Austerity and Gross Domestic Production

Posted by Eugen von Böhm-Bawerk

The Europeans tried austerity, the act of reducing budget deficits, and they did not like it. It was no fun, so they decided to focus on growth instead. We have no idea what that means, but apparently they believe they can go back to the heydays when consumption had nothing to do with actual production. For example, the Greeks ran a massive goods deficit with the rest of the world (and they still do). At the peak this amounted to a staggering sum of 48 billion euros. At the time that meant almost 12 thousand euros per Greek worker, which corresponds roughly to what he made on a net basis that year! In other words, the Greek worker got 12 thousand euros from his employer which he spent on consumption and simultaneously consumed an additional 12 thousand through indebting himself to foreigners. According to the Organization of Economic Co-operation and Development (OECD) saving rates in Greece, as per cent of disposable income, is deeply negative and has been for many years. In other words, the Greek society has consumed far more than they themselves produced of value. This is not unique to the western world; on the contrary, most western countries have consumed more than they have produced for quite some time.

Knowing a thing or two about capital theory we would expect output in these economies to nosedive over the same period. Production comes out of capital accumulation and if society regresses through capital decumulation it follows logically that output must fall. However, if we look at consumption and GDP in Greece since 2000 we find a positive correlation! And even more striking, the correlation between savings and GDP is negative! Everything we have ever learnt about personal finance, building a business or capital theory seems lopsided! According to the data it is the exact opposite! The more you consume and the less you save the more you grow your economy!

To make matters even more obscure, we can also find a positive correlation between government expenditure and output. If the government spends more money output increases and visa verse. No wonder the Europeans found austerity boring. Only an evil person (or an environmentalist) would advocate austerity when faced with such “proof”.

Source: Eurostat, OECD, own calculations

Source: Eurostat, own calculations

In order to answer this apparent conundrum we need to ask ourselves what GDP actually measure? In “Taking the Pulse on the Economy: Measuring GDP” by Landefeld et al. we learn that “the method [to calculate GDP] produces consistent estimates of the value of final sales to consumers…” in addition one has to add “government expenditures on goods and services”. This is what economists call final demand, or expenditure, approach. In other words, gross domestic production is derived primarily from household and government consumption. We say primarily, because statistical bureaus do adjust for net exports and government transfer payments. However, as per cent of the total these are relatively small.

The Bawerk.net reader will immediately understand why we consistently call GDP for gross domestic consumption, or GDC. It does not measure production at all, but rather consumption. And due to today`s perverted credit system the two can be completely decoupled both for individuals and nations!

Historically the so-called GDP concept were made out of the Keynesian worldview expressed in the infamous tautological equation Y = C + I + G + X where output (Y) equals consumption adjusted for net export.

Through a complete obfuscation of the terms and expression now used in our daily conversation about economics we often hear utter nonsense such as the US economy is driven by household consumption. In sheer ignorance one can even hear self-proclaimed experts; banksters and pundits state that 70 per cent of the US economy is household consumption. If that were true, we would see the following development in the US of A:

The simple fact that we do not see this should be enough to discredit the whole notion of GDP and we recommend everyone to start call it what it really is; gross domestic consumption, or GDC. Only by doing so can we once again have a meaningful conversation about economics in general and austerity in particular. Yes, if you reduce consumption, then measured consumption as expressed by GDC will also fall. Conversely, if you lower your saving rate GDC will increase.

However, there is an entirely different way of thinking about GDC. We have established that GDC measures aggregate demand. We also know that aggregate demand (AD) can be expressed in currency units. In other words, GDC = AD = M2*Velocity. We also know that M2 = monetary base * multiplier. Substituting for AD, we can say that GDC = Velocity * (Monetary base * multiplier). In this sense we can deconstruct the GDC for every nation with available statistics as pure monetary phenomena. The next chart shows US GDC as reported by the Bureau of Economic Analysis (BEA) and broken down to its logical monetary constructs.

Source: Bureau of Economic Analysis (BEA), Federal Reserve (Fed), own calculations

Suddenly it becomes obvious how destructive programs such as quantitative easing (QE), which allocate resources directly into the ominous 1 per centers pockets, can actually lift GDC. At this point the reader might ask if the price deflator used to calculate a real GDC number will compensate for the effect from QE-programs.

We test for that by deflating GDC with various price gauges, such as the official BEA GDC deflator, the BLS CPI, the Billion Prices Project (only from 2008) and ShadowStat`s constant CPI methodology to see what have happened with real GDC. Interestingly enough, the BEA deflator that is actually used to derive the real GDC number is the most lenient. Even using the CPI we get consistently lower GDC growth. If we were to use Mr. Williams’s constant CPI methodology concept we see how detrimental overconsumption can be to actual wealth creation to the extent GDC measures wealth.

Source: Bureau of Economic Analysis (BEA), Bureau of Labor Statistics (BLS), Billion Price Project (BPP), Shadowstat (SGS), own calculations

Conclusion

The concept we call gross domestic production is highly distortive. In obfuscate intelligent debate in economics as the true underlying force for economic growth, capital accumulation, is seen as detrimental to prosperity.

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Both Ends Burning

by Pater Tenebrarum

Political Risk Threatens to Reignite Crisis in Europe

It couldn't come at a more inopportune moment: the crisis that is increasingly engulfing Mariano Rajoy, and the mounting legal troubles besetting Silvio Berlusconi, the realization that Portugal's crisis remains intractable and Greece  careening toward another summer of discontent (even as the tourism industry is recovering slightly), as civil servants and their unions gear up to fight the latest troika-imposed cuts. The moment is so inopportune because Olli Rehn and others have to once again fear for their summer vacation. Euro area crises  have an odd habit of flaring up in the middle of the summer.

Rajoy's troubles, as some speculate, may actually be the result of a kind of palace coup: apparently there are factions within the PP that want to be caliph instead of the caliph. No-one ever doubted that Spain's politics were riddled with corruption, so the main question should actually be: 'why is it all coming to light all of a sudden'? After all, if former PP treasurer Louis Barcenas is to be believed, the particular scams he and his buddies were engaged in went on for 20 years running. Former prime minister Jose Maria Aznar has been mentioned as a possible culprit, but he too is on the 'Barcenas list' of receivers. Others suspect that the Most Excellent Countess of Bornos, Esperanza Aguirre y Gil de Biedma, the former president of Madrid, may have a hand in the proceedings, since she isn't implicated and is loudly calling for a clean-up of the party.

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Somewhere in the PP, there is an Iznogoud lying in wait.

(Tabary, Goscinny)

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Interestingly, Rajoy seems to be on a mission to remain right where he is, regardless of what new information comes to light (the latest being his text messages of support to the jailed Barcenas). The FT reports:

“Mariano Rajoy was battling on Monday to contain the political fallout from the slush fund scandal that has rocked his party, dismissing calls for him to step down and warning of the risks of plunging Spain and its long-suffering economy into “political instability”.

“I will defend political stability and I will complete the mandate given to me by the Spanish people,” the Spanish prime minister said.

His comments came amid growing concern over the political and economic impact of the scandal, which revolves around allegations that the ruling Popular party operated a slush fund from which it made undeclared cash payments to senior party leaders.

The affair has sapped the government of political capital and popular support at a time when Madrid is locked in a desperate struggle to lift the country out of recession and tackle Spain’s unemployment crisis. European leaders and foreign investors have long regarded Spain’s political stability as a key asset – and one that has set Madrid apart from other crisis-hit countries in southern Europe, such as neighboring Portugal.

Polls show the scandal has already inflicted severe damage on the standing of both the PP and Mr Rajoy personally, with fewer than a quarter of voters saying they would vote for the ruling party if elections were held now.

Mr Rajoy was speaking just hours after the man at the center of the scandal launched a fresh legal broadside against the prime minister and other senior PP officials. Luis Bárcenas, the former party treasurer, told a criminal court in Madrid that he indeed managed a slush fund that was fed by secret donations from construction companies and other businesses.

According to several accounts of the closed-door hearing, he also confirmed allegations that the fund was used to make quarterly cash payments to top party functionaries, including to Mr Rajoy himself. In a new revelation, Mr Bárcenas said he made additional cash payments worth €20,000-€25,000 to Mr Rajoy and to Dolores de Cospedal, the party leader, between 2008 and 2011.”

(emphasis added)

It doesn't sound as though that 'key asset' of political stability is still worth much in Spain, but for now Rajoy and his supporters have decided to attempt to undermine Barcenas' version of events by implying that he is just trying to divert attention from the €48 million he managed to spirit away for himself.

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Spain's 10 year government bond yield – no big moves yet, but it remains at some distance from recent lows – click to enlarge.

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The IBEX index in Madrid, weekly – click to enlarge.

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Cavaliere in Dire Straits

That Berlusconi's past is now catching up with him is fairly easy to explain: the eurocratic elites want to get rid of this embarrassing maverick. He's not with the program, no fan of Monti's austerity policies and on record for stating that Italy should rather opt for leaving the euro than becoming an economic vegetable under the diktats of Brussels. The peculiarities of Italy's penal code ensure that Berlusconi will never see a prison from inside, but if he gets convicted again, it will almost certainly finish his political career. Ironically, he is driven to keep going as a politician precisely because he can most effectively fight against the courts from a position of political power.

However, if his final appeal in a tax fraud case on July 30 ends with a conviction, he will be banned from public office for five years – his political career will be over. Not only that, his party will lose its main attraction. It is interesting how this case has progressed. The latest developments suggest that the outcome is almost preordained:

“Lawmakers from the People of Liberty party, known as the P.D.L., asked for time for consultation, the day after Italy’s highest court scheduled a hearing on July 30 for Mr. Berlusconi’s final appeal in a tax fraud case. This date came months earlier than expected. The decision by the court, motivated by the need to prevent the statute of limitations from expiring on one of the charges facing the former prime minister, caused a political uproar.

A definitive conviction would result in a five-year ban from public office for Mr. Berlusconi. If the high court’s decision is upheld by the Court of Cassation and by Parliament, it would likely result in a political earthquake for the left-right coalition.”

(emphasis added)

Meanwhile, a burgeoning scandal over the deportation of the family of a Kasakh dissident threatens to sink Berlusoni's top political aide and his man in Italy's cabinet, interior minister Angelino Alfano.

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Italy, 10 year government bond yield – click to enlarge.

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The MIB Index in Milan, weekly – click to enlarge.

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Political Risk Likely to Crystallize Somewhere

As Nordea points out in a summary of the growing political risks in the euro-land periphery, it would almost be a miracle if all the bullets were dodged. In brief:

Greece's government is hanging by a thread. The now smaller coalition (minus the Democratic Left, which has taken 14 MPs with it), has a slim majority of just five seats in parliament. It won't take much to bring it down, and the government may not be able to push through the 'troika's' demands without breaking apart (note in this context that junior partner PASOK is strongly intertwined with the public sector).

In Portugal it is not certain that the socialist opposition will yield to the president's demand of a 'national salvation agreement' with the tottering government – it is after all leading in the polls at the moment.

As to Italy and Spain, see above – it should also be mentioned though that Italy has just been downgraded again, along with France. The recent Fitch downgrade of France, which is a major guarantor of the EU's bailout vehicles, has incidentally also led to a downgrade of the EFSF.

John Dizard writes in the FT that the new rules that allow rating agencies to only issue ratings on European sovereigns at set time intervals could lead to unintended consequences (surprise!):

“European authorities, even more than their US counterparts, have taken note of the shortcomings of rating agencies, which now must allow at least six months between changes in the ratings of EU sovereign issuers. The US regulators are still chafing at the restrictions imposed on them by the First Amendment’s “freedom of speech”. And yet . . . isn’t it possible there could be unintended consequences of these changes? Consequences that could lead the hated speculator class to make outsized, socially useless, profits?

For example, when S&P downgraded the Italian sovereign to triple-B last week, it suggested that the next change, obviously at least six months from now, could be for more than one notch. After all, by next February it may appear to be the case that Italian political, economic, and financial risk is accelerating at a rapid rate. If so, the agency could be in the position of being forced to rate Italy as an investment-grade credit long after Beppe Grillo or his successors and allies had followed through on their threat to turn it into a junk issuer.

The tightening in collateral requirements by regulators and institutional risk managers could have even more serious effects. Take a look at the Bank for International Settlements’ May 2013 Paper No. 49 on “Asset encumbrance, financial reform, and the demand for collateral assets”.

You really must read the entire document, perhaps at the beach. It goes into interesting details such as “the cliff effect”, which is not a good thing, and “procyclical liquidity management practices”, which means that crashes get bigger as financial institutions demand more and better security from their counterparties.”

(emphasis added)

Dizard suggests that one way of making a bit of 'socially useless profit' out of this situation would be to go long German Bunds before Italy's rating is dropped to junk. After all, in that case there will likely be a scramble to get hold of the above mentioned 'better security' provided by collateral issued by Germany, i.e., the recently favored carry trades would likely go into reverse in a hurry.

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Germany, 10 year Bund yield – click to enlarge.

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Nordea also mentions in passing that neither the Cyprus crisis, nor the still simmering situation in Slovenia can be said to be 'over' by any stretch of the imagination (Slovenia's budget deficit is set to double after the bank bailout. Note that since the banks belong to the government, it is essentially bailing out itself).

The Luxembourg snap election due to JC Juncker resigning over a spying scandal is probably not so important (it is interesting that in Luxembourg, the prime minister has to resign over a spying scandal, while elsewhere much greater spying scandals seem to be taken in stride by the ruling class). How important the steep slide in president Hollande's popularity is remains to be seen.

It is a good bet that Bryan Ferry didn't have Mariano Rajoy, Pedro Passos Coelho, Silvvio Berlusconi and Antonis Samaras in mind when he wrote the following words, but they are oddly appropriate to the situation (the people 'counting sheep' would be the bond traders buying periphery bonds at present in the hope that the fire won't reach them):

Both ends burning while you're counting sheep

Hell– who can sleep in this heat this night?

Tell me will I ever learn?

It's too late, the rush is on

Both ends burning and I can't control

The fires raging in my soul tonight

Oh will it never end?

Put your foot around the bend

Drive me crazy to an early grave

Tell me what is there to save tonight

Both ends burning

Burning

Burn

Keep on burning till the end, until the end

Keep on burning till the end, the very end”

(from Roxy Music's 'Both Ends Burning')

Conclusion:

The summer of 2013 may become more interesting than was hitherto expected.

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Chinese cotton inventories may usher in the bear

By Sholom Sanik

Global cotton (NYBOT:CTV13) output is expected to fall by 2.6% from the previous season, to 118 million bales, while consumption is expected to grow by 2.2%, to 110 million bales. Still, the balance sheet for the global cotton market is set to record yet another production/consumption surplus that will be heaped on top of burdensome carryover stocks from the 2012-13 marketing year. Ending stocks are estimated to grow to a record 94.34 million bales, or a staggering 85.9% of usage. That’s up from 79.6% last season and 68.9% in 2011-12.

What’s been keeping the market afloat, and whatever it is, can it last?

The U.S. is the world’s largest exporter of cotton, so there is a heavy focus on the U.S. crop. Planted area was 17% below last year and 30% smaller than in 2011-12. The crop was planted very late because of the very wet spring. Some key growing regions in Texas are now experiencing severe drought that will probably result in a high rate of abandonment that will reach 40% in the Southwest.

Average national yields are expected to suffer, falling to 831 pounds per acre, compared with 887 pounds per acre last year. In the July crop report, the USDA raised its acreage and yield estimates, but also increased its estimate for abandoned acres, leaving the forecast for the crop unchanged from June at 13.5 million bales. That will be the smallest crop since 2009-10. The supply side is not the issue, though. As illustrated above, warehouses are bursting at the seams. Crops in producing nations, other than the U.S., are about the same size as in recent years.

The Indian monsoon has been above average. The USDA raised its estimate for Indian production by 1 million bales from its June estimate, to 28 million bales, or 5.6% higher than last year. The upward revision was possibly a reflection of the successful passing of the critical on-time arrival of the monsoon. The Chinese crop is down 1 million bales from last year, or 2.8%, but that is not very likely to result in increased imports — as explained below. A U.S. crop failure — while, still a possibility — may not mean what it once did.

As with many commodities, Chinese import trends are the key. China’s cotton stocks have ballooned to 59 million bales — having grown from only 10 million bales in 2010-11. The government is rumored to be poised to sell off inventories, and imports are expected to decline. In 2011-12, 54% of U.S. exports went to China, compared with only 42% for the current marketing year.

Chinese imports from all sources peaked in 2011-12 at 24.5 million bales. In 2012-13 that figure fell to 20 million bales, and for the coming season, imports are expected to plummet to only 11 million bales. If China were to unleash its stocks, it would take a full season or perhaps two to see it return as a steady and reliable purchaser.

The flip side is that we do not actually know how large the stockpile is. The only solid information is the study of China’s importing patterns. But as such, we may indeed be at the beginning of a period of greatly reduced Chinese imports.

U.S. shipments for the outgoing 2012-13 marketing year have tapered off over the past four weeks, averaging only 160,000 bales. The July crop report cut the export estimate by 300,000 bales, to 13.3 million bales. But with only three weeks left to the marketing year, exporters would have to ship just under 300,000 bales per week to reach the USDA target, which is unlikely to occur. The USDA will have to cut its estimate again, which will increase the already-exhausting estimates for ending stocks.

We were stopped out of long position at 82.5¢ per pound, basis December, as per our May 8 recommendation. Massive global stockpiles will eventually find their way to the market and will depress prices. Establish short positions in December cotton. Place initial stops at 88¢, basis December, close only.

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High Gas & Oil prices will damage the consumer if this happens-

by Chris Kimble

CLICK ON CHART TO ENLARGE

Without a doubt high gas prices has its negative impact on the consumer.  The talking heads have been discussing how high gas prices could reach in the near future. Lets step back for a moment and look at Crude oil prices, traders positions and gas prices.

The upper left chart reflects that traders have established positions where Crude oil has been closer to a high than a low over the past few years. The upper right chart takes a different slant on traders positions in crude oil, yet the message is the same. The lower left chart reflects that a falling resistance line is coming into play in gasoline futures, that has stopped the rally in the past couple of years.

Bottom line, resistance is at hand in Crude oi & gas futures. If the oil markets can break above these resistance levels, it would send a concerning message to the consumer....at this time resistance is resistance.

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Goodbye Full-Time Jobs, Hello Part-Time Jobs, R.I.P. Middle Class

By Michael Snyder

A fundamental shift is taking place in the U.S. economy.  In fact, this transition is rapidly picking up momentum and is in danger of becoming an avalanche.  The percentage of full-time jobs in our economy is steadily declining and the percentage of part-time jobs is steadily increasing.  This is not a recent phenomenon, but now there are several factors which are accelerating this trend.  One of them is Obamacare.  The truth is that Obamacare actually gives business owners incentive to cut hours and turn full-time workers into part-time workers, and according to the Wall Street Journal and other prominent publications this is already happening all over the United States.  Perhaps this is part of the reasons why the U.S. economy actually lost 240,000 full-time jobs last month.

In a recent article entitled "Restaurant Shift: Sorry, Just Part-Time", the Wall Street Journal explained the choices that employers are faced with thanks to Obamacare...

The Affordable Care Act requires employers with 50 or more full-time equivalent workers to offer affordable insurance to employees working 30 or more hours a week or face fines. Some companies have said the requirement could increase their costs significantly, although others have played down the potential hit.

The cost for small firms to comply with the health law will depend largely on the number of additional full-time employees that sign up for employer-sponsored coverage. Average annual premiums for employer-sponsored health insurance in 2012 were $5,615 for single coverage and $15,745 for family coverage, according to the Kaiser Family Foundation. That is up from $3,083 and $8,003, respectively, in 2002.

Thankfully the implementation of this aspect of Obamacare was recently delayed, but a lot of employers are saying that it won't make a difference.  They know that it is coming at some point, and so they are already making the changes that they feel they will need to make in order to comply with the law...

Restaurant owners who have already begun shifting to part-time workers say they will continue that pattern.

"Does the delay change anything for us? Absolutely not," Mr. Adams of Subway said, explaining that whether his health-care costs go up next year or in 2015, he will have to comply with the law. "We won't start hiring full-time people."

This is very sad, because we have already been witnessing a steady erosion of "breadwinner jobs" in this country.

It is very, very difficult to support a family if you just have a part-time job or a temp job.  But those are the jobs that our economy is producing these days.

In fact, if you can believe it, the second largest employer in the United States is now a temp agency.  Kelly Services is actually the second largest employer in the country after Wal-Mart.

Isn't that crazy?

And full-time employment continues to lag far, far behind part-time employment.  The number of part-time workers in the United States recently hit a brand new all-time record high, but the number of full-time workers remains nearly 6 million below the old record that was set back in 2007.

For much more on this, please see my previous article entitled "15 Signs That The Quality Of Jobs In America Is Going Downhill Really Fast".

At this point, employees are increasingly considered to be expendable "liabilities" that can be dumped the moment that their usefulness is over.

For example, employees at one restaurant down in Florida were recently fired by text message...

It's bad enough losing your job, but more than a dozen angry employees say they were fired from a central Florida restaurant via text message.

Employees at Barducci's Italian Bistro said they lost their jobs without notice after the restaurant suddenly closed and are still waiting for their paychecks.

This shift that we are witnessing is fundamentally changing the relationship between employers and employees in the United States.  The balance of power has moved very much toward the employers.

Most employers realize that there is intense competition for most jobs these days.  If you get tired of your job, your employer can easily go out and find a whole bunch of other people who would be thrilled to fill it.

So why has the balance of power shifted so dramatically?

Well, for one thing we have allowed millions upon millions of good paying jobs to be shipped out of the country.  Now American workers literally have to compete for jobs with workers on the other side of the planet that live in nations where it is legal to pay slave labor wages.

This should have never happened, but voters in both major political parties kept voting for politicians that were doing this to us.

Now we all pay the price.

Another factor is the rapid advancement of technology.

These days, businesses are trying use machines, computers and robots to automate just about everything that they can.  The following example comes from a recent Business Insider article...

On a windy morning in California's Salinas Valley, a tractor pulled a wheeled, metal contraption over rows of budding iceberg lettuce plants. Engineers from Silicon Valley tinkered with the software on a laptop to ensure the machine was eliminating the right leafy buds.

The engineers were testing the Lettuce Bot, a machine that can "thin" a field of lettuce in the time it takes about 20 workers to do the job by hand.

The thinner is part of a new generation of machines that target the last frontier of agricultural mechanization — fruits and vegetables destined for the fresh market, not processing, which have thus far resisted mechanization because they're sensitive to bruising.

So what happens when the big corporations that dominate our economy are able to automate everything?

What will the rest of us do?

How will the middle class survive if they don't need us to work for them?

Over the past couple of centuries, we have witnessed several fundamental shifts in our economy.

Once upon a time, a very high percentage of Americans worked for themselves.  There were millions of farmers, ranchers, small store owners, etc.

But then the industrial revolution kicked in to high gear and big corporations started to gain more power.  Millions of Americans went to work for these big corporations, but it was okay because they paid us good wages to work in their factories and the middle class thrived.

Unfortunately, the big corporations have realized that things have changed and that they don't really need us anymore.  They can replace us with technology or with super cheap labor overseas.

So that leaves the rest of us in quite a quandry.  Very few of us own our own businesses.  In fact, the percentage of self-employed workers in the United States is at an all-time record low.  And the number of us that are needed by the monolithic corporations that dominate our system is dropping by the day.

All of this is very bad news for the middle class.  The only thing that most of us have to offer is our labor, and the value of our labor is continually declining.

Unless something dramatic happens, the future of the middle class looks very bleak.

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Goldman Sachs: Net Income Doubles

By tothetick

As the trial of Fabulous Fab gets under way in Manhattan, there is someone that will be hearing the clinking of champagne glasses as they celebrate the doubling in profits of the rogue ( well, we love a scapegoat in the story, even though we all know it can’t be true) trader’s former employer, Goldman Sachs.

Goldman Sachs has just announced that their net income increased in the second quarter this year and announced this morning that it hit $1.93 billion. Last year they had a net income of only $962 million at the same time. Net revenue was also announced as having increased by 30%, which means either a jump or a leap from $6.06 billion to $8.61 billion. It had been suggested by some analysts that quarterly revenue would only rise by 20.5% (which in itself was already high), reaching $7.98 billion. Over the past year there has been a 37% growth in revenue for the bank.

Goldman Sachs in the meantime decided to cut 300 jobs in the second quarter this year in a bid to reduce expenses. That's certainly called living up to your name. Goldman does sack. Compensation (including salaries, bonuses and deferred pay) increased by 10% to $8.04 billion from January to June. But, it is debatable obviously as to who might be getting the biggest chunk of all of that. Total revenue increased by 13% (reaching $18.7 billion). It all seems rather surprising that there are cuts in jobs and yet increases across the board in net revenue, revenue and net income for the investment bank. The present Chief Executive Officer and Chairman of the bank is Lloyd Blankfein, who has an estimated net worth of $450 million, with an annual salary that hits the $55-million mark. He is estimated to be one of the highest paid guys in the business and his bonuses reach levels of over $27 million.

Goldman Sachs: Lloyd Blankfein

So, the champagne should be flowing, right? Net income up, net revenue up. Both are better than estimates had predicted. But, it obviously doesn’t work like that, does it? The value of Goldman Sachs’ shares fell at 9:39 ET today by 0.07% (down $0.1100 to $162.89). Share value has ranged from $91.15 to $168.20 over the past 52 weeks for the investment bank.

So, why the fall?

There have been growing concerns that Goldman Sachs will not be in a position to meet the stringent capital standards that are imposed on the largest banks in the USA. Financial regulators have made it a requirement to increase capital leverage from a 3% to a 5% ratio (of assets). This may mean that there will be a reduction in dividend payouts in order to maintain the capital. The ratio is regardless of whether there is a risk or not in the company. However, it does seem that that might be to the detriment of the number of employees in the bank. Skimming off a few hundred employees might just mean that they will be able to pay something out. Although, by the reaction of Wall Street this morning, the investors are not quite so certain.

However, there are some that might also suggest that if the banks are having to amass large amounts of capital to reach that ratio percentage, then the only ones that are going to suffer are going to be the people that see their access to loans being reduced and limited while the banks get the cash. Market volatility would undermine credit availability and there would be ensuing worsening of the situation. Looks as if we are ready to go round in circles again. The authorities and the regulators impose stringent requirements to protect the people, the banks close the taps and pull the plugs and the objective that was meant to be avoided actually comes into being. They will have done exactly what they wanted to avoid doing. The borrowers, the people will be the ones that are affected, certainly not the shareholders and not the banks themselves.

The Federal Reserve and the Federal Deposit Insurance Corp., with increased pressure being put on them by policy makers and the legal system decided to go even further than Basel III requirements which stand at 3% for capital leverage ratios. This means that the requirements imposed on US banks are almost double those that are being required of other banks around the world.

The banks are currently trying to push the regulators to accept a different type of calculation of leverage (including fewer off-balance-sheet assets, as well as the exclusion of some items). Some have even suggested excluding Treasury holdings and money that is held at the Federal Reserve. That alone would vastly improve their ability to meet the new standards and at the same time provide the possibility of still paying out dividends.

In the meantime, the trial of Fabrice Tourre opened yesterday and brought Goldman Sachs into the spotlight once again. As the trial opened Tourre was said to be either a ‘liar’ or a ‘scapegoat’ by his defense lawyers. He was said to be far from ‘fabulous’ at all and just a childish trader that wrote teenage love-letters to his girlfriend telling of the portending doom. Look as if we are getting ready for a complete descent into hell, with the destruction of one man’s credibility and character along the way as usual.

I guess Fabrice Tourre should have remembered that story about the guy that dies and gets to choose whether he wants to go to heaven or hell. He spends a day in heaven where life is cool, but nonetheless rather staid and boring. Nothing actually happens. In hell, as the lift doors open, he is greeted by good-looking people and everybody is having a whale of a time. Parties, smiles, back-slapping, laughter. Obviously the place to be! He opts for hell, tells God and then goes there the next day. But, when the doors open this time, it’s a different scenario, fire-breathing sweltering heat and the devil pops up, far uglier than he was the day before. The guy that’s just died says, "this wasn’t like this yesterday". The devil replies, “no, but yesterday, we were recruiting. Today, you are staff!”

Fabrice Tourre should have known that the doors opened onto a hellish nightmare.

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