In this issue:

'Great Shock' Coming to U.S. Economy, Says European Economist

Greenspan: No Limit to Liquidity Pumping

Current Account Deficit May Be Problem, Greenspan Finally Admits

Business Roundtable Says Fundamentals Not Sound

Auto Industry Pensions Threatened by Stock Market Blowout

Fourth-Quarter Growth Forecast a Feeble 1.1%

Wall Street Hit Hard by Layoffs; More Coming

THE DERIVATIVES DEBACLE

All Forms of Derivatives Show Explosive Growth

Fed Reports Record Levels of Home Mortgage Refinancing

WALL STREET POLICE BLOTTER


From Volume 1, Issue Number 37 of Electronic Intelligence Weekly, Published Monday, Nov. 18, 2002

U.S. ECONOMIC/FINANCIAL NEWS

'Great Shock' Coming to U.S. Economy, Says European Economist

"The world economy is caught in a general profit and investment depression," a leading continental European economist told EIR Nov. 13, and the "single hope" by investors, that the Fed's rate cuts will rescue the economy and the stock markets worldwide, will soon be destroyed by the "great shock" of "renewed drastic weakness of the U.S. economy." A slumping dollar will then turn the shock "into a nightmare."

The principal point to note concerning the U.S. economy and the Fed policy, said the source, is that we are not dealing with any kind of cyclical downturn. "For the first time in the whole postwar period, the U.S. economy has slumped against a backdrop of the most aggressive rate cuts by the Federal Reserve and the most rampant money and credit growth ever. Implicitly, the forces depressing the U.S. economy this time are radically different from those that fuelled past recessions."

While Washington and Wall Street are persistently claiming that the economy's "fundamentals have never been sounder," the fact is that the U.S. economy, in the past several years, went through a dramatic macro-economic "restructuring" which has produced "a plethora of unsustainable structural maladjustments, imbalances, distortions, or dislocations." Among these "restructurings" are the "unprecedented consumer borrowing and spending binge that sent personal consumption to its highest level ever as a share of GDP," the "sharply lower personal savings," the "sharply lower net business investments," and the "exploding trade deficit."

Accompanying these developments was "exploding money and credit growth." Broad money M3 went up $500 billion during the first half of the decade, but then shot up by five times that amount—$2.5 trillion—during the second half.

In view of all these giant imbalances and distortions, the "new catchword in the discussion"—that is, "deflation"—actually "tends to distract from the true causes." There is the "intrinsic" notion in the "deflation" debate, that all our economic problems could be solved if only the central banks would offer sufficient liquidity, worldwide. There is, as an example, an "American consensus" that "Japan owes its economic misery simply to insufficient monetary easing," in spite of the fact that "Japan has already had near-zero interest rates for years."

Greenspan: No Limit to Liquidity Pumping

In testimony to the Joint Economic Committee of Congress Nov. 13, the increasingly out-of-touch Federal Reserve chairman Alan Greenspan said the interest-rate cut should help get the economy through a " 'soft patch' that is not something which is the precursor of far more significant weakening." He then admitted that the rate cut was considered by the Federal Reserve as the right policy even if the U.S. is not going through a short-term soft patch, but something worse.

The economy is not close to a "deflationary cliff," Greenspan babbled (indicating that the so-called "soft patch" might be in his head), but, if we get to that point, and the Federal funds rate has been lowered to 0%, the Federal Reserve could still increase the liquidity of the system by purchasing long-term Treasury securities and increasing the maturity of Treasuries. "There's virtually no meaningful limit to what we could inject into the system, were that necessary," he claimed. Weimar, anyone?

Current Account Deficit May Be Problem, Greenspan Finally Admits

Under questioning, following his testimony to the Congressional Joint Economic Committee, Fed chairman Alan Greenspan for the first time admitted Nov. 14, that the swelling U.S. current account deficit could be a problem. In reality, America's inability to finance its deficit could rupture the entire world financial system.

During Congressional testimony over the last several years, Greenspan has denied the U.S. current account deficit was a cause for concern. For example, during questioning on July 17, Greenspan asserted to Congress that "the current account deficit [is] not, in and of itself, a measure of anything bad, because what that means is that that much money is coming into the United States on the part of those who want to invest here."

Now, four months later, Greenspan told the Congress that the current account "cannot go on." He continued, "as our current account deficit continues [to grow], the net debt to foreigners [who finance the deficit] of necessity rises, that the servicing costs of that debt rises"; this "becomes ... ultimately unsustainable." Greenspan stated that "when the dollar was strengthening," this attracted more foreign capital into the U.S., which facilitated "an ever-increasing capability of importing goods." Now, "it's a type of situation that we know cannot exist indefinitely." Greenspan expresses his hope that "it will eventually simmer down because our propensity to import will continue to decline.... But I have been wrong on this for years."

Business Roundtable Says Fundamentals Not Sound

Contrary to the fairy tales issued by Treasury Secretary Paul O'Neill, and endorsed by the White House, the "economic recovery has not been strong or sustained [and] CEOs do not expect the situation to improve significantly in 2003," said John Dillon, chairman of the Business Roundtable, which represents the 200 largest U.S. corporations.

According to the group's survey of 150 chief executives, released Nov. 12, some 60% expect to cut jobs next year, and 80% are planning no increase in investment for plant and equipment, with nearly 25% planning to reduce capital spending. The economy's weakness "has nothing to do with mood, or lack of confidence," Dillon said, countering O'Neill's claim. "It's about the fundamentals of orders, operating rates, profitability, and cash flow."

Auto Industry Pensions Threatened by Stock Market Blowout

Pension funds at 22 U.S. automakers and suppliers will likely be underfunded by $30 billion by the end of the year, due to the stock-market collapse, according to a study by Fitch Ratings, AP reported Nov. 14. The shortfall, more than twice the level of underfunding the companies faced at the end of 2001 ($13 billion), would have to be plugged with money used for product development and investment in plant and equipment—and draining profits.

General Motors, the largest automaker, expects to put $12-17 billion into its pension fund over the next five years. Ford said it will inject $1 billion over the next two years into its pension plans, which are expected to be underfunded by $6.2 billion by the end of the year.

Fourth-Quarter Growth Forecast a Feeble 1.1%

A new survey predicts a puny 1.1% fourth-quarter growth of consumer spending, indicating that, once again, Lyndon LaRouche was right—this time by insisting that economic reality would strike immediately after the Nov. 5 elections.

The Blue Chip Economic Indicators survey released Nov. 11, finds that 55 economists expect the weakest growth in consumer spending in nine years, when it was 0.8% in the first quarter of 1993. Two months earlier these same economists were still predicting a fourth-quarter growth rate of at least twice this size.

But reality intervened as consumers, millions of whom have been laid off or face layoffs, cut back on purchases of cars, trucks, and even clothing. What's more, a Bloomberg News survey of economists expects that the Nov. 14 Commerce Department's figures for retail sales will show a 0.2% fall for October, after a 1.2% fall in September. Not since October-November 2000 have retail sales fallen two straight months in a row. Already May Department stores, owners of Lord & Taylor and Filene's Basement, said its sales were 4.1% lower this August to November, than the same period last year.

One economist spins this as merely "a pause in the recovery," while Bear Stearns & Co.'s chief market economist derided the consumer spending slowdown news as insignificant, since a "true demise" of consumer spending would have to be coupled with "a real turning down in the job market." Even though the jobless rate increased to 5.7%, it hasn't hit the eight-year high of 6% it was in April.

Wall Street Hit Hard by Layoffs; More Coming

Morgan Stanley & Co. will sack 20% of its global investment-banking staff, amounting to 250 layoffs, according to the New York Post Nov. 13, which recapped the wave of brokerage layoffs underway. In August, Morgan laid off 150 bankers. "Morgan Stanley's head count fell 9.3% to 57,799 employees globally at the end of August, from 63,708 at the end of February 2001." Merrill Lynch will be letting go 250-300 in the next few weeks. Wall Street brokerage firms have already cut 65,400 jobs, about 8.4% of their staff, according to the Bureau of Labor Statistics. Lehman Bros. and Bear Stearns Co. are rumored to be planning more cuts before bonus season.

THE DERIVATIVES DEBACLE

Reflecting EIR's analysis of the implications of the derivatives bubble, Washington Post economics writer David Ignatius penned a commentary Nov. 15 titled "Bush and the Credit Bubble." He began by asking: "What's the chance that credit markets could suffer the kind of bubble-bursting collapse that has afflicted stock markets around the world over the past two years?"

Ignatius advises Bush to appoint as chairman of the Securities and Exchange Commission, someone of the stature of former Treasury Secretary Robert Rubin—who "often complained privately about the danger of a cascading failure in the derivatives market that could take down the rest of the financial system"—or former SEC chairman Arthur Levitt.

"There's far more weakness in credit markets than most policymakers recognize," he warns, adding that there are "severe weaknesses in the banking sectors of other key countries," namely, Japan, China, and Germany.

"The scariest numbers involve those exotic financial instruments known as 'credit derivatives,' which have exploded in volume over the past several years," he writes. Their value has grown from just $50 billion in December 1998 to an estimated $2.4 trillion in December 2002—dwarfing the dot.com bubble.

"It's a big, unregulated circus, and sensible analysts have been scared about the derivatives market for years."

But, he concludes, "despite all this high-level worry, Washington has done little to address the problem."

All Forms of Derivatives Show Explosive Growth

EIR has put together the following sketch of the dramatic increase in derivatives trading over the past year:

*Over-the-Counter Derivatives: The amount of OTC derivatives outstanding increased 15% to $128 trillion during the first six months of 2002, largely driven by an increase in interest-rate contracts, the BIS reported Nov. 8. When combined with the $24 trillion in exchange-traded derivatives, the global derivatives total was $151.6 trillion at mid-year, the highest figure ever reported by the BIS. The BIS figures are "adjusted for double-counting. Notional amounts have been adjusted by halving positions vis-à-vis other reporting dealers," report noted.

*Credit Derivatives: Growth "dramatically surpassed" expectation, said the British Bankers Association. At the end of 2001, the global market for credit derivatives was $1,189 billion, and the market is expected to grow to $1,952 billion in 2002 and reach a "staggering $4.8 trillion by 2004," according to the group's 2001/2002 credit derivatives report. By comparison, credit derivatives outstanding stood at $180 billion in 1997, $350 billion in 1998, $586 billion in 1999, and $893 billion in 2000.

"In a year fraught with major bankruptcies such as Enron, Swissair and Argentina's failure to pay—the largest sovereign default ever—credit derivatives have proven their effectiveness in buffering major shocks to the global financial system," the report said.

*Exchange-Traded Derivatives: Volume was up 40% in the first nine months of 2002, and is headed for a record year, the Futures Industry Association forecast Nov. 6. The total turnover in futures, options on futures, and options on securities was 4.32 billion contracts for the first nine months of 2002, a 40% increase over the volume for the same period last year, as the futures exchanges head for another record year, according to FIA. A record 3.2 billion contracts were traded in 2001, which itself was a 57% increase over 2000.

Leading the increase was the Korea Stock Exchange, home of the world's most active exchange-traded derivative, the option on the Kospi 200 stock index. More than 1.25 billion Kospi 200 options changed hands in the first nine months of 2002, accounting for 63% of the global increase in exchange-traded derivatives activity. The KSE was the leading derivatives exchange in 2001, thanks to a 300% increase in trading which boosted it from fourth in 2000.

Equity Derivatives: Surveyed for the first time this year, totalled $2.3 trillion for the first six months. The notional amount of interest-rate and currency derivatives rose 19% in the first half of 2001, to $82.7 trillion, and credit derivatives grew 44% to $1.6 trillion, according to the International Swaps and Derivatives Association's mid-year survey.

"All swaps in the Survey grew significantly in the first half of 2002, but the growth in credit derivatives exceeded all expectations," said ISDA Chairman Keith Bailey.

Fed Reports Record Levels of Home Mortgage Refinancing

The Federal Reserve Board, in its "Senior Loan Officer Opinion Survey on Bank Lending Practices" for October, noted that 2002 has "seen record levels of home mortgage refinancing," and that a large part of that is cash-out-refinancing. "About 70% of banks reported that the typical increase [of the amount the home-owner's new mortgage was greater than his old mortgage] was between 5% and 15% of the original outstanding balance. More than 25% indicated that the typical increase, again as a percentage of the original outstanding balance, was greater than 15%." Thus, 25% of banks experienced, in the case of customers who refinance their mortgages at higher levels, that these home-owners increased the amount they borrowed by at least 15%, and thus used a portion of that to increase consumer spending.

WALL STREET POLICE BLOTTER

*William Webster, former CIA and FBI Director, was forced to step down as chairman of the FEC's Accounting Oversight Board, just one week after chairman Harvey Pitt resigned. Webster himself is now the subject of an SEC investigation, for his role as head of the audit committee of U.S. Technologies, which is now insolvent and is being investigated for accounting fraud.

*R.J. Reynolds has been accused of money-laundering in a lawsuit filed Oct. 31 by the European Union in New York. The lawsuit charges RJR and its subsidiaries with a vast conspiracy: helping Russian organized crime and Columbian drug traffickers launder billions of dollars, and smuggling cigarettes into Iraq, including through the Kurdistan Workers Party (PKK), designated a terrorist group by the U.S. in 1998.

RJR executives, according to the complaint, made it "part of their operating business plan to sell cigarettes to and through criminal organizations and to accept criminal proceeds in payments for cigarettes by secret and surreptitious means."

RJR and its subsidiaries, allegedly set up special operating units to help launder money for criminal groups, using special accounting methods, offshore tax havens and false invoicing.

*Adelphia's former vice president for finance, James Brown, pleaded guilty to charges he conspired with founder John Rigas and two of his sons to defraud the sixth-largest U.S. cable television operator. He is cooperating with Federal prosecutors. Brown admitted, in U.S. District Court in New York, that he conspired to misstate Adelphia's revenue and earnings. He faces up to 30 years in prison, for charges of conspiracy, securities fraud, and bank fraud.

*Merck, the world's third-largest drugmaker, is under investigation by the U.S. Department of Justice for its marketing practices.

*Schering-Plough has received two additional grand jury subpoenas from the U.S. Attorney's office in Massachusetts, over whether it improperly inflated the whole sale prices of its drugs, resulting in higher government reimbursement rates.

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