2012Media Placements ~ The Abbi Agency.

Universal Value AdvisorsTable of Contents

Date Publication Title12/30/2012 Reno Gazette Journal 2013: Forecasts For The Unsettled Road Ahead12/21/2012 International Business Times Fiscal Cliff 2012: What It Means For Consumers12/20/2012 Fox Business Fiscal Cliff' Hangs Over Consumer Spending

12/19/2012 bankrate.com Fiscal Cliff' Hangs Over Consumer Spending

12/16/2012 Reno Gazette Journal The Demonization Of Corporate Tax Avoidance

12/16/2012 Reno Gazette Journal Corporate Giving

12/6/2012 Financial AdvisorsAdvisors Could be Affected By Proposed Money Market Fund

Reforms

12/2/2012 Reno Gazette Journal Spending: The Nation's Real Fiscal Cliff Issue

11/18/2012 Reno Gazette Journal The 'Fiscal Cliff' And The Illusion Of Prosperity11/17/2012 News 2 Face The State

11/15/2012 News 2Economist: "Major Disconnect Between Wall Street And Main

Street

11/14/2012 News 2Local Economist: Unemployment Numbers Don't Tell The Full

Story11/5/2012 Fox Business Are You Betting On TIPS And Inflation?11/4/2012 Reno Gazette Journal Nation Has Impediments To Economic Growth

10/24/2012 bankrate.com Fed Noiselessly Keeps Rates Low10/22/2012 bankrate.com Borrow Money? 'No Thanks,' Say Consumers10/22/2012 Fox Business Borrow Money? 'No Thanks,' Say Consumers

10/21/2012 Reno Gazette Journal Employment Data: What You Should Know To Interpret Them

10/17/2012 Star Tribune4 Things To Remember About The Upcoming Minnesota Jobs

Report

10/16/2012 Forbes Why Jack Welch Has A Point About Unemployment Numbers

10/7/2012 Reno Gazette Journal Todays Bizarro World9/22/2012 MarketWatch US Housing Data8/27/2012 Minyanville The Recession That Won't End8/26/2012 Reno Gazette Journal Europe's On Road To Ruin

8/12/2012 Reno Gazette Journal Today's Market Not Driven By Fundamentals

7/29/2012 Reno Gazette Journal Equities: Is A Bear Market Inevitable In This Economy?

7/26/2012 The Street New Soap Opera: The Comedy Of Euros

7/7/2012 Spokesman Review Jobs Report Holds Market Back

7/6/2012 MarketWatch U.S. Stocks End Lower After Lackluster Jobs Gains

7/6/2012 bankrate.com Investors Lose In Libor Scandal

7/4/2012 Minyanville The New Bank Paradigm: Squeezing Out The Private Sector

6/27/2012 Forbes Way Too Soon Into Natural Gas

6/20/2012 KOLO 8 South Reno: Robert Barone

6/17/2012 Reno Gazette Journal Why Greece Is A Big Deal?

6/12/2012 Monica Jay Show UVA: Housing

6/6/2012 Forbes Don’t Bite Into Apple At These Prices

6/4/2012 SmartBlog Analysis

6/3/2012 Reno Gazette Journal Spanish Banks Hold The Key To U.S. Market's Volatility

5/24/2012 Minyanville Too Big To Fail: Four Years Later, Things Are Riskier Than Ever

5/21/2012 Forbes Rebellion Against Austerity From Greece To Washington

Universal Value AdvisorsTable of Contents

Date Publication Title

5/20/2012 Reno Gazette Journal Cheaper Energy Like Natural Gas Is The Key To Prosperity

5/11/2012 Reno Gazette Journal Company's Kitchen Featured In Article5/6/2012 Reno Gazette Journal Chained-CPI Is Not An Accuarate Deflation Gauge

5/4/2012 Fast CompanyWhy You Should Swap Your Corporate Boardroom For A

Company Kitchen

4/22/2012 Reno Gazette Journal Further Review: Employment Remains Weak Despite Surge

4/9/2012 Reno Gazette Journal Financial Armageddon: Should You Worry?

3/26/2012 Reno Gazette Journal Is U.S. Housing Healing?

3/15/2012 FindLaw Markets Hooked On Liquidity Drug From Central Bank Pushers

3/15/2012 Checks And Balances Markets Hooked On Liquidity Drug From Central Bank Pushers

3/15/2012 Forbes Markets Hooked On Liquidity Drug From Central Bank Pushers

3/9/2012 Reno Gazette Journal Wall Street Gives Hayes The Runaround2/8/2012 Seniors WWW Avoiding The Austerity Death Spiral2/7/2012 Forbes Avoiding The Austerity Death Spiral2/7/2012 Yahoo Finance Avoiding The Austerity Death Spiral2/7/2012 Hot Topic 24 Avoiding The Austerity Death Spiral

1/26/2012 Monica Jay Show Universal Value Advisors

With Washington stuck in a confusing gridlock over how to avert the economically devastating

set of cost and revenue measures constituting the so-called fiscal cliff, it appears that, no

matter what happens, consumer spending is likely to take a hit in the coming year.

That’s because one of the most significant aspects of the fiscal cliff -- the expiration of the payroll-tax cut enacted in 2010 -- seems to be the one item nobody in the nation's capital is fighting to keep from taking place.

Doing away with the 2-percentage-point cut in the payroll-tax rate for almost all U.S. workers would trim net median household income by $1,035. This measure is credited with having created more than 400,000 jobs during the past three years, according to a Macroeconomic Advisers estimate reported by the Wall Street Journal. Unlike other parts of the fiscal-cliff package that lower spending on specific programs or raise taxes on specific groups, it’s the one item most consumers will see directly affecting them in the form of smaller take-home pay.

Many bank economists believe this one item is likely to whack the country's gross domestic product by about 0.6 percent next year, and they are shocked Washington is taking the expiration of the payroll-tax cut in stride.

“We are surprised that neither party has seriously challenged the case for near-term fiscal retrenchment. In particular, the expiration of the $126 [billion] payroll tax cut (1% of disposable income) is almost universally accepted,” Goldman Sachs chief economist Jan Hatzius wrote in a note to clients in October. He added that the move didn’t make sense at a time investors were lending money to the government at a negative real interest rate.

“While we agree that the US government will ultimately need to tighten its belt, a big move in a restrictive direction still looks decidedly premature to us,” Hatzius wrote.

Similarly, Michael Feroli at JPMorgan Chase Bank NA wrote in a note to clients the same month (available via Slate) that the expiration of the payroll-tax cut -- an event that would “reduce household disposable income by around $125 billion next year” -- had a difficult-to-explain cause. Feroli, who previously believed politicians would work an extension of the cut into any

compromise agenda, changed his view, explaining his shift “wasn’t because of something that happened, but rather what didn’t happen: no one in the political establishment came forward to push an extension of this tax break.”

Feroli, who contended the effect from this tax hike will be felt nearly immediately in 2013, said it is possible that just this policy shift is enough to put the U.S. into recession during the first quarter of next year.

Indeed, there is already some evidence the public’s view of the fiscal cliff -- likely to get even darker once the sticker shock of a tinier paycheck is made manifest -- is affecting holiday shopping.

The nation’s most widely followed indicator of consumer confidence, the Thomson-Reuters/University of Michigan consumer sentiment index, was down in December to its lowest level since July, the Wall Street Journal reported Friday.

And the latest National Federation of Independent Business index of small business optimism is similarly pessimistic, the Washington Post reported recently.

Greg McBride of the financial-information portal Bankrate.com in North Palm Beach, Fla., said a survey conducted by the site indicates one in three consumers has "cut back on their spending within the last 30 days specifically due to concerns about the fiscal cliff," according to ABC News Radio via KMBZ. "That's not good news regardless of whether or not it's holiday shopping season," McBride said.

"If that 33 percent each spend 10 percent less and the others spend the same, consumption goes down by 3.3 percent," Robert Barone, an economist and portfolio manager at Universal Value Advisors in Reno, Nev., told Bankrate.com.

One thing seems clear: No matter what happens in Washington in the next couple of weeks, John Lieberman, a certified public accountant at Perelson Weiner LLP in New York, told CNNMoney.com, "People will spend less, and it will affect the economy.”

'Fiscal Cliff' Hangs Over Consumer Spending

The economic benefits of the holiday spending season could be compromised by the threat of looming tax increases and spending cuts known as the "fiscal cliff." Though most consumers say they are not limiting their spending due to these concerns, a third of Americans, 33%, have cut back on personal spending as a result of the budget showdown in Washington, D.C., according to Bankrate's December Financial Security Index. This month, the index dropped to 95.6, the lowest of 2012.

"If that 33% each spend 10% less and the others spend the same, consumption goes down by 3.3%," says Robert Barone, Ph.D., an economist and portfolio manager at Universal Value Advisors in Reno, Nev.

"The fiscal cliff can't be making it better. Consumer confidence took a horrible plunge in November -- but I can't tell whether this was due to Republicans losing confidence because

(former Massachusetts Gov. Mitt) Romney lost or because of the looming fiscal cliff. Probably some of both," he says.

The survey respondents who did say that they have cut back on spending were much more likely to be Republican or Independent voters, at 42% and 38%, respectively, compared to 24% of Democrats.

Consumers earning less than $30,000 per year were more likely to say they have curtailed spending, at 43%, than the highest earning cohort. Only 25% of those earning $75,000 or more say they are spending less due to fiscal cliff concerns.

If Americans truly are spending less, it could be reflected in the gross domestic product, an indicator of how fast -- or slow -- the economy grows.

"Consumer spending is two-thirds of the economy. It's a big driver," says Jeff Nauta, CFA, CFP professional and principal at Henrickson Nauta Wealth Advisors in Belmont, Mich.

Battering the almighty consumer

The fiscal showdown comes at an inopportune time of year. Retailers typically rake in the majority of their profits in the fourth quarter. In addition, Superstorm Sandy has diverted discretionary spending dollars to repairs of storm-damaged homes rather than gifts or dining out.

With several events conspiring to undermine consumer spending, teasing out the specific influences is complicated, according to Chris Christopher, a senior principal economist and director of U.S. and global consumer markets with IHS Global Insight, a global market information and analytics company.

Though most consumers ignored the tax and spending showdown all year, fiscal cliff fears may have started to drag on consumer confidence right after the election.

"You sort of notice, especially with the University of Michigan Consumer Sentiment Index, that (confidence) was climbing up to the presidential election. And then after the presidential election, it took a hit. The politicians were talking about the fiscal cliff almost the day after the election," Christopher says.

"Our analysis of Black Friday and online sales looks pretty robust. However, we do think that getting into the month of December that consumer spending won't be as strong as it would be otherwise if the fiscal cliff issues weren't around. People are not going to cut back completely, but they're going to be a little cautious. One, because confidence is lower, but two, they're a little worried that maybe coming into the new year, they'll be paying higher taxes," he says.

Nauta says taxes have been the main focus of his clients with regard to the fiscal cliff.

"If taxes are going up, consumers are going to spend less," he says.

As resilient as consumers have been this year, tying up the loose fiscal ends in a neat bow before the end of the year would soothe economic fears -- at least until the next crisis. Congress doesn't have to put it under a tree, but resolving the problems would be a nice year-end present for everyone.

12/19/2012

The economic benefits of the holiday spending season could be compromised by the threat of looming tax increases and spending cuts known as the "fiscal cliff." Though most consumers say they are not limiting their spending due to these concerns, a third of Americans, 33 percent, have cut back on personal spending as a result of the budget showdown in Washington, D.C., according to Bankrate's December Financial Security Index. This month, the index dropped to 95.6, the lowest of 2012. "If that 33 percent each spend 10 percent less and the others spend the same, consumption goes down by 3.3 percent," says Robert Barone, Ph.D., an economist and portfolio manager at Universal Value Advisors in Reno, Nev.

"The fiscal cliff can't be making it better. Consumer confidence took a horrible plunge in November -- but I can't tell whether this was due to Republicans losing confidence because (former Massachusetts Gov. Mitt) Romney lost or because of the looming fiscal cliff. Probably some of both," he says.

The survey respondents who did say that they have cut back on spending were much more likely to be Republican or Independent voters, at 42 percent and 38 percent, respectively, compared to 24 percent of Democrats.

Consumers earning less than $30,000 per year were more likely to say they have curtailed spending, at 43 percent, than the highest earning cohort. Only 25 percent of those earning $75,000 or more say they are spending less due to fiscal cliff concerns.

If Americans truly are spending less, it could be reflected in the gross domestic product, an indicator of how fast -- or slow -- the economy grows.

"Consumer spending is two-thirds of the economy. It's a big driver," says Jeff Nauta, CFA, CFP professional and principal at Henrickson Nauta Wealth Advisors in Belmont, Mich.

Battering the almighty consumer

The fiscal showdown comes at an inopportune time of year. Retailers typically rake in the majority of their profits in the fourth quarter. In addition, Superstorm Sandy has diverted discretionary spending dollars to repairs of storm-damaged homes rather than gifts or dining out.

With several events conspiring to undermine consumer spending, teasing out the specific influences is complicated, according to Chris Christopher, a senior principal economist and director of U.S. and global consumer markets with IHS Global Insight, a global market information and analytics company.

Though most consumers ignored the tax and spending showdown all year, fiscal cliff fears may have started to drag on consumer confidence right after the election.

"You sort of notice, especially with the University of Michigan Consumer Sentiment Index, that (confidence) was climbing up to the presidential election. And then after the presidential election, it took a hit. The politicians were talking about the fiscal cliff almost the day after the election," Christopher says.

"Our analysis of Black Friday and online sales looks pretty robust. However, we do think that getting into the month of December that consumer spending won't be as strong as it would be otherwise if the fiscal cliff issues weren't around. People are not going to cut back completely, but they're going to be a little cautious. One, because confidence is lower, but two, they're a little worried that maybe coming into the new year, they'll be paying higher taxes," he says.

Nauta says taxes have been the main focus of his clients with regard to the fiscal cliff.

"If taxes are going up, consumers are going to spend less," he says.

As resilient as consumers have been this year, tying up the loose fiscal ends in a neat bow before the end of the year would soothe economic fears -- at least until the next crisis. Congress doesn't have to put it under a tree, but resolving the problems would be a nice year-end present for everyone.

As soon as Robert Barone heard rumors that money market funds were in trouble back in 2008, the financial advisor switched his clients’ assets out of prime money market funds and into government-backed money market funds. Fast forward to 2012, financial advisors may want to examine money market fund assets before investing or transferring, given proposed regulatory reforms that, among other things, would allow the net asset values of money market funds to float based on their portfolio values rather than be guaranteed at $1. “We didn’t want any of our clients’ money in European banks, which is why we switched to money market funds guaranteed by the U.S. government. As a result, my clients haven’t lost any money,” said Barone. “If prices float, financial advisors will make decisions on the quality of the paper of money market funds.” The reforms have come, in large part, as a response to events on September 16, 2008. That day America’s oldest money-market mutual fund, Reserve Primary Fund, broke the buck when its shares fell to 97 cents after writing off debt issued by Lehman Brothers, which had declared bankruptcy the day before. Panicked investors subsequently redeemed their holdings en masse. “The Fed ended up saving money market mutual funds by making so much liquidity available that risky assets were all able to find the cash to pay,” said Barone, who currently has up to $20 million of his $90 million in assets under management invested in government-backed money market funds. Barone refers to the optional guarantee backed by the Treasury Department’s Exchange Stabilization Fund announced on Friday September 19, 2008, which promised that if a covered fund broke the buck, it would be restored to $1 NAV. The insurance stabilized the system and put a stop to outflows. Since then, a new regulatory agency called the Financial Stability Oversight Council (FSOC) has proposed money market fund reforms that the SEC is being asked to implement. According to the U.S. Treasury Department, FSOC’s proposed reforms include:

• Funds floating their net asset value to reflect actual market value rather than maintaining it at $1 per share.

• Funds maintaining 1 percent of assets as a NAV buffer to absorb day-to-day fluctuations in value. A small amount of a shareholder’s investment would be subject to a delayed redemption and could be lost if the fund suffered losses over the NAV buffer.

• Funds maintaining 3 percent of assets as a buffer to increase their resiliency. The FSOC is holding a comment period on the reforms that ends January 18. After the comment period closes, FSOC will make a final recommendation to the SEC, which will then have 90 days to implement it or explain in writing why it is not. “The SEC, by virtue of its institutional expertise and statutory authority, is best positioned to implement reforms to address the risks that MMFs present to the economy,” said Treasury Secretary Timothy Geithner in a prepared statement. Geithner added that FSOC’s proposal should take into account the concern expressed that reform of money market funds may result in outflows from them to less-regulated parts of the cash-management industry. “Our objective should be to propose reforms to MMFs that protect their stability, without creating a competitive advantage for unregulated cash-management products,” he said. The SEC declined to elaborate on why its chief Mary Schapiro withdrew a similar proposal for reform in August. “While we pursue this path, the council and its members should, in parallel, take active steps in the event the SEC is unwilling to act in a timely and effective manner,” said Geithner in September. In other words, FSOC isn’t taking no for an answer and will be prepared to wage its authority as granted under title I of the Dodd-Frank act. Meanwhile, the ICI issued a press release explaining its displeasure with the proposed fixes. “We are disappointed by the proposals featured in the FSOC’s release, which forces money market funds to float their value, capital requirements and daily redemption holdbacks,” said ICI President and CEO Paul Schott Stevens. “If implemented, they will increase risks to the financial system by concentrating assets in a few large institutions or drive assets into alternative products that are far less regulated and transparent than money market funds.” Barone said if the proposals are implemented, money market funds will have to invest in less risky assets producing lower returns or introduce some sort of capital or parent-company guarantee, leaving less for investors. “Smaller MMFs lacking capital will either close or be merged into larger funds, resulting in less competition and no need to pay out as much,” he said. Charles Schwab has stepped up with a proposal to apply the reforms to prime money market funds that invest in corporate, government and international securities rather than funds that invest only in state and federal government notes. Barone says floating rates and higher capital among prime money market funds will bring market discipline to bear, allowing investors to choose how much risk they want to tolerate for the return. “The new rules should mitigate the moral hazard issue of taxpayers coming to the rescue,” said Barone.

Local Economist: Unemployment Numbers Don't Tell Full Story

Nov 14, 2012

Right now, the national unemployment rate stands at 7.9% and we've seen 32 straight months of

job growth. However, those numbers don't tell the full story.

The following chart provided by Zero Hedge, shows how many jobs have been created and

breaks down job growth and job loss by age groups.

Change in Employment from July '09 to September '12

Total Job Growth: 3 million

Change in Number of Part-Time Jobs: 4 million

Job Growth by Age Group:

16-19 -500,000

20-24 +730,000

25-54 -730,000

55+ +3.5 million

As you can see, 3.5 million jobs were added for those 55 and older. The majority of those are

part-time jobs. I asked Dr. Robert Barone, a local economist for Universal Value Advisors why

that is.

"We have huge impediments to employment in this country,"said Barone. "Full-time

employment means you have to give them healthcare, now Obamacare taxes are coming and

then you have to have retirement benefits for them. If you have part-time people, you can have

lower wages and you don't have to provide those benefits. That's what all the big companies are

doing."

That's hurting people between the ages of 25 to 54. They have lost 730,000 jobs since July 2009.

Dr. Barone said it's simple, they cost employers too much to hire.

"The first thing that has to be done is it has to be recognized as the issue. What we have as the

big issue now is the fiscal cliff and it's a big danger, but solving the fiscal cliff doesn't solve the

underlying issue of employment."

To watch my entire interview with Dr. Robert Barone, tune into Face the State Saturday at

4:30am and 4:30pm. It also airs Sunday at 6:30am.

Low yields on Treasuries, even for Treasury inflation-protected securities, or TIPS, aren't fading anytime soon.

In September, the Federal Reserve extended the period during which it will keep short-term interest rates near 0% through mid-2015 to spur economic growth. The Fed also plans to keep inflation, which feeds higher interest rates, at just 2% per year.

These pledges should be easy to keep, says Robert Barone, economist and portfolio manager at Reno, Nev.-based Universal Value Advisors. The U.S. is in a deflationary time because the economy is struggling. Consumer prices are mostly falling -- the opposite of inflation, he says.

The result is that bond prices are at historic lows, and it's improbable that interest rates will rise, with inflation a long way off from returning, Barone says. With that backdrop, here is what it will mean for one type of investment -- Treasury inflation-protected securities.

TIPS and inflation

As their name says, TIPS are meant to act as a counterweight to inflation. You can buy them directly at auctions or through mutual funds.

These are bonds backed by the U.S. government that are pegged to a key inflation barometer -- the U.S. Consumer Price Index. It measures the cost of a basket of goods and services.

As the index falls or rises, so does the face value, or principal, of TIPS. TIPS also pay a fixed rate of interest, or coupon rate, every six months. When inflation rises, TIPS gain in value as their principal readjusts upward.

Even if inflation does heat up, TIPS are currently overvalued, says Marilyn Cohen, co-author of "Surviving the Bond Bear Market: Bondland's Nuclear Winter." "People have been pouring money into them," she says.

There's a reason they may be overvalued. These days, the Treasury Department is auctioning TIPS at negative yields. For example, five-year TIPS maturing in 2017 were sold recently at such yields. A negative yield occurs when the TIPS "real" yield -- the coupon rate minus the current annual rate of inflation -- is below zero. Without inflation, the investor will receive a smaller amount paid out than was originally invested.

That's a good reason to avoid TIPS at shorter maturities, Cohen says: "You won't make any money."

TIPS may not be the inflation cure-all that investors think they are anyway. "They're not good inflation hedges," says David Houle, portfolio manager at Colorado-based Season Investments. "People think that you'll get a positive return on TIPS if inflation heats up."

In fact, the inflation component only adds a small return, he says. If held to maturity, TIPS holders receive the face value of the bond plus interest, even if inflation doesn't rise.

"Huge spikes in inflation could help you make good money, but usually buying a TIP and holding it for 10 years only translates into returns similar to regular Treasuries," Houle says. The result is a small yield that may equal that of a traditional Treasury bond. And deflation, the opposite of inflation, can dampen returns even more.

Cohen says selling TIPS before they mature also could land you in negative territory even if interest rates do rise. Why? Despite their inflation kicker, TIPS are still essentially Treasury bonds. So, as interest rates rise, prices may fall.

That's why stocks and real estate are the ultimate hedges over time, says Rick Ashburn, a chief investment officer at Creekside Partners in Lafayette, Calif. "When buying TIPS, you must first accept negative real yields, and that's not all. TIPS gains and yields are taxed every year, even though payouts are at maturity," he says.

On the upside, TIPS suit investors hungering for some liquidity, says Greg McBride, CFA, senior financial analyst at Bankrate.com. "(But) at best, you're lucky to preserve your buying power," McBride says.

For consumers and investors, this was not a life-changing meeting of the Federal Reserve's policymaking group. Interest rates will remain painfully low for savers, while borrowers who qualify will find the mortgage rates of a lifetime. Credit card rates will remain low, as will car loan rates.

The federal funds rate, the benchmark interest rate controlled by the Fed, will remain targeted between zero percent and 0.25 percent until mid-2015, and the central bank will continue with Operation Twist through the end of the year.

And the policymaking Federal Open Market Committee will stick with the plan announced at the last meeting: a third round of bond buying, known as QE3, which will funnel $40 billion a month into mortgage-backed securities.

Operation Twist is the maturity extension program in which short-dated securities already owned by the Fed are swapped out for longer-term investments to push down long-term interest rates.

Throw in a presidential election just 13 days away, and it's easy to see why the monetary policy committee decided to keep a low profile this week. Even if there were significant moves to be made, "The election is right around the corner, and they don't want to be perceived as being political," says Robert Barone, Ph.D., partner, economist and portfolio manager at Universal Value Advisors in Reno, Nev.

With all of these influences coming to bear, the committee appeared to be restrained at this meeting. But the Fed is far from inactive, according to the statement released following the meeting.

The combined effect of the central bank's actions "will increase the Committee's holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative," the statement read.

The arguable impact of QE

Interest rates are the main lever of monetary policy, and that switch has been in the off position since December 2008, when the federal funds rate was dropped close to zero percent.

"Typically, monetary policy is adjusting rates and adding or reducing the money supply over each period. We're not operating like that today; we're operating by these massive acquisitions

of securities," says Ernie Patrikis, banking partner at the law firm White & Case in New York, formerly general counsel to the New York Federal Reserve.

In September, the Federal Reserve announced a third round of securities purchases. Unlike the first two rounds of quantitative easing, QE3 is open-ended and focused only on the housing market.

The announcement of QE3 had a nearly instantaneous effect on mortgage rates. The day before the September Fed meeting, the average 30-year fixed-rate mortgage was 3.81 percent, according to Bankrate's data. After that, rates fell nearly a quarter of a percentage point. But that's just mortgage rates; the full impact of QE3 will take time to move through the economy.

"The whole rationale behind QE1, 2 and 3 has been and continues to be to stimulate job growth, credit availability, to stimulate housing and stimulate risky markets such as the stock markets and other markets -- commodities, for example," says Werner Bonadurer, clinical professor of finance at the W.P. Carey School of Business at Arizona State University.

"The hope is that it will lead to a higher level of consumer confidence, and that will lead to consumption going up. And if consumption goes up, credit becomes more available," Bonadurer says. "That should trickle through and stimulate the whole economy."

Wait and see

Though the economy has shown some signs of improvement, many economic indicators still point in the wrong direction.

There has been a "reduction in the level of capital expenditures by companies, a slate of recent weak corporate-earnings announcements, there is some industrial production going down, exports are going down, so it is a very mixed picture," Bonadurer says.

The FOMC seems to agree with that assessment. In the statement released following the meeting, economic improvements were noted but tempered with caveats.

"Growth in employment has been slow, and the unemployment rate remains elevated. Household spending has advanced a bit more quickly, but growth in business fixed investment has slowed. The housing sector has shown some further signs of improvement, albeit from a depressed level," the statement read.

With no significant changes, positive or otherwise, since the last meeting and only a question mark looming in the future, this week's meeting was a wash.

The committee members "shouldn't have even come to Washington for the meeting. They could have done it all on the telephone," Patrikis says.

The Federal Reserve's latest declaration to keep interest rates shockingly low until 2015 has not galvanized the populace into borrowing truckloads of money. In fact, most consumers say the Fed's announcement does little to make them more inclined to borrow money, according to Bankrate's October Financial Security Index.

Just 23 percent of consumers say they are tempted to take on more debt, but 74 percent say "no thanks" to low-rate borrowing right now, Bankrate's survey reveals.

At the Sept. 13 meeting of the Federal Open Market Committee, the Federal Reserve's monetary policy group, it was announced that the federal funds rate -- the very short-term interest rate controlled by the Fed -- will remain close to zero percent for a year longer than the group previously thought.

Though one of the stated aims of the central bank's policy is to stimulate economic activity through consumer spending and borrowing, economic theory posits that the announcement may have the opposite consequence in the short term, according to Bill Hampel, senior vice president of research and policy analysis and chief economist at the Credit Union National Association.

"If anything, the effect of the announcement itself would be to reduce borrowing today," he says. "Some people may want to borrow now because credit is so cheap, but you've just told them you don't need to rush out and borrow now because it is going to be cheap next quarter, next year, the year after that and the year after that."

Even in normal times, though, consumer loan demand is rarely moved by interest rates, says Hampel.

What affects consumer borrowing

Though consumers do shop by price when they need a loan, a squishier metric is actually more influential when it comes to deciding whether to take on more debt: consumer confidence.

"If people were comfortable that they would be able to find jobs or keep their jobs, then, even if rates were a little bit higher, they would be willing to borrow more and spend. But that is not

the situation," says Brian Rehling, managing director and chief fixed-income strategist at Wells Fargo Advisors.

Uncertainty about everything from the recession in Europe, the presidential election and the looming fiscal cliff is limiting consumer confidence -- as is the still-high unemployment rate, currently 7.8 percent, according to the Bureau of Labor Statistics.

All of that might be bearable if household incomes were moving up. But they aren't.

"Median income continued to fall even after the recession ended," says Robert Barone, economist, portfolio manager and partner at Universal Value Advisors in Reno, Nev.

Data from the Census Bureau released in mid-September show that real median household income in 2011 was $50,054, down 8.1 percent from 2007, the year before the recession began. Real income reflects the erosive effects of inflation.

"In today's environment, it's upside down: Incomes are falling. So, when incomes are falling, people worry, 'How am I going to pay it back if I borrow?' no matter what the interest rate is," Barone says.

No shortage of debt

While more consumer spending would boost economic activity, consumers are still recovering from previous spending binges.

The most recent numbers from the Federal Reserve showed that total household debt is at 103 percent of disposable income.

Hampel says that number represents total debt in the household sector -- both mortgage and nonmortgage debt combined. "It peaked at the beginning of the financial crisis at 123 percent. Normal, back 10 to 15 years ago, was somewhere south of 80 percent," he says.

So what do low interest rates do?

In normal times, low interest rates might nudge consumers to borrow money, but the Federal Reserve intends to stimulate the economy by helping homeowners refinance their existing mortgages.

The most recent actions by the central bank -- the announcement of the third round of quantitative easing, or QE3 -- pushed mortgage rates to new lows. If many people can refinance their mortgages, that will free up some household income that can then be spent or invested.

"That is sort of how the Fed policy of keeping rates low will stimulate the economy: by increasing the disposable income of households through refinancing. And also by keeping interest rates low, it will make it easier for households to buy new houses, which will stimulate the construction sector slightly," says Hampel.

But refinancing isn't taking on new debt; it's just repackaging debt that's already on the books, so to speak. The real rush to borrow money may only come just before the sale ends, about three years from now.

The Federal Reserve's latest declaration to keep interest rates shockingly low until 2015 has not galvanized the populace into borrowing truckloads of money. In fact, most consumers say the Fed's announcement does little to make them more inclined to borrow money, according to Bankrate's October Financial Security Index.

Just 23% of consumers say they are tempted to take on more debt, but 74% say "no thanks" to low-rate borrowing right now, Bankrate's survey reveals.

At the Sept. 13 meeting of the Federal Open Market Committee, the Federal Reserve's monetary policy group, it was announced that the federal funds rate -- the very short-term interest rate controlled by the Fed -- will remain close to 0% for a year longer than the group previously thought.

Though one of the stated aims of the central bank's policy is to stimulate economic activity through consumer spending and borrowing, economic theory posits that the announcement may have the opposite consequence in the short term, according to Bill Hampel, senior vice

president of research and policy analysis and chief economist at the Credit Union National Association.

"If anything, the effect of the announcement itself would be to reduce borrowing today," he says. "Some people may want to borrow now because credit is so cheap, but you've just told them you don't need to rush out and borrow now because it is going to be cheap next quarter, next year, the year after that and the year after that."

Even in normal times, though, consumer loan demand is rarely moved by interest rates, says Hampel.

What affects consumer borrowing

Though consumers do shop by price when they need a loan, a squishier metric is actually more influential when it comes to deciding whether to take on more debt: consumer confidence.

"If people were comfortable that they would be able to find jobs or keep their jobs, then, even if rates were a little bit higher, they would be willing to borrow more and spend. But that is not the situation," says Brian Rehling, managing director and chief fixed-income strategist at Wells Fargo Advisors.

Uncertainty about everything from the recession in Europe, the presidential election and the looming fiscal cliff is limiting consumer confidence -- as is the still-high unemployment rate, currently 7.8%, according to the Bureau of Labor Statistics.

All of that might be bearable if household incomes were moving up. But they aren't.

"Median income continued to fall even after the recession ended," says Robert Barone, economist, portfolio manager and partner at Universal Value Advisors in Reno, Nev.

Data from the Census Bureau released in mid-September show that real median household income in 2011 was $50,054, down 8.1% from 2007, the year before the recession began. Real income reflects the erosive effects of inflation.

"In today's environment, it's upside down: Incomes are falling. So, when incomes are falling, people worry, 'How am I going to pay it back if I borrow?' no matter what the interest rate is," Barone says.

No shortage of debt

While more consumer spending would boost economic activity, consumers are still recovering from previous spending binges.

The most recent numbers from the Federal Reserve showed that total household debt is at 103% of disposable income.

Hampel says that number represents total debt in the household sector -- both mortgage and nonmortgage debt combined. "It peaked at the beginning of the financial crisis at 123%. Normal, back 10 to 15 years ago, was somewhere south of 80%," he says.

So what do low interest rates do?

In normal times, low interest rates might nudge consumers to borrow money, but the Federal Reserve intends to stimulate the economy by helping homeowners refinance their existing mortgages.

The most recent actions by the central bank -- the announcement of the third round of quantitative easing, or QE3 -- pushed mortgage rates to new lows. If many people can refinance their mortgages, that will free up some household income that can then be spent or invested.

"That is sort of how the Fed policy of keeping rates low will stimulate the economy: by increasing the disposable income of households through refinancing. And also by keeping interest rates low, it will make it easier for households to buy new houses, which will stimulate the construction sector slightly," says Hampel.

But refinancing isn't taking on new debt; it's just repackaging debt that's already on the books, so to speak. The real rush to borrow money may only come just before the sale ends, about three years from now.

The Minnesota monthly jobs report comes out Thursday morning and if we judge by recent

headlines it should be a positive one. Don't put any money on that, though.

Two national stories in the past two weeks have cheered up the economic outlook. Retail sales

grew 1.1 percent in September and national unemployment fell below 8 percent for the first time

since 2009.

But Minnesota is coming off net job losses in August. Employers cut 2,000 positions, and the

state's robust estimate for job creation in July was revised downward -- from 6,800 to 4,800 net

jobs.

As the September numbers for the state come out this week, what should we expect? Here are

four things worth remembering:

1. Strong retail sales appear to signal the jobs numbers should improve. Because more than

two thirds of the American economy is driven by consumer spending, the 1.1 percent increase in

retail sales prompted a 128-point rally in the stock market on Tuesday. Minneapolis-based

Target's retail sales were up 2.1 percent in September and a survey of large retailers showed 3.9

percent growth in the lull between back-to-school spending and the Christmas season.

There are two caveats: First, retail sales were partly driven upward by sales of the iPhone 5,

which was released on Sept. 21. Apple always tends to boost monthly retail sales when it

releases new models. Second, Jeffrey Bartash, writing for Marketwatch, argues that the rise in

retail sales in part reflects the rising costs of gasoline and groceries:

So bravo for Apple and iPhone lovers. Yet the bulk of the increase in retail spending in

September occurred in other segments, mainly auto dealers, gas stations and grocery

stores. These categories accounted for more than 58% of the increase in spending last month,

compared to a combined 22% gain for nonstore and electronics retailers. Spending on gas and

food, moreover, reflected the high price of fuel in September as well as the rising cost of

groceries. These are not positive developments for consumers or the economy overall. When

Americans have to spend more on basic necessities, they have less cash for other goods and

services.

2. The recent trend for manufacturing does not bode well. U.S. manufacturers shed 16,000

jobs in September, and in Minnesota, manufacturers cut 2,700 jobs in August. The Mid-America

Business Conditions index predicted flat to negative growth in the Midwest for the fourth

quarter, and Minnesota was one of the weakest states in the index in September, according to

Creighton professor Ernie Goss:

For a third straight month, the Minnesota Business Conditions Index slumped below growth

neutral. The index, based on a survey of supply managers in the state, decreased to 47.2 from

49.7 in August. This is the first time since the recession that the overall index has been below

50.0 for three straight months.

3. There are some reasons to take the drop in unemployment to 7.8 percent with a grain of

salt. Not that anyone manipulated the numbers, as a loud minority has claimed, but just that the

Bureau of Labor Statistics has some built-in volatility in the household survey on which the

unemployment rate is based. Try to ignore the headline on this piece, and you'll find some

reasonable skepticism about the drop in joblessness from Forbes contributor Robert Barone:

...the economy would need to be growing at breakneck speed for unemployment to drop from

8.3% to 7.8% over two months. While this is quite different from the “manipulation” charge, it

does make sense. The fact is, almost all other underlying data point to weaker, not stronger jobs

numbers. New part-time jobs dominated the Household Survey data in September. Goods

producing jobs actually fell.

4. The state monthly reports are even more volatile than the national reports, and probably

don't paint a bright enough picture of the state job market. The more solid employment

number in the state comes from a quarterly census of employers. That number indicates the state

may have created 18,000 more jobs in the early part of the year than the monthly figures have

shown, but because it is a more rigorous analysis, the census figures only come out four times a

year and lag by about five months. Wisconsin Gov. Scott Walker got into trouble in his state for

arguing this same point and releasing the census figures early, just before his recall election. The

second quarter census figures for Minnesota should come out in late November. But the larger

point is that the monthly figures are based on a more limited survey, extrapolated based on the

census, and then benchmarked back to it. If the census for the first quarter shows a better jobs

picture than the monthly reports from the first quarter, the picture is probably better.

When the September employment data were released by the Bureau of Labor Statistics (BLS), depending on political persuasion, the news was either excellent or it was a sham. We saw reactions like those former General Electric CEO Jack Welch, who tweeted a suggestion of manipulation. On the other hand, the Obama administration has made political hay with the rapid fall in the unemployment rate in August and September.

Every month the BLS takes two surveys relative to employment, the Household Survey (officially

titled The Current Population Survey), and the Establishment Survey (The Current Employment Statistics Survey). Both surveys have acknowledged flaws and both have a significant bias that pushes the number of jobs upward and the unemployment rate lower. To correctly interpret the data, one must understand how the statistics are calculated, how the biases are imparted, and the magnitude of those biases.

The Household Survey is used to calculate the various employment and unemployment indexes and rates. There are several of these indexes. Most of the public only hears about one of them, the one the BLS refers to as U-3 (7.80% seasonally adjusted (SA) for September). The public may be vaguely aware of one other one, the U-6. The numbers are produced from a monthly survey of 60,000 households. Here are some of the flaws:

Because the sample of households is small relative to the total number of households, the series is notoriously volatile. In August, for example, the raw data (Not Seasonally Adjusted (NSA)) showed the number of jobs fell by 568,000. In September, that same number showed an increase of 775,000 jobs (NSA). The BLS reported this as 873,000 SA which is the number that the media got all excited about. Using the NSA data, over the two months, 207,000 jobs were created, or 103,500 per month on average. This leads to a very different conclusion from a single 873,000 data point.

In 1994, the BLS changed the way in which it counts “discouraged” workers for the U-3 index. If one is unemployed for more than 52 weeks, even if one continues to look for employment, one is dropped from the labor force. A smaller denominator with the same number employed leads to a higher employment rate and a lower unemployment rate. Ask yourself how much sense this makes in today’s world where the average unemployment duration is 40 weeks and there have been several years where unemployment benefits last for 99 weeks.

The definition of employment is biased. If one worked part-time in the last 30 days, even baby sitting for a few hours one time, one is counted as employed. There is no weighting for part-time work in the U-3 index.

The biggest issue with the Household Survey is the seasonal adjustment (SA) process itself. Theoretically, for the year as a whole, the changes in employment by month should add up to the same number, i.e., the monthly SA and NSA changes should each add up to the same amount. And, theoretically, the SA should be calculated once at the beginning of the year. But, for the last few years, the BLS has adopted what they call a “Concurrent” SA process in which they recalculate the seasonal factors every month. The practical result of this method is that every month, all of the 12 seasonal factors change, which means that all of the year to date monthly SA data also changes. As a result, by December, the January number has changed 11 times, the February number 10 times, the March number 9 times, etc. Here’s the rub. The BLS will not publish the changed monthly data on the grounds that they don’t want to “confuse” the data users. Because they do this, the monthly change in the unemployment rate is not meaningful because the number it is being compared to has changed, but the BLS won’t tell us what it has changed to. The September 7.8% SA unemployment rate (U-3) as reported in early October is being compared to August’s 8.1% SA rate (reported in early September) despite the fact that August’s unemployment rate has likely changed due to the calculation of new seasonal factors. The BLS knows what the changed August number is, but they won’t publish it until January, 2013.

All in all, the U-3 unemployment number is deeply flawed and should not be relied on as the business media and even the capital markets do. A better (though still flawed) indicator of labor market conditions is the U-6 measure. For both August and September, U-6 showed an unemployment rate of 14.7%. Unlike U-3, U-6 adds back to both the labor force and to the unemployed “discouraged’ and “marginally attached” workers, i.e., those who have stopped looking for work but still want a job, and accounts for part-time workers who want full time employment. The flaw is that U-6 removes the long-term discouraged worker after 52 weeks of unemployment. Nevertheless, it is still a much better indicator than U-3. John Williams estimates that if U-6 counted the long-term discouraged workers, the unemployment rate would be 22.8%.

The Establishment Survey collects data from more than 141,000 businesses and government agencies. The sample is about one-third of all nonfarm payroll employees in the U.S., and, as such, it is much less volatile than the Household Survey. Normally, the business media concentrates on this survey. This survey suffers from the same seasonal adjustment issues as the Household Survey except that BLS reports the current number (141,000 SA for September) and the revised data from the immediate past two months. It does not report the changes from earlier months, so it is possible that jobs reported in the current month were “borrowed” from earlier months, which aren’t reported until the next January. In fact, Mr. Williams contends that this is precisely what happens in the second half of each year.

Besides the transparency issue in the SA process (which can lead some to the manipulation conclusion) which the BLS could easily remedy simply by publishing the changed data on a monthly basis, the

Establishment Survey suffers from a significant upward bias, known as the Birth-Death model. In the 80s, the BLS was constantly embarrassed that it was under reporting the number of jobs in the Establishment Survey by approximately 50,000 jobs per month. That occurred because more small businesses were being established than were being closed. And, one could probably argue that this was also true in the 90s during the tech boom. As a result, BLS adds approximately 50,000 jobs per month to the Establishment Survey report. That seems inappropriate in today’s world.

From all of this, it is clear that the U-6 measure is a lot more reliable than the U-3, the one that is most widely reported. In addition, when dealing with the Establishment Survey, be wary of the 50,000 jobs bias.

When I began work on this paper in early October, I was skeptical that there could be actual manipulation of the data. Mr. Williams has documented at least three cases of manipulation which he says have been confirmed by employees or former employees going all the way back to the 1960s. That is not a lot. Yet, one must worry about the lack of transparency in BLS’s reporting. After all, for the years 2010 and 2011 for which we have final numbers released in January of the following year, there were much lower levels of job creation than originally reported. Unfortunately, the media pays no attention to such revisions, and the bias goes unnoticed.

In an October 9 Wall Street Journal op-ed, Jack Welch defended his tweet, indicating that the economy would need to be growing at breakneck speed for unemployment to drop from 8.3% to 7.8% over two months. While this is quite different from the “manipulation” charge, it does make sense. The fact is, almost all other underlying data point to weaker, not stronger jobs numbers. New part-time jobs dominated the Household Survey data in September. Goods producing jobs actually fell. The National Federation of Independent Businesses index of employment softened in September as did Monster’s employment index. All of this seems to be in direct conflict with a SA increase of 873,000 jobs in September (Household Survey), the largest increase since 1983. The data also show that in August and September, governments added 602,000 new employees. Anyone following state and local government finances knows that number has to be far from accurate.

While there is no direct proof of manipulation, there are a lot of sound reasons, based on flawed methodologies, and based on nearly every other underlying employment data series, not to trust the headline making unemployment data.

SAN FRANCISCO (MarketWatch) — U.S. investors will be looking for a possible bailout request from Spain and U.S. housing data to set the trading tone in the coming week, as they watch out for any corporate guidance ahead of the so-called quarterly earnings season in mid-October.

The market will also get updates on GDP and consumer sentiment, as well as quarterly earnings results from home-builder Lennar Corp. and footwear and apparel retailer Nike Inc.

“Many investors and traders are wondering if the market has enough catalysts to push higher, or if we have run our course,” said Robert Fuest, head of investment research at Landor & Fuest Capital Managers.

Among potential euro-zone developments, investors will keep an eye on Spain as speculation grows over whether the country may be setting the stage for a bailout request.

Spain may formally ask the European Central Bank for assistance within the next couple of weeks, “and that much-needed request already has been baked into the current [European Union] bourses, as well as a major contributor to Spain’s dip in bond yields,” said David Brown, chief market strategist at Sabrient Systems.

“However, should there be a bump in the road between Madrid and the ECB, markets on both sides of the Atlantic would be spooked,” he added. “The same holds true for the ECB. If [ECB Chief Mario] Draghi is unable to implement his proposed bond-purchase program, the markets will respond in a sharply negative fashion.”

Fed drive

Following a Federal Reserve-inspired rally earlier this month that lifted benchmark stock indexes to multiyear highs, equities ended little changed for the week.

“The equity markets are torn between the very powerful force of the Fed’s ‘QEnifinty’ program, which is going to create new money at a minimum rate of $40 billion per month, and the rapidly decelerating world’s industrial economies,” said Robert Barone, a portfolio manager and partner at Universal Value Advisors in Reno, Nev.

Robert Barone, Universal Value Advisors

“After more than three years of money creation programs and 0% interest rates, the world’s economies continue to sputter,” he commented. “The new QE programs are simply more of the same, largely ineffective medicine. Eventually, the markets will figure that out, and having shot its last bullet, even the Fed won’t be able to keep this equity market rally alive.”

Mostly housing data, Apple Inc.’s iPhone 5 release and big moves in oil grabbed the spotlight in the past week. The Dow Jones Industrial Average and Nasdaq Composite Index each lost 0.1% from a week earlier, while the S&P 500 Index lost 0.4%. See Market Snapshot: U.S. stocks lifted by Apple and price of oil.

In the week ahead, “a potentially strong catalyst may just be consumer confidence” data due out Tuesday, said Fuest of Landor & Fuest. “If we can show a decent uptick in this figure, it can push the market forward as this will indicate good things for housing and jobless claims.”

Also ahead, the market will see the latest on the Case-Shiller home-price index Tuesday, followed by new homes sales data Wednesday.

Pending home sales, durable-goods orders and second-quarter figures on GDP are on tap for Thursday, while Friday will see consumer spending, Chicago PMI and consumer sentiment.

“The fact that the Fed implemented QE3 would indicate that GDP will come in at best 1.7%, or a tad lower,” said Sabrient’s Brown. “But the improvement in housing could be enough to boost it to maybe 1.9%.”

This past week saw a slew of housing data, with home-builder optimism hitting a six-year high in September and advances in housing starts and sales of existing homes in August. See: Home-builder optimism hits six-year high.

Earnings watch

With the earnings season set to begin in a few weeks, traders will also be on the lookout for corporate guidance, as a few big names report results.

Among notable companies slated to report results next week are Lennar Corp. and Red Hat Inc. on Monday; Carnival Corp. Tuesday; Nike Inc., Micron Technology Inc. and Discover Financial Services on Thursday; and Walgreen Co. Friday.

Lennar, due to announce before the bell Monday, is projected to report a third-quarter profit of 28 cents a share, on revenue of $1 billion, according to a mean estimate of analysts polled by FactSet.

Nike, with results set for release after the market closes Thursday, is forecast to earn $1.12 a share on revenue of $6.4 billion for its fiscal first quarter. The company recently announced plans to buy back $8 billion of its Class B common stock. See: Nike splashes its cash on more buybacks.

Of the eight companies that have reported earnings to date for the third quarter, 50% have reported earnings above the mean estimate and 50% have reported sales above the mean estimate, according to John Butters, senior earnings analyst at FactSet.

The estimated earnings-growth rate for the S&P 500 for the third quarter is -2.7%, up slightly from a week earlier, but well below the 1.9% estimate seen at the start of the quarter, Butters said.

Also on the docket next week, scheduled Federal Reserve speeches include San Francisco Fed President John Williams on Monday and Philadelphia Fed President Charles Plosser on Tuesday, with both speaking about the economic outlook. Chicago Fed President Charles Evans will offer views Wednesday on current economic issues.

The Road to Ruin in Europe

Greece is near the end of its tenure in the European Monetary Union (EMU). Deposits continue to flee

the country. Worse, 20% of Greek bank loans are now non-performing (that number is only 9.5% in

Spain, a record high there and causing increased concern). The non-performing loans in Greece are

bound to get worse, as the government does not have enough cash to return VAT tax refunds to small

businesses which depend on such rebates for survival. So, it is highly likely that the non-performing

assets in Greek banks will rise as small businesses fail.

With its economy continuing to contract (6.2% this past quarter) and the EMU's insistence that it

implement more austerity in return for emergency funding, Greece has to be near the end of the road

with the euro.

Meanwhile, the party continues in Italy. Despite the threat that they could be cut off from any capital

funding, and despite the talk of it, there is no austerity here. According to the Zerohedge blog of August

13, Italy's fiscal deficit continues to balloon. The table below shows that Italy's monthly deficit is rapidly

expanding from €2 billion/month in 1999 (prior to joining the EMU), to €9.5 billion/month over the last

nine months. This is what you get when you hire an unelected bureaucrat (Mario Monti) to run your

government.

Europe is in recession. While the northern countries, like Germany, have not yet entered recession, all

of the indicators point that way. Things are going to get much worse in Europe before they get

better. The first condition to heal a malady is to recognize what it is. So far, the European politicians

have yet to recognize that the underlying problem is too much debt and overpromises.

The Worldwide Slowdown

In China , the housing bubble is deflating. Prices are falling rapidly. Lack of new construction has had a

worldwide impact on the prices of raw materials, especially iron ore, coal, and other industrial input

products. The slowdown in demand and fall in raw material prices has significant negative implications

for the commodity producing countries like Australia and Canada. The banking system in China, already

undercapitalized, is facing major increases in non-performing loans. The Chinese government is going to

be spending a lot of its efforts to deal with the non-performance of the projects it began in 2009, rather

than concentrating on trying to stimulate new growth. Furthermore, in just a couple of months, China

will have a political transition to new leadership (which happens once every 10 years). The new

administration will have every opportunity to blame the old one for the economic mess – one of the

universal truths of politics.

For the past 20 years, the Japanese economy has been a basket case. Their debt and demographics are

truly scary. Debt/GDP continues to grow and their traditional internal funding sources, their post-WWII

generation, are retiring and have become net fund demanders. Japan has never depended on external

funding, but now they will have to. That means interest costs, already 20% of their budget, will be

rising. Inflation appears to be the only alternative.

Recent Upbeat Data in the US Is Misleading

GDP

GDP managed to eke out a 1.5% growth rate in the second quarter. But, the private sector remained

in stagnation. The nominal GDP (defined as Consumption + Investment + Government Spending + Net

Exports) rose by $117.6 billion ($1.29 billion/day), while federal debt grew $274.3 billion ($3.01

billion/day). That means that it took $2.33 of new debt to produce $1.00 of economic activity

[GDP]. Whatever happened to the Keynesian theory that every government stimulus dollar produces

$2-$3 of economic activity? Would anyone in their right mind sign up to repay a $233,000 loan principal

balance when the bank was only going to fund $100,000? Insanity, you say? Yet, that is what happened

in the second quarter as shown in the GDP. When costs [debt] are increasing faster than revenue [GDP],

every business leader knows that those costs have to be cut!

John Williams of Shadow Government Statistics continues to calculate inflation based on the market

basket concept used in 1980. He says in his July 28 commentary, under the 1980 methodology, we

would "add back roughly two-percentage points of annual inflation estimated to have been lost due to

methodological changes of recent decades." These include hedonic quality adjustments (i.e., imputing a

value for increased "quality") and revisions to the fixed "market basket" of goods to reflect changing

consumer buying patterns. The following two graphs show the current "real" GDP series. The first

graph uses the official Bureau of Economic Analysis (BEA) data as adjusted for inflation, the second

uses the nominal GDP data, adjusting it with what Mr. Williams believes is a more realistic set of

inflation numbers. Quite a difference!

To corroborate Mr. Williams' price index claims, a small Texas investment firm , Chapwood

Investments, publishes its own price index based on a measurement of the prices of 4,000 items

(including Starbucks' (SBUX) coffee, Advil (PFE), pizza, oil changes, toothpaste, etc.) for 50 major US

cities. For 2011, the average price increase in those 50 cities was 9.9%, versus the 3.0% rate published

by the BEA.

Given these observations, if inflation was underreported by just 1.5 percentage points, then, the second

quarter's GDP was actually negative, even despite massive federal spending. This, of course, implies

what many Americans already know – the '08-'09 recession never really ended.

Employment

The raw data show that in July, employment was 1.2 million lower than in June. Yet, through the magic

of seasonal adjustment, plus the now discredited birth-death model resulted in a reported number of

163,000 new jobs in July (the BEA assumes approximately 50,000 more new small business are created

each month than go out of business. While possibly valid in the 1990s, this is clearly a faulty assumption

in today's economic environment; yet they continue to add those 50,000 jobs to the Establishment

Survey each month).

The unemployment rate rose to 8.3% from 8.2% reported in June. Because the BEA reported that

163,000 jobs were created, several media outlets reported that the unemployment rate must have risen

because more workers had entered the labor force ((Total Employed/Labor Force)-1 = unemployment

rate). Unfortunately, the unemployment rate is calculated using a completely different survey, the

Household Survey. That survey showed job losses (mainly full time jobs) of 195,000 for July and a

continuing trend of people dropping out of the labor force. Because job losses were greater than the

number of people dropping out of the labor force, the unemployment rate rose.

Retail Sales

Despite the fact that the raw data showed that retail sales actually fell .9% in July from $405.8 billion in

June to $402.0 billion, once again, through the magic of seasonal adjustment, the Census Bureau

declared that they actually rose $1.9 billion (.8%). On August 14, the Zerohedge blog questioned the

veracity of the numbers, noting that over the past decade, the seasonal adjustment process has always

subtracted from the raw data ($5.9 billion on average from '02 thru '11). The table shows the Not

Seasonally Adjusted and Seasonally Adjusted data for both July and June from 2000 to 2012. Note that

the seasonal adjustment process consistently subtracts from June's raw data. For July, one has to go all

the way back to 2001 to find a time when the seasonal adjustment process added sales to the July raw

data.

At the end of the year, the sum total of all retail sales for all months of the year should be the same in

both Seasonally Adjusted and Not Seasonally Adjusted series. That is, the seasonal adjustment process

is supposed to smooth out the data to remove the impacts of seasonal events (Christmas, Easter, Back

to School, etc.). So, what seasonal or social pattern changed so dramatically in July of 2012 from the

past decade to allow the addition of $1.94 billion? None that I can think of. Because the seasonal

factors must, on net, be neutral by years' end, I suspect that we will be seeing weaker than expected

seasonally adjusted retail sales going forward. Of course, there is always the possibility that,

unannounced to the public, a few billion dollars were "borrowed" from past data and added to current

data. But let's not go there yet.

The Long-Term Impact of Rapidly Rising Government Indebtedness

In his July 23 investment letter, Outside the Box, John Mauldin highlights a Van Hoisington and Lacy

Hunt quarterly research piece in which the two review three recent studies which confirm

independently that high and growing government debt has a significant negative impact (24% over 23

years) on economic growth. In addition, the studies show that one of the results of huge debt

overhangs and growing government debt is that long-term yields remained depressed at very low

levels for the better part of two decades. One conclusion is "that those waiting for the detrimental

aspect of extreme government indebtedness to be apparent in [rising] interest rates will have to be very

patient indeed."

[The three studies are: 1) Debt Overhangs: Past and Present, Carmen M. Reinhart, Vincent R. Reinhart

and Kenneth S. Rogoff, NBER Working Paper 18015, April, 2012; 2) Government Size and Growth: A

Survey and Interpretation of the Evidence, Andreas Bergh and Magnus Henrekson, IFN Working Paper

No. 858, April 2011; 3) The Impact of High and Growing Government Debt on Economic Growth – An

Empirical Investigation for the Euro Area, Christina Checherita and Phillip Rother, ECB, Working Paper

Series 1237, August 2010.]

Markets and Central Bankers

The equity markets appear to be totally transfixed on the next policy statement from the Fed or

European Central Bank (ECB), and to be totally ignoring the fundamental growth slowdown worldwide

and the negative implications of exploding government debt. In reality, there is really very little the Fed,

the ECB, the Bank of Japan, the Bank of England, or any central bank can do to help their respective

economies during a debt deleveraging cycle by the private sector.

The central banks can provide liquidity, but their actions cannot resolve the solvency crises now facing

the major industrial economies. It is, in fact, really tough for Fed officials or any of these central bankers

to even talk about the real solvency issues for fear of upsetting the financial marketplace. Let's not

forget that these bankers only have the "wealth effect" (when financial markets go up, asset holders

feel wealthier and consume more) with which to impact economic activity. (All studies of the "wealth

effect" that I am aware of conclude that it is very weak and has only minor impacts on economic

activity.)

In an August 6 address to the International Association for Research in Income and Wealth, Mr.

Bernanke stated that "exclusive attention to aggregate numbers is likely to paint an incomplete picture

of what many individuals are experiencing." Well said! Clearly, the weakening private sector, as

confirmed in the GDP numbers, corroborate the view that the recession has never really ended.

Conclusions

1. Europe is, and will continue to be, a significant source of instability for the capital markets, and is likely to lead to huge volatility in asset prices before any lasting resolution occurs; 2. The world's major economies are experiencing a concurrent slowdown, led by Europe, but also apparent in China , Japan, the US, in the commodity producing nations (like Australia and Canada), and even in the emerging markets; 3. Rising government debt is masking the true health of the private sector. In depth recent studies show that rising government debt levels have significant negative impacts on future economic growth and impact interest rates for up to two decades; 4. Recent data in the US (employment, retail sales, GDP) do not square with other underlying data series; 5. The recession has never really ended. Until the debt issues are recognized and properly confronted, slow or no growth will be the norm. Editor's Note: Dr. Robert Barone is a Managing Partner / Portfolio Manager of Universal Value Advisors.

New Soap Opera: The Comedy of Euros 07/26/12

NEW YORK (TheStreet) -- The term "European Theater" was first coined during World War II.

Today in the financial markets, the term has come to symbolize an ongoing soap opera, where

the audience is continually held in suspense as the bad actors (the politicians) promise actions

and solutions to current crises, which have been created by their prior actions. Each time

solutions are proposed, the audience breathes a sigh of relief (i.e., relief rally in the equity

markets) only to be disappointed when they find out that the solutions won't work or can't be

implemented.

As a result, the crisis and suspense continues, keeping the audience's total attention (even while

dinner on the stove at home is burning). Meanwhile, a new issue or crisis appears, it seems, on a

daily basis.

Likely New Episodes

Daily we watch yields on Spanish and Italian debt move ever higher, now in zones where other countries

have cried "uncle" and asked for bailout help. At the same time, the credit default swaps on Spanish and

Italian debt have risen to record levels.

New Episode: Will the capital markets force a Spanish bailout by locking Spain out of the debt

markets?

Spanish bank recapitalization: We have recently learned that the European Central Bank is willing to impose losses on the shareholders and junior bondholders of some of the Spanish savings banks. (When they bailed out Ireland, all bondholders were saved.) The draft of the document meant to give Spain's banks 100 billion euros has this provision, but the periphery's finance ministers are opposing it.

New Episode: Is 100 billion euros enough for Spain's banks? The general rule of thumb

appears to be that the ultimate amount needed is usually higher by a factor of at least two. Spain's regional provinces are now coming hat in hand for bailouts of their own. And those

regional governments must refinance more than 35 billion euros in the near future.

New Episode: Are there enough resources in the European Financial Stability Facility

(EFSF), the temporary bailout fund, and the European Stability Mechanism (ESM), the

proposed permanent bailout fund, to bail out Spain and its regions? What about Italy?

The problematic link between Spain's sovereign and its bank's balance sheets has not been severed, as the audience was led to believe during the "Summit" episode.

New Episode: Will the ESM require the Spanish government to guarantee the bank

capital? If so, will market reaction drive borrowing rates for Spain even higher, or lock

them out of the capital markets altogether?

Greece now appears unable to produce an austerity plan acceptable to the Troika (EU Commission, ECB and International Monetary Fund). Greece has a 3.8 billion euro bond payment due in August. And the ECB just announced that it will no longer accept Greek government bonds as collateral for loans, thus locking Greece out of ECB borrowing.

New Episode: Will the Troika impose its own plan, or will it withhold bailout funding?

Without access to the ECB, will Greece default again? And, will this lead to Greece's

immediate and disorderly exit from the monetary union?

Each monetary union country is required to put capital into the ESM. Italy will be required to pony up 20% of the ESM capital.

New Episode: What sense does it make for Italy to borrow at 7% when the ESM would

offer a rate of return that is closer to 3%?

The ECB holds tons of Greek debt on their balance sheet at par (i.e., 100% of face value) (Portuguese, Spanish and Italian debt, too). If (when) Greece leaves the monetary union, they will renounce this debt, causing the ECB to need more capital to cover this loss.

New Episode: Will the remaining members be able to contribute even more capital? That

will put additional pressure on the weaklings -- again, Portugal, Spain and Italy will have

to go to the capital markets to borrow at extremely high rates to meet their capital

contribution requirements.

Will the ESM be allowed to purchase sovereign debt in the secondary market as promised in the "Summit" episode? This is meant to support Spain and lower the interest rate it has to pay to borrow. The Dutch, Finns and probably the Germans may say 'Nein.'

Politicians in a Box

The bad actors in this soap opera, the politicians, know that if they attempt to do the right thing, they

will be voted out of office by populations who value their entitlements more than anything else. Look at

Greece and the near victory by the Syriza party (anti-austerity) in the last set of elections. And now, we

see riots in Spain.

These bad actors have proposed so-called "fixes" that merely kick the can down the road, from

bailouts (Greece, Portugal, Spain, Ireland) to a banking union in order to avoid addressing the

core issues. The fixes enacted calm the audience for shorter and shorter periods. For example, the

deposit flight from Spain's banks now continues unabated, despite the capital plan for Spanish

banks announced during the recent "Summit".

This soap opera will continue to play out because liquidity does not produce solvency. The ECB

and politicians can throw all of the money they can create at the problem, but, until debt

restructuring occurs (i.e., dealing with the debt), the soap opera will continue.

Debt restructuring means that some lenders won't get repaid at all and others will have to take a

haircut. Inevitably, some financial institutions (i.e., lenders) will fail. The game to keep them

alive cannot go on forever. Eventually, the markets will tire of the soap opera, lose confidence

(as they appear to be doing), and close the capital market to these players. It would be much

better to have an orderly restructuring than a disorderly one imposed by a panicky market. But,

so far, no European leader has stepped up with such a plan (i.e., a plan to exit the weaklings from

the monetary union).

Without such a plan, the stronger European nations (like Germany, Finland and The

Netherlands) will soon have had enough and will leave the monetary union on their own, most

likely, to go back to their old currencies.

The Final Episode?

It appears that many of the New Episodes described above will soon play out as the situation appears to

be in endgame mode. Some sort of resolution acceptable to the capital markets is being demanded by

those very markets. The roller coaster is at full speed and it appears the tracks are about to end.

What new games can the European politicians play to buy more time? Is there anything they can

do, short of having a plan to exit the southern weaklings that can now save the euro? What can

they do now to even buy more time?

Unfortunately, it appears that a market-imposed resolution, which means market panic and

financial chaos for Europe with grave worldwide implications, is rapidly approaching.

This article is commentary by an independent contributor, separate from TheStreet's regular

news coverage.

Jobs report holds market back July 7, 2012

SAN FRANCISCO – U.S. stocks closed lower Friday, with the Dow industrials and S&P 500 suffering losses for the week after a report on the U.S. labor market showed tepid, below-forecast growth in payrolls last month.

The markets were, “for the most part, prepared for the poor (jobs) number,” said Robert Barone, a portfolio manager and partner at Universal Value Advisors in Reno, Nev.

And while there was a reaction to the downside, by the end of the day, the markets were only off by about 1 percent, he said. “Some volatility – yes. Major damage – no.”

The Dow Jones industrial average fell 124.20 points, or 1 percent, to close at 12,772.47. The S&P 500 index fell 12.90 points, or 0.9 percent, to 1,354.68.

The two benchmark indexes have now posted declines for two out of the past three weeks.

The Nasdaq composite index lost 38.79 points, or 1.3 percent, to 2,937.33. It climbed 0.1 percent on the week to score its fifth-straight weekly gain.

“Markets have a lot to digest here,” said Michael Gayed, chief investment strategist at Pension Partners LLC. “We got stimulus from (the Bank of England, People’s Bank of China and European Central Bank) this week, which risk assets would normally see as bullish, but that near-term optimism is being countered by a reminder of the weak jobs market.”

The Labor Department reported the U.S. economy created 80,000 jobs in June, less than the 100,000 expected in a MarketWatch survey of economists. Hiring slowed sharply in the second quarter, with job growth averaging 75,000 a month versus 226,000 in the first quarter.

“Buying stocks and hiring people are both things you do when you want to take risks,” according to Jerry Webman, chief economist at OppenheimerFunds.

Right now, there’s enough uncertainty to keep “investors and employers from wanting to take additional risk,” he said. “That’s reflected both in the employment numbers and in what stocks are doing.”

U.S. stocks end lower after lackluster jobs gains

July 6, 2012, 4:48 p.m. EDT

SAN FRANCISCO (MarketWatch) — U.S. stocks closed lower Friday, with the Dow industrials

and S&P 500 suffering losses for the week after a report on the U.S. labor market showed tepid,

below-forecast growth in payrolls last month.

The markets were, “for the most part, prepared for the poor [jobs] number,” said Robert Barone, a

portfolio manager and partner at Universal Value Advisors in Reno, Nev.

And while there was a reaction to the downside, by the end of the day, the markets were only off by

about 1%, he said. “Some volatility — yes. Major damage — no.”

What to watch for the week of July 9

Coming up: the unofficial start to quarterly

earnings, including Alcoa and J.P. Morgan Chase,

plus Yahoo's annual meeting. (Photo: AP)

The Dow Jones Industrial Average DJIA +0.72% fell

124.20 points, or 1%, to close at 12,772.47, tallying a

0.8% loss for the week.

The S&P 500 Index SPX +0.81% fell 12.90 points, or 0.9%, to 1,354.68, ending 0.6% lower for the week.

The two benchmark indexes have now posted declines for two out of the last three weeks.

The Nasdaq Composite Index COMP +0.66% lost 38.79 points, or 1.3%, to 2,937.33. It climbed 0.1% on

the week to score its fifth-straight weekly gain.

“Markets have a lot to digest here,” said Michael Gayed, chief investment strategist at Pension Partners

LLC. “We got stimulus from [the Bank of England, People’s Bank of China and European Central Bank]

this week, which risk assets would normally see as bullish, but that near-term optimism is being

countered by a reminder of the weak jobs market.”

The Labor Department reported the U.S. economy created 80,000 jobs in June, less than the 100,000

expected in a MarketWatch survey of economists. Hiring slowed sharply in the second quarter, with job

growth averaging 75,000 a month versus 226,000 in the first quarter. Read more on jobs growth.

“Buying stocks and hiring people are both things you

do when you want to take risks,” according to Jerry

Webman, chief economist at OppenheimerFunds.

Right now, there’s enough uncertainty to keep

“investors and employers from wanting to take

additional risk,” he said. “That’s reflected both in the

employment numbers and in what stocks are doing.”

Friday’s selloff was broad. On the Dow, only five of 30 components — including McDonald’s Corp. MCD

+1.08% and Wal-Mart Stores Inc. WMT -0.48% — ended higher.

All 10 S&P 500 component sectors finished lower, with nearly half down more than 1%, led by a 1.8%

drop in technology. Read more on technology stocks.

On the Nasdaq, Informatica Corp. INFA -0.96% shares led the decline, losing 28% after the software

maker lowered its outlook for the second quarter late Thursday.

For every stock advancing, more than two declined on the New York Stock Exchange, where about 596

million shares traded. Composite volume topped 2.7 billion, or less than three-quarters of the last

month’s average.

QE3 prospects

Despite recently downbeat economic data, Gayed said he doesn’t believe that expectations for a third

round of quantitative easing by the Federal Reserve are rising, “given that bond yields are already at

historic lows.” Read more reactions to the jobs data.

But Michael Yoshikami, chief executive of Destination Wealth Management in Walnut Creek, Calif., said

that “without a clear shock-and-awe strategy from the Fed, markets are concerned that inaction will

lead to a more severe slowdown.”

So although “the current reaction to the jobs numbers suggest worry over the future of the economy,

the Fed can (and in our view) will take action very soon,” he added. “This, coupled with the coordinated

action this week from international monetary agencies, will provide enough economic lubrication to get

the global economy moving again.”

For now, commodities were broadly lower, with gold futures closing at $1,578.90 an ounce, down

$30.50 for the session, and crude ending below $85 a barrel in reaction to the U.S. jobs data. Read more

on gold.

In currencies, the U.S. dollar traded at a two-year high versus the euro, with the euro EURUSD

+0.01% buying $1.2278, its lowest since the middle of 2010. The dollar index DXY +0.02% , tracking the

greenback against a basket of global currencies, was up at 83.235 from 82.826 late Thursday. Read more

on currencies.

In fixed income, yields on 10-year Treasury notes 10_YEAR +0.18% fell 5 basis points to 1.55%. Bond

prices move inversely to their yields. Read more on the action in U.S. bonds.

Looking ahead, “major market movers next week will be Spain and Italy yields, and a watchful eye for

any contagion from the Finland attitude about living without euro,” said Richard Hastings, a macro

strategist at Global Hunter Securities, who also noted that it’ll also be a big week for Chinese economic

data. Read about the Finnish finance minister’s comments.

“The underlying market theme remains dominated by sovereign debt-induced deflation and huge global

demand for dollars and Treasurys,” he commented. “Nothing right now is more powerful.”

Investors lose in Libor scandal?

By Sheyna Steiner · Bankrate.com

Friday, July 6, 2012

Posted: 4 pm ET

It was recently revealed that traders at Barclays, an international investment bank headquartered in the United Kingdom, engaged in schemes to manipulate the interbank lending rate known as Libor, or the London Interbank Offered Rate. It's analogous to the federal funds rate, the overnight lending rate in the U.S. -- except it's not overnight; the shortest is a one-month rate.

Ordinary investors, us little people, probably weren't and won't be directly impacted in the pocketbook by the rate-fixing schemes of Barclays and other banks that may have been involved.

However, bank stocks may flounder: A host of U.S. banks are rumored to be under investigation, and Barclays' share price plummeted more than 15 percent after the scandal was revealed.

The types of investors most likely to have been impacted by the Libor-fixing scheme are those with a long string of zeroes on the good side of the decimal point in their account balance and a professional interest in credit derivatives.

In a piece on DailyFinance.com on Thursday, "The LIBOR scandal is bigger than you think," Dan Caplinger wrote:

LIBOR figures are used for an estimated $350 trillion in notional value of credit-default and interest-rate swaps. For instance, both Annaly Capital (NYS: NLY) and American Capital Agency (NAS: AGNC) hedge their extensive borrowings using swaps tied to LIBOR. All told, more than $800 trillion in loans,

securities, and notional derivative contracts has links to LIBOR. Those securities include interest-paying investments which pension funds and other institutional investors own, making for an indirect impact on tens of millions of workers and retirees.

What might have been

What's unclear now is whether the rate manipulations actually had an impact and which way Libor could have been influenced.

"An entity that uses swap agreements would have been hurt if they were a pay-floating counterparty and Libor were overstated. But they would have been helped if it had been understated," says Greg McBride, Bankrate's senior financial analyst.

The opposite of a pay-floating counterparty is a pay-fixed counterparty, and they would have been hurt by Libor being understated and helped by its overstatement.

Banks and other financial institutions or entities use swap agreements to hedge exposure to interest rates.

For instance, "if you are a bank that has a very large portfolio of adjustable-rate loans subject to the movement of interest rates, you might wish to enter into a swap agreement whereby you are a pay-floating counterparty," McBride explains.

"In that agreement, you would receive a fixed payment. If they fall and you're getting less income from loan portfolio, your payments to the counterparty also drop. But the fixed payments you receive from the swap do not," he says.

There are hundreds of trillions of dollars in the derivatives market pegged to Libor, most of which are not loans.

"The vast majority is the notional amount of derivatives pegged to Libor," McBride says.

The term notional value denotes the value of the assets underlying the derivatives being traded. It's all very complicated, but with hundreds of trillions of dollars involved, movements of a single basis point in the index could be pricey.

Bond investors could also have been impacted.

When bonds are issued, "they look at the spreads between basic indexes. And Libor is one of those and always has been," says Robert Barone, partner, economist and portfolio manager at Universal Value Advisors in Reno, Nev.

Libor monkey business could have hit outstanding bonds as well.

"If Libor were understated, that could decrease the coupon payments investors receive, but (it) could actually have led to a higher value on the bonds they're holding, as bond prices rise when interest rates fall," McBride says.

In general, lower interest rates benefit riskier assets while higher interest rates "are a drag on the performance of riskier investments," he says.

The ongoing banking saga

At this point, it’s a lot of speculation. According to McBride, it would take several banks bidding on the same side of the equation to push Libor either way.

According to a story on the BBC website, "Libor scandal: Who might have lost?" it's not entirely clear that rate manipulations ever succeeded, "but a statement of facts published by the U.S. Department of Justice goes further in suggesting 'the manipulation of the submissions affected the fixed rate on some occasions,'" the story reports.

For more information, see: http://online.wsj.com/public/resources/documents/Barclays_statement_of_facts.pdf

While it's still unclear who lost what in the Libor-fixing machinations, the scandal does mar the credibility of financial-market participants and further underscores the need for regulation.

"It's just another nail in the coffin of how much confidence people have in these large financial institutions," Barone says.

"This isn't the last (scandal). They wouldn't happen if there wasn't the backstop of too big too fail," he says.

What do you think?

Get more CD and Investing News with our free weekly newsletter.

Follow me on Twitter @SheynaSteiner.

The New Bank Paradigm: Squeezing Out the

Private Sector

Jul 05, 2012

Because government doesn't create any real economic value, the domination

of government assets on bank balance sheets in place of private sector assets

spells real trouble for the future economic growth in Western economies.

MINYANVILLE ORIGINAL Since the world adopted Basel I in 1988, it has allowed the Europeans to

dictate the bank capital regime for major industrial economies. We are now in the process of adopting

Basel III capital rules. Unfortunately, these rules have so biased the financial system that the private

sector, the engine of job creation, has all but been squeezed out.

Under all of the Basel regimes, "sovereign" debt is considered riskless. Everything else has a varying

degree of risk to it which requires a capital reserve. Loans to the private sector have the highest capital

requirements. Americans have always viewed our US Treasury debt as "riskless." So, on the surface, it

appears reasonable that no capital should be required, and Americans think no further. But, further

thought would reveal two significant issues: 1) The "sovereign" debt of other countries may not be

riskless (ask the private sector holders of Greek debt, or Jon Corzine and MF Global (MFGLQ) folks about

the risks associated with Italian debt); 2) The bias imparted with this sort of capital regime makes loans

to the private sector unattractive, especially in times of economic stress where bank capital is under

pressure. But, it is in times of such stress that loans to the private sector are needed to create

investment, capital spending, and jobs.

One of the reasons for all of the stress in Europe is the fact that their banking system holds huge

amounts of periphery country debt (Greece, Spain, Portugal, Italy) with no capital backing. On a mark to

market basis, most, if not all, of the capital of the periphery banks disappears. In fact, the European

Central bank (ECB) itself is still carrying the Greek debt it holds on its books at par, as if there is no

chance that they won't be repaid in full.

Since the financial crisis of '08-'09, Western banking systems have come to rely on government, at first

as the capital provider of last resort, but now, at least in Greece and Spain, as the capital provider of first

resort (most likely because there is no other). In a symbiotic relationship, those same governments

have come to rely on the banks to purchase their excessive supply of debt. The capital rules favor this

unhealthy relationship. In effect, we now have a banking DNA bias against private sector lending.

We have heard the politicians in Washington rail against the banks for not making loans to the private

sector. Yet, all of the rules, regulations, and enforcement processes make it difficult, if not impossible,

to do just that. The overbearing regulatory process strangles private sector lending at small community

banks. And, as indicated above, the capital regime itself, which impacts all banks, discourages private

sector loans. For example, a $1 million loan to the private sector requires $200,000 in capital backing

plus an additional $20,000 to $30,000 in loss reserve contribution from the capital base. That same $1

million loan to the US Treasury, via purchases of Treasury securities, requires no capital or reserve

contribution. The ultimate result is that, since the financial crisis when western governments found out

that it was politically okay to "save" (i.e. recapitalize) large banks with public monies, they also found

out that the capital and regulatory regime now made those same banks major buyers of excessive

government debt.

Unfortunately, while governments like this and will continue to promote it because it keeps the cost of

borrowing low and provides them with a ready market for deficit spending, government is not the

economic engine. That is what the private sector is. Simply put, the banking model in the west now

promotes moral hazard (banks making bets that are implicitly backed by taxpayers) and Too Big To Fail

(TBTF) policies while it stifles private sector lending. The Dodd-Frank legislation has institutionalized this

model with government intervention now seen as the first response to a banking issue. If it hasn't, then

why did President Obama say on The View the business day after JPMorgan Chase (JPM) announced its

trading loss that it was a good thing that JPMorgan had a lot of capital else the government would have

had to "step in." Or why has Jamie Dimon, JPMorgan's CEO, been required to testify before both House

and Senate Committees about a loss of less than 3% of the bank's $190 billion capital base? As further

proof of government control of the banking system, the FDIC recently announced that, under its Dodd-

Frank mandate, it is ready to take over any TBTF institution, "when the next crisis occurs." Isn't it clear

that the relationship between the US federal government and the banking system is unhealthy, perhaps

even incestuous, to the detriment of the private sector? That very same banking model is emerging in

Europe with the emergency funding by the European Financial Stability Fund (EFSF) to recapitalize the

Spanish banks and talk of a pan-European regulatory authority and deposit insurance.

The emerging banking model is one in which central governments and the money center banks co-exist

in a mutual admiration society where government capitalizes the banks and the banks are the primary

buyers of excessive government debt. Because government doesn't create any real economic value (it

regulates it and transfers it from one group to another), the domination of government assets on bank

balance sheets in place of private sector assets spells real trouble for the future economic growth in the

Western economies.

Editor's Note: Dr. Robert Barone is a Mangaging Partner / Portfolio Manager of Universal Value Advisors.

Over the past four years, the slow creep of government into the private sector has become a gallop. Unfortunately, a high level of structural unemployment is the unintended consequence of social engineering, picking winners, over-taxing and over-regulating every aspect of the business process.

The conventional wisdom is that a balanced budget will be a magic solution to the sluggish economy and the employment situation, but if it is done with just austerity and tax hikes but without relief from an overbearing set of governments on the business sector, what we will get is an “austerity death spiral.” Federal Reserve Chairman Ben Bernanke said as much to the Senate Banking Committee on Tuesday.

Intervention is the Norm

We now live in a world where government intervention in the business process is expected. When any sort of economic issue arises, government is now expected to fix it.

Financial institutions in trouble? No problem – the taxpayers, via the government are expected to bail them out!

Domestic auto companies historically made awful decisions around retiree medical and pension issues and, as a result, can’t compete and are staggering toward bankruptcy. Again, no problem. Ask the government to shore them up, even if it means trampling on bondholder contract rights like in the General Motors case.

Some homeowners can’t, and others don’t want to make their mortgage payments. That’s easy. Ask the government to intervene, stop or slow the foreclosure process, and, perhaps, even require the lenders to reduce principal balances! This deal is in the works now with the government prepared to offer big lenders like Citigroup, Bank of America, Wells Fargo and JPMorgan Chase money to offset losses on short sales.

The markets now expect intervention. When the government intervenes in an economic issue, the markets rise. If the government doesn’t, it falls precipitously. On September 29, 2008, the Dow Jones Industrial Average (DJIA) fell 778 points when Congress failed to pass the initial TARP legislation; From the time QE1 began in November, 2008 until it ended in March, 2010, the DJIA rose 28% or 2,378 points.

QE2 elicited a similar market response, 1,199 points (10.7%) from November, 2010 to June, 2011, even more if you go back to August when Bernanke articulated the strategy in Jackson Hole, Wyo.

In late November, 2011, on the day when the Fed gave unlimited swap lines to the European Central Bank (ECB), the DJIA rose 490 points; it rose 337 points just before Christmas when the ECB opened its lending facility to 540+ European banks.

I suspect we will see similar market reaction if the Fed goes through with its hinted at QE3.

Unintended Consequences

Unfortunately, nearly every government intervention carries with it unintended consequences, and, if such interventions interfere with the free market processes, they have long-term negative implications on economic growth. Recent examples in the U.S. include the Keystone Pipeline and the National Labor Relations Board’s attempt to block Boeing from opening a plant in South Carolina.

Nearly every economic malady that exists today is directly traceable to the unintended consequences of government interference in the economic process or via its attempt at social engineering:

Sub-prime and housing crisis: It is widely recognized that this was caused by three concurrent factors: 1) an extended period of low interest rates engineered by Greenspan’s and Bernanke’s Fed; 2) the social engineering goals of the Community Reinvestment Act (CRA); 3) the political and monetary aspirations of Fannie Mae and Freddie Mac executives and sponsors;

Social Security and Medicare unfunded liabilities: As the baby boomer generation reaches retirement age, unfunded liabilities will increase by more than $3.5 trillion each year. To show how absurd this is, the payroll tax reduction, in effect since January 1, 2011, and currently an issue in the Congress, simply puts the Social Security system ever deeper into debt that cannot be repaid without hugely inflated dollars;

Unfunded pension liabilities: While some private sector corporations have unfunded pension liability issues, the bulk of the problem lies at the local, state and federal levels;

High structural unemployment: As alluded to earlier, impediments to business from all levels of government, but especially from the federal government, are a huge issue. Recent legislation, including Sarbanes-Oxley, Dodd-Frank, and Obamacare, is crushing small business. In addition, business must be confident that the future environment will be friendly. So, the notion of a “temporary” tax reduction doesn’t reduce business uncertainty, as businesses invest for the long-term.

This last item is particularly poignant. In a three part op-ed series published by Bloomberg in mid-January, Carl Pope, former chairman of the Sierra Club, bemoans America’s loss of manufacturing jobs. “It’s not the wages, stupid!”, he says. If wages were key, how is it that Germany, where wages are higher and unions stronger, enjoys a growing manufacturing base?

For the auto industry, which in 1998 had over 70% of the U.S. domestic auto market but now has 44%, it was the health care and pension costs of its retirees that caused the industry’s economic crisis, he says. Since the turn of the century, America’s manufacturing base has shrunk by one-third, not because of wages, which are similar to wages paid in the rest of the world, but the lack of support or even outright hostility on the part of government. (When even the Sierra Club recognizes that government is choking free enterprise, the issue must be terribly obvious!)