it at full value. Then it cheapens all existing money as moves through the system. That's the way it works unless you drop it equally and on everyone at once.

I am hardly the only one who foresees a "lost decade." A recent Atlantic magazine article argues that even by 2011, 2012, even 2014, the employment rate may decline very little and describes the current economic climate as "a trauma that will remain heavy for quite some time."

Foresee? I see a lost decade looking back to 2000. I also foresee our second lost decade going forward. And maybe a third if we keep kicking the can.

We've avoided the violent demonstrations seen in Greece, the massive demonstrations against inequality seen in Tel Aviv and the random torching of cars common in riots in Germany, France or Britain. If Obama can speak candidly about the coming tough times and the shortfalls we all will have to accept as part of the cure, he may do better; we most assuredly will.

I disagree that Obama can charm the masses by speaking candidly. Obama either doesn't understand what happened, or more likely does understand, but up to now hasn't wanted to confront the money trust the way Andrew Jackson did. He is an insider, groomed to maintain the status quo. He would not have packed his administration with cronies like Geithner and Summers if wanted to address the real issues.

Updated Gold Price vs. Debt statistics

The monthly model (R-squared = 0.95) going back to 2001, shows some major froth on the upside. The intra-month highs in August and September approached 1900 and reached more than 4 sigma above the linear regression. The closing price on 9/30/2011 was $1,620. Here are the prices predicted by the model:
Two sigma below: $1,335.27
One sigma below: $1,417.52
Best fit: $1,498.20
One sigma above: $1,578.87
Two sigma above: $1,661.13

Expanding the model to yearly prices back to 1971 (R-squared = 0.64), prices are well above trend (predicted best fit price = $1,126.52). The long bull market periods are marked by extreme stress in the financial system. I could be wrong, but the nature of the stress in banks and sovereigns seems much more severe than it did in the 1970s and 1980s. European countries were not going bankrupt in the 1970s while tied to a Euro wide currency. The private debt levels, financial sector debt levels, and sovereign debt levels were not close to what we have now, and no resolution seems to be near. Instead, every effort is being made to sustain the unsustainable. A lot of paper promises are going to be broken. That doesn't mean the gold price hasn't already discounted all of the turmoil to come.

Whether the big gold sell off in September was the start of a bubble collapse or just a correction in an ongoing bull market, I don't know. I think we will know within six months. While I made some good trades during the August and September froth, I also gave some back. Until I have a better understanding of what story gold is telling, I am going to back to the discipline of my statistical models.