Do Warning Signs Abound For U.S. Economy?
by Harley Schlanger

A plan to save the U.S. economy?  

July 7 — In the build-up to the G20 summit in Hamburg, there has been much happy talk coming from Trans-Atlantic government officials, Central bankers and the media about the arrival of the long-awaited “economic recovery.” From Brussels, European Central Bank (ECB) chairman Mario Draghi sounded cautiously optimistic, telling European Union leaders on June 23 that the EU is experiencing economic growth and an “improving business climate”, while ECB Executive Board member Peter Praet was much less constrained. In a meeting of bankers in Paris on July 6, he declared that the recovery “has gathered some further momentum recently,” and that there is a “solid upswing” becoming an “increasingly solid cyclical recovery.”

One might ask if the two of them consider the unresolved Greek debt crisis, and the bailouts of Spanish and Italian banks, in violation of new EU banking rules, evidence of a “solid upswing”!

As for the United States, Federal Reserve Chairman Janet Yellen was even more upbeat, after the major U.S. banks passed the most recent “stress test.” In an exchange with London School of Economics Professor Lord Nicholas Stern, Yellen said the U.S. banking system is now “very much stronger” due to Fed supervision and higher capital levels. In fact, she added, another banking crisis is unlikely “in our lifetimes.” When asked if she thinks stock valuations are too high, Yellen replied that “by some standard metrics, asset valuations look high,” but then hedged, saying “there’s no certainty about that.” Her explanation sounded eerily reminiscent of former Fed Chair Alan Greenspan, who publicly announced he saw no evidence of “irrational exuberance” as investors sent tech stocks soaring in the late 1990s, before the dot-com stock bubble proved him wrong, by crashing in 2000.

Yet, for all this “good news” from the U.S., there are warning signs that all is not well. Yellen’s vice chair, Stanley Fischer injected a note of concern, saying the “increase in prices of risky assets (that is, corporate stocks and bonds, including junk debt — HS)…points to a notable uptick in risk appetites,” adding that continued high valuations in the face of low earnings “is also a cause for concern.” He concluded by stating that the corporate sector — the stock valuations of which are at record levels — is “notably leveraged”. This is a strange, understated way of looking at the $14 trillion of non-financial corporate debt, much of which will never be collected, which has surpassed the amount of mortgage-backed securities debt which crashed the market in 2008, when that debt reached $11 trillion.

THE FRAUD OF THE STRESS TESTS

The belief that the stress tests demonstrated the security of the banking system, as touted by Yellen, has come under fire, ironically by the Wall Street-loving New York Times. In a July 3 editorial, the editors write, “It’s entirely possible that the system is more fragile than the Fed’s stress tests indicate.