One episode has always stuck in my mind ”“ which illustrates the mentality of the City. I once travelled to Zug in Switzerland, to interview a metals trader who had been at the centre of a suspected £150 million fraud. As ever, the companies concerned had preferred not to press criminal charges (they don’t because the burden of proof is higher and they don’t want any negative publicity falling on them). But there had been a civil case and the judge’s findings had been pretty conclusive and highly critical. The metal concerned was aluminium. Instead of finding a dealer full of remorse for what he’d done, I met a person who expressed bafflement ”“ he could not understand why I’d gone all that way and why I was so concerned about events that had occurred some years previously.

“Why don’t you ask me about copper?” he said. “Make a note of where the copper price is six months from now.” Mostly for theatrical effect and to please him, I produced a diary and wrote down “copper” in six months’ time. Exactly six months to the day, copper was reported to have risen to an all-time high ”“ on the back of rumoured buying from my interviewee and his associates.

That’s what the City is like. One of the abiding terms in the market is “eat what you kill” ”“ you hear it trotted out regularly as a justification for the bonus system. It’s a “me, me” culture in which everyone is out for themselves.

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With the American economic recovery hanging in the balance, private employers added 71,000 jobs in July, up from a downwardly revised 31,000 in June but below the consensus forecast of 90,000. The unemployment rate stayed steady at 9.5 percent.

Over all, the nation lost 131,000 jobs in July, but those losses came as 143,000 Census Bureau workers left their temporary posts, the Labor Department said. June’s number was revised dramatically downward to a total loss of 221,000 jobs. The Department of Labor originally reported that the nation lost 125,000 jobs in June.

Figures released last week confirmed that the United States economy slowed down in the spring, and the Department of Labor’s monthly statistical snapshot of hiring pointed toward a stall in hiring this summer, as employers failed to add jobs at the rate they were earlier this year.

It is a very disappointing report–but alas one that is not surprising. Read it all–KSH.

This year, the U.S. public debt is projected to reach 62 percent of the economy””up from 40 percent in 2008 and nearly double the historical average, according to recent Congressional Budget Office (CBO) estimates. The financial crisis and recession drove much of this debt swing, yet larger problems loom in the future.

By 2030, the CBO projects that debt will more than double to 146 percent of GDP.[1] The only good news, if it can be called that, is that the U.S. is not alone. Two recent studies by the International Monetary Fund (IMF) and the Bank for International Settlements (BIS) highlight the significance of the global debt challenge and stress the need for governments to aim higher than short-term deficit reductions. For the U.S., one of the most poorly positioned countries, addressing the long-term debt challenge must include prompt reform of Social Security, Medicare, and Medicaid.

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Tim Congdon from International Monetary Research said the Fed has been wasting its powder by using the wrong mechanism to inject monetary stimulus. Instead of buying bonds from pension funds, insurance companies and other bodies outside the banking system, as the Bank of England did with its £200bn gilts purchase, it has been buying from banks. This method has different effects. It has gained less traction because banks have sat on “dead cash”. This has not increased the deposits held by companies and households.

“A really powerful way for the Fed to boost the economy is to buy bonds directly from the public, which will increase the quantity of broad money. They won’t do that because they have a totally different model and in my view they are confused about the transmission mechanism. If they bought say $1.5 trillion of long-dated Treasuries from non-banks I believe they would get the US out of its liquidity trap very quickly,” Mr Congdon said.

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While the support to economic activity from stimulative fiscal policies and firms’ restocking of their inventories will diminish over time, rising demand from households and businesses should help sustain growth. In particular, in the household sector, growth in real consumer spending seems likely to pick up in coming quarters from its recent modest pace, supported by gains in income and improving credit conditions. In the business sector, investment in equipment and software has been increasing rapidly, in part as a result of the deferral of capital outlays during the downturn and the need of many businesses to replace aging equipment. At the same time, rising U.S. exports, reflecting the expansion of the global economy and the recovery of world trade, have helped foster growth in the U.S. manufacturing sector.

To be sure, notable restraints on the recovery persist. The housing market has remained weak, with the overhang of vacant or foreclosed houses weighing on home prices and new construction. Similarly, poor economic fundamentals and tight credit are holding back investment in nonresidential structures, such as office buildings, hotels, and shopping malls.

Importantly, the slow recovery in the labor market and the attendant uncertainty about job prospects are weighing on household confidence and spending….

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In between the statistical data, the dour outlook for state budgets, and the declaration that the longest recession since World War II is at least technically over, Federal Reserve Chairman Ben Bernanke talked Monday of how the South has come a long way in educating its residents and transforming its economy.

Bernanke could speak with a degree of authority on the topic, having attended public schools in tiny Dillon, where he also worked for three summers at the famous South of the Border tourist attraction.

“When I attended public schools in South Carolina in the 1960s, measures of per-pupil spending, years of schooling, and student achievement in the South lagged significantly behind other parts of the country,” the Fed chief said in a speech at the Southern Legislative Conference in Charleston. “Since then, those indicators have changed, very much for the better.”

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….these macroeconomic arguments between policy-makers and intellectuals are blind to obstacles to growth faced on a micro level by real, live entrepreneurs and managers. Confronted with incredible uncertainty about the future business climate brought about by massive regulatory and tax changes, they are sitting on cash instead of investing in capital equipment and, especially, hiring new workers.

White House Chief of Staff Rahm Emanuel famously said never let a crisis go to waste. But the policy changes on health-care and financial services that have emerged from the current crisis, plus the largest tax increase in history that will hit Jan. 1 without Congressional action, are restraining companies, especially mid-to-small-sized ones.

Atlas didn’t shrug; he’s sitting on his hands””and his wallet.

That is the message heard repeatedly from entrepreneurs, their private-equity investors and their wealth managers. And it is becoming increasingly apparent, not so much in the parade of stronger-than-expected second-quarter earnings numbers from Standard & Poor’s 500 companies, but in regional Federal Reserve Bank reports.

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“I just can’t believe it,” Mr. [Dezso] Kocs said, looking around at his current quarters, with empty cardboard boxes used as night stands. “I used to be a business owner. Now I’m a slave.”

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Did you know?

Under an underreported set of new provisions of the new financial reform law, whistleblowers who notify the SEC about alleged fraud will be entitled to collect 10%-30% of money actually recovered by the government.

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The administration’s second assumption, meanwhile, is a matter of academic theories about the sizes of the relevant economic multipliers. Textbook Keynesian economics tells us that government-purchases multipliers are larger than tax-cut multipliers. And, as we have seen, the Obama administration’s economic team consulted these standard models in deciding that spending would be significantly more effective than tax cuts.

But a great deal of recent economic evidence calls that conclusion into question. In an ironic twist, one key piece comes from Christina Romer, who is now chair of Obama’s Council of Economic Advisers. About six months before she took the job, Romer teamed up with her husband and fellow Berkeley economist David Romer to write a paper (“The Macroeconomic Effects of Tax Changes”) that sought to measure the influence of tax policy on GDP. Crucial to the Romers’ method was their effort to identify changes in tax policy made during times of relative economic stability, and driven by a desire to influence economic behavior or activity (to encourage growth, say, or reduce a deficit), rather than those changes made in response to a recession or crisis. By studying such “exogenous” tax-policy changes, the Romers could be more confident that they were in fact measuring the effects of taxes and not those of extraneous conditions.

The Romers’ conclusion, which is at odds with most traditional Keynesian analysis, was that the tax multiplier was 3 ”” in other words, that every dollar spent on tax cuts would boost GDP by $3. This would mean that the tax multiplier is roughly three times larger than Obama’s advisors assumed it was during their policy simulations.

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You may find it here.

Hugh Hendry has a big mouth, as Hugh Hendry will tell you.

With a sharp wit and a sharper tongue, Mr. Hendry, a plain-spoken Scot, has positioned himself as the public contrarian thinker of this city’s very private hedge fund community.

The euro? It’s finished, Mr. Hendry proclaims.

China? Headed for a fall.

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U.S. officials need to outline more clearly their plans to reduce the nation’s fiscal deficit, said Stephen Roach, Morgan Stanley’s non-executive chairman for Asia.

“What the markets are ultimately going to want is far more specificity and credibility on deficit reduction and normalization of Fed policy,” Roach, 64, said during a radio interview with Tom Keene on Bloomberg Surveillance.

President Barack Obama said on July 15 his economic- stimulus program is gradually pulling the U.S. out of the economic slump. The nation’s budget deficit is forecast to swell 14 percent this year to a record $1.6 trillion. Obama has said he will offset spending by more than $1.2 trillion over 10 years, partly through a freeze on many domestic programs and more than $800 million in higher taxes and fees on households earning more than $250,000.

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The Securities and Exchange Commission has reached a $550 million settlement with Goldman Sachs Group Inc. that will resolve its lawsuit against the firm alleging that it misled investors in a subprime mortgage product, the agency announced Thursday.

The SEC sued Goldman in April, charging it with fraud in marketing of a complex financial product called Abacus 2007-AC1 that was based on mortgage-backed securities. The suit is the highest profile of a number of inquiries regulators are making into synthetic collateralized debt obligations.

In agreeing to the SEC’s largest-ever penalty paid by a Wall Street firm, Goldman also acknowledged that its marketing materials for the subprime product contained incomplete information, the SEC said.

Goldman denied any wrong doing in the SEC lawsuit but has been under pressure from shareholders to reach a settlement on the fraud lawsuit and other SEC probes.

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Investors are worried that the risk of default for US local governments is growing, amid signs that some regions are facing the same type of difficulty in curbing pension and budget deficits as some eurozone countries.

The yield attached to some forms of infrastructure municipal bonds has risen relative to US Treasury bonds because of fears that cash-strapped local governments will struggle to repay these loans.

Absolute borrowing costs for regional governments remain relatively low in historical terms because of the Federal Reserve’s ultra-loose monetary policy. But any swings in municipal yields will be watched closely by investors, since they suggest that the fiscal anxieties about the eurozone could now infect the US.

“The risk in the second half of the year is that investor attention switches from Europe to the US,” said Robert Parker, senior adviser at Credit Suisse Securities, who singled out parts of California, as well as towns and cities in Illinois, Michigan and New York state as among the most vulnerable.

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Federal Reserve Chairman Ben S. Bernanke and then-New York Fed President Timothy Geithner told senators on April 3, 2008, that the tens of billions of dollars in “assets” the government agreed to purchase in the rescue of Bear Stearns Cos. were “investment-grade.” They didn’t share everything the Fed knew about the money.

The so-called assets included collateralized debt obligations and mortgage-backed bonds with names like HG-Coll Ltd. 2007-1A that were so distressed, more than $40 million already had been reduced to less than investment-grade by the time the central bankers testified. The government also became the owner of $16 billion of credit-default swaps, and taxpayers wound up guaranteeing high-yield, high-risk junk bonds.

By using its balance sheet to protect an investment bank against failure, the Fed took on the most credit risk in its 96- year history and increased the chance that Americans would be on the hook for billions of dollars as the central bank began insuring Wall Street firms against collapse. The Fed’s secrecy spurred legislation that will require government audits of the Fed bailouts and force the central bank to reveal recipients of emergency credit.

“Either the Fed did not understand the distressed state of some of the assets that it was purchasing from banks and is only now discovering their true value, or it understood that it was buying weak assets and attempted to obscure that fact,” Senator Sherrod Brown, an Ohio Democrat and member of the Senate Banking Committee, said in an e-mail when informed about the credit quality of holdings in the Maiden Lane LLC portfolio. The committee held the April 3 hearing.

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Debt is as powerful a drug as alcohol and nicotine. In boom times Western consumers used it to enhance their lifestyles, companies borrowed to expand their businesses and investors employed debt to enhance their returns. For as long as the boom lasted, Mr Micawber’s famous injunction appeared to be wrong: when annual expenditure exceeded income, the result was happiness, not misery.

For a long time debt in the rich world has grown faster than incomes. As our special report this week spells out, it is not just government deficits that have swelled. In America private-sector debt alone rose from around 50% of GDP in 1950 to nearly 300% at its recent peak. The origins of the boom go even further back, reflecting huge changes in social attitudes. In the 19th century defaulting borrowers were sent to prison. The generation that lived through the Great Depression learned to scrimp and save. But the wider take-up of credit cards in the 1960s created a “buy now, pay later” society. Default became just a lifestyle choice. The reckless lender, rather than the imprudent debtor, was likely to get the blame….

Rich-world countries now face two sets of problems. The most pressing is how to pay off their debts. Many people who have cut back their credit-card spending and firms which have seen their credit lines slashed would be horrified to see how little the rich world’s overall burden has fallen. Much of the debt has merely moved from the private to the public sector as governments have correctly stepped in to support banks and save the economy from falling into depression. And in the future, even more money will have to be raised, because of governments’ lavish promises of pensions and health care for the retiring baby-boom generation.

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So far, European leaders have tried to deal with this spreading disaster by ruses. Existing European treaties ban bail-outs of member states. So the “European Stabilisation Mechanism”, recently set up precisely to provide these illegal bail-outs, does so under Article 122.2 of the Lisbon Treaty. This article gives emergency assistance to a member state “threatened with severe difficulties caused by natural disasters or exceptional circumstances beyond its control”.

Natural disasters! We are experiencing a totally unnatural disaster, one brought about by the artificial structure of the European project. Exceptional circumstances beyond its control! It was this system that every eurozone member state proudly (though usually without asking their electorates) voted for.

The situation is not funny for the people of Greece, Portugal, Spain, and so on, because their governments have run up dreadful public debts while sacrificing their power to devalue to become competitive. They cannot cut their exchange rate, so they must cut wages and jobs. Unemployment in Spain is already 20 per cent ”“ and 40 per cent among young people.

It is not funny for Germany, either. German banks are overcommitted in the southern countries now afflicted. The German people are fed up with paying for the profligacy of their poorer neighbours and furious at the suggestion that the only solution is that they should pay even more.

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Democracy could ”˜collapse’ in Greece, Spain and Portugal unless urgent action is taken to tackle the debt crisis, the head of the European Commission has warned.

In an extraordinary briefing to trade union chiefs last week, Commission President Jose Manuel Barroso set out an ”˜apocalyptic’ vision in which crisis-hit countries in southern Europe could fall victim to military coups or popular uprisings as interest rates soar and public services collapse because their governments run out of money.

The stark warning came as it emerged that EU chiefs have begun work on an emergency bailout package for Spain which is likely to run into hundreds of billions of pounds.

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French and German banks have lent nearly $1 trillion to the most troubled European countries and are more exposed to the debt crisis than the banks of any other countries, according to a new report that is likely to add pressure on institutions to detail their holdings.

French banks had lent $493 billion to Spain, Greece, Portugal and Ireland by the end of 2009 while German banks had lent $465 billion, according to the report by the Bank for International Settlements, an institution based in Basel, Switzerland, that acts as a clearing house for the world’s central banks.

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“The collapse of the financial system as we know it is real, and the crisis is far from over,” Soros said today at a conference in Vienna. “Indeed, we have just entered Act II of the drama.”

Soros, 79, said the current situation in the world economy is “eerily” reminiscent of the 1930s with governments under pressure to narrow their budget deficits at a time when the economic recovery is weak.

Concern that Europe’s sovereign-debt crisis may spread sent the euro to a four-year low against the dollar on June 7 and has wiped out more than $4 trillion from global stock markets this year. Europe’s debt-ridden nations have to raise almost 2 trillion euros ($2.4 trillion) within the next three years to refinance, according to Bank of America Corp.

“When the financial markets started losing confidence in the credibility of sovereign debt, Greece and the euro have taken center stage, but the effects are liable to be felt worldwide,” Soros said.

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That said, I think part of the business community’s complaint about Obama has merit. Although there are many “innovation” initiatives ongoing in this administration, they are not well coordinated or a top priority or championed by knowledgeable leadership. This administration is heavily staffed by academics, lawyers and political types. There is no senior person who has run a large company or built and sold globally a new innovative product. And that partly explains why this administration has been mostly interested in pushing taxes, social spending and regulation ”” not pushing trade expansion, competitiveness and new company formation. Innovation and competitiveness don’t seem to float Obama’s boat. He could use a buoyant growth strategy.

What might that include? I asked two of the best people on this subject, Robert Litan, vice president of research and policy at the Kauffman Foundation, which specializes in innovation, and Curtis Carlson, the chief executive of SRI International, the Silicon Valley-based innovation specialists.

Carlson said he would begin by creating a cabinet position exclusively for promoting innovation and competitiveness to ensure that America remains “the world’s new company formation leader.” “Secretary Newco” would be focused on pushing through initiatives ”” including lower corporate taxes for start-ups, reducing costly regulations (like Sarbanes-Oxley reporting for new companies), and expanding tax breaks for research and development to make it cheaper and faster to start new firms. We need to unleash millions of entrepreneurs.

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Heavy rain hampered an evening rally through the city’s streets.

Spanish unions said 75-80% of public sector workers had joined the day-long strike.

The labour ministry, however, put the figure at 16%.

“We are very angry because this is not only an attack to our rights and to our salaries – there is an attack to the welfare,” protester Elisia Deoran told the BBC.

“It’s an attack on all the public services.”

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I’ll reiterate that from our perspective, the essential difficulty of the market here is not Greece, it is not the Euro, it is not Hungary, and it is really not even the slow pace of job growth in the latest report. The fundamental problem is that we have not, as a global economy, accepted the word “restructuring” into our dialogue. Instead, we have allowed our policy makers to borrow and print extraordinarily large band-aids to temporarily cover an open wound that will not heal until we close the gap. That gap is the difference between the face value of debt securities and the actual cash flows available to service them. The way to close the gap is to restructure the debt. This will require those who made the bad loans to accept the associated losses. By failing to do that, we have failed to address the essential problem faced by the world, which is that we have created more debt than we are able to service.

A few observations. First, I remain convinced that the other shoe to drop is not Greece or Spain or Hungary, but rather a second wave of major credit strains here in the U.S. related to fresh delinquencies from exotic adjustable rate mortgages.

Second, it is a delusion to interpret economic statistics suggesting an economic turnaround over the past year without factoring out the extent to which that has been driven by unsustainable levels of deficit spending.

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(Please note the headline above is the one given to this piece today in the local paper in the op-ed section–KSH).

“The United States faces a fundamental disconnect between the services that people expect the government to provide, particularly in the form of benefits for older Americans, and the tax revenues that people are willing to send to the government to finance those services,” Douglas Elmendorf, director of the non-partisan Congressional Budget Office, writes in a May 17 blog post.

Addressing the current tax and spending gap to make fiscal policy sustainable is “an urgent task for policy makers,” Elmendorf says.

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IT’S a $2.6 trillion mystery.

That’s the amount that foreign banks and other financial companies have lent to public and private institutions in Greece, Spain and Portugal, three countries so mired in economic troubles that analysts and investors assume that a significant portion of that mountain of debt may never be repaid.

The problem is, alas, that no one ”” not investors, not regulators, not even bankers themselves ”” knows exactly which banks are sitting on the biggest stockpiles of rotting loans within that pile. And doubt, as it always does during economic crises, has made Europe’s already vulnerable financial system occasionally appear to seize up. Early last month, in an indication of just how dangerous the situation had become, European banks ”” which appear to hold more than half of that $2.6 trillion in debt ”” nearly stopped lending money to one another.

Now, with government resources strained and confidence in European economies eroding, some analysts say the Continent’s banks have to come clean with a transparent and rigorous accounting of their woes. Until then, they say, nobody will be able to wrestle effectively with Europe’s mounting problems.

“The marketplace knows very little about where the real risks are parked,” says Nicolas Véron, an economist at Bruegel, a research organization in Brussels. “That is exactly the problem. As long as there is no semblance of clarity, trust will not return to the banking system.”

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The big news is France. With sentiment worsening across Europe, France has lost its relative safe haven status ”“ credit default swap spreads on French government debt were up sharply today.

The trigger ”“ oddly enough ”“ was Hungary’s announcement that its budget is worse than expected (blaming the previous government; this is starting to become the European pattern) and in the current fragile environment discussed yesterday, this relatively small piece of news spooked investors. But these developments only reinforced a trend that was already in place.

It did not help that the Irish Minister of Finance announced Ireland has 74.2bn euros of guaranteed bank loans, bonds, and systemic support falling due between now and Oct 1. This is around 55% of GNP. It sounds like everyone backed by the Irish government had the “clever” idea to roll over their debts to just before the guarantees expire.

The big losers are Portugal-Ireland-Italy-Greece-and-Spain as always, but Belgium is now in the line of fire, and France is clearly under pressure. The spread between French and German credit default swaps (measuring the relative probability of default) is up ”“ yesterday this was 40 basis points, today it stands at 44 (up from just 5 basis points at the end of 2009; most of the increase is since mid-March, with a sharp acceleration recently). French bonds have become illiquid, with wide bid-ask spreads; not what is supposed to happen in a safe haven. This is going to make the French angry ”“ watch for more market slanders from top French politicians over the weekend; you know they would just love to ban trading in something.

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The Greek government has been advised by British economists to leave the euro and default on its €300 billion (£255 billion) debt to save its economy.

The Centre for Economics and Business Research (CEBR), a London-based consultancy, has warned Greek ministers they will be unable to escape their debt trap without devaluing their own currency to boost exports. The only way this can happen is if Greece returns to its own currency.

Greek politicians have played down the prospect of abandoning the euro, which could lead to the break-up of the single currency.

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Like last week, with stocks lurching wildly with the headlines — up by triple digits one day, down the next. For the month, the Dow Jones Industrial Average dropped 7.9% and is negative for the year. The Nasdaq Composite and the Standard & Poor’s 500-stock index also are in the red for the year.

Some pretty smart people are cautious. Seth Klarman at Baupost Group is worried. John Hussman of the Hussman Funds says all sorts of warning lights have lit up across his screen. Even Ron Muhlenkamp of the Muhlenkamp Fund, who usually takes a sunnier view of things, says he has moved a big chunk of his mutual fund into cash in case there’s a plunge.

How far will it go? Mr. Hussman says the technical indicators have only been this bad 19 times before in the last half century — and on average the market plunged about 20% over the following 12 months. When markets were also high, like now, the picture’s even worse.

Ugh.

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While a restructuring may not take place for another year or two, it’s a move that Greece may be unable to avoid, many say, despite assurances to the contrary from officials at the EU and IMF.

Restructuring is essentially a default, under which Greece would renegotiate its debt with bondholders, either lengthening its maturities or reducing the amount it owes, causing bondholders to take a loss.

“At this point, it is very clear that restructuring is the only option,” says Lena Komileva of Tullett Prebon in London.

Josef Ackermann, the chief executive of Deutsche Bank, said earlier this month he thought it “doubtful” that Greece would be able to repay all its borrowings.

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