Tuesday, May 8, 2012

More involvement from the European Central Bank

Stock futures pared early losses Monday after Sunday's elections in France and Greece rattled investors' confidence.
Dow futures were off 41 points. Nasdaq 100 futures traded down 8.25 points and S&P 500 futures dipped 4.2 points.
Voters in France dumped President Nicolas Sarkozy for socialist candidate Francois Hollande. Hollande ran in opposition to the austerity measures backed by Sarkozy, calling for higher taxes to support growth and more involvement from the European Central Bank.
In Greece's parliamentary elections, 60% of the popular vote went to fringe parties, but fell short of

Agricultural chemicals industry

IBD has long emphasized that investors ought to pay particular attention to relatively young companies.
Many such companies have become big stock market winners in the years just after their IPOs.
With that in mind, IBD's NYSE + Nasdaq Research Tables point out highly rated companies that came public in the last 15 years. Those stocks have a triangle next to their names.

The Stock Spotlight screen also can be a good place to look for recent IPOs.
Two agricultural chemicals companies that went public last year have made the screen: Sugar Land, Texas-based CVR Partners (UAN) and Los Angeles-based Rentech Nitrogen Partners (RNF).
The thinly traded CVR appears to be working on the right side of a new consolidation. The pattern appears to be part of a base-on-base formation.

The previous session's steep losses

Cocoa futures soared to a five-week high Tuesday, recouping the previous session's steep losses as the ICE market vaulted more than 6% on short-covering.
July cocoa soared $100, or 4.5%, to $2,319 per metric ton, the highest since March 28, after flying as high as $2,356. Cocoa climbed in an initial corrective bounce from Monday's 7.1% tumble, but sharply extended its gains ahead of the settlement window on a wave of short-covering, dealers said.
"It's a mixture of some spec short-covering, some new longs as we rejected the lows of yesterday," said Drew Geraghty, a commodity broker at ICAP North America in New Jersey. "I think this is technical short-covering."
Cocoa futures closed above their 100-day moving averages, after falling below those levels on Monday.
The rally lifted volumes, which were light prior to the surge, to just below the 30-day average, though traders in continental Europe were on holiday for the May 1 "May Day"and many dealers away from their desks before a trade dinner in London on Friday.
"The open interest reflecting yesterday's business shows the funds got short the market," Geraghty said. "Looking at the volume profile of yesterday's business, it looks like a lot of these shorts are trapped between $2,210 and $2,146, yesterday's low."
Open interest jumped to 182,814 lots on April 30, the highest in nearly six months, while Monday's volume jumped to nearly 36,000 lots, a two-week high, ICE data showed.

Thursday, May 3, 2012

Health insurance plans

Insurance companies will have to return more than $1 billion this year to consumers and businesses, thanks to a new requirement in President Barack Obama's health care overhaul, a report released Thursday concludes.
That's real money, says Larry Levitt of the Kaiser Family Foundation, which analyzed industry filings with state insurance commissioners. The law requires insurers to spend at least 80% of the premiums they collect on medical care and quality improvements — or issue rebates to policyholders.
"This is one of the most tangible benefits of the health reform law that consumers will have seen to date," said Levitt, an expert on private health insurance. The nonpartisan foundation is an information clearinghouse on the nation's health care system, and its research is widely cited.
The report comes with a caveat. It lacks data on the nation's most populous state, California, because complete filings there were not available. Nonetheless, the analysis estimates that consumers and businesses in other states will receive rebates of $1.3 billion, in some cases in the form of a discount on next year's premiums.

Among the leading stocks

Stocks have shown better action this week, helping switch IBD's market outlook to "in confirmed uptrend."
That switch came after Wednesday's session, when the S&P 500 delivered a follow-through day.
Still, the follow-through day was on the marginal side. Investors following IBD's CAN SLIM strategy should proceed with caution.
Among the leading stocks that are acting well, one common theme is a rebound off support near the 10-week moving average.
Some of the main indexes are displaying that same behavior, so it's no surprise to also see it among highly rated stocks.
Remember that in a rising market, 10-week pullbacks can provide a chance to buy a winning stock or add shares to an existing position.
Credit-card networks MasterCard (MA) and Visa (V) both have executed 10-week rebounds. MasterCard's actually looks a little better. You prefer to see active turnover in a rebound, and MasterCard has that, while Visa has rallied in below-average volume.
Longtime leader Priceline.com (PCLN) also has lifted off support at its 10-week line. Its IBD industry group, Leisure-Travel Booking, continues to sport a strong ranking, standing at No. 13 out of 197 groups as of Thursday.
Genesco (GCO) has staged a 10-week rebound, too. The shoe and hat retailer tried to clear a 75.65 buy point from a flat base April 17, but it couldn't close above that level.
The stock then fell back near its 10-week line before jumping Thursday. It now has managed to close above 75.65.
Other leading stocks have at least regained their 10-week lines, even if they haven't lifted above them at this point. Take Lululemon Athletica (LULU), for example.
Lululemon could be working on a new base as it finds 10-week support. The seller of high-end athletic clothing has been consolidating for about three weeks.

Tuesday, May 1, 2012

U.S. Federal Reserve forecast

Copper rallied Thursday to its highest level in more than two weeks, fueled by a more optimistic economic outlook from the Federal Reserve and by strong technical momentum that may drive prices back toward their 2012 highs.
Copper is higher for a third straight day, extending gains from the previous session during which the U.S. Federal Reserve forecast U.S. growth to "remain moderate over coming quarters and then pick up gradually."
The Fed also said it was ready to launch another round of bond buying if the U.S. economy weakens.
Copper prices moved through two lines of technical defense — the 100-day moving average at around $3.72 per pound and the 200-day at $3.76.
Matthew Zeman, head of trading with Kingsview Financial in Chicago, said the market's ability to hold above the 200-day should attract more buyers and again challenge the upper end of this year's trading range near $4.
"We're going to re-challenge the top end of the previous trading range ... just under $4 (per pound)," Zeman said.
July copper jumped 6.60 cents, or 1.8%, to $3.7735 per pound, after dealing between $3.6960 and $3.7845, another high dating back to April 10.
Comex volumes were heavy once again, with over 101,000 lots traded in late New York business, more than 40% above the 30-day average, according to preliminary Thomson Reuters data.

Saturday, April 28, 2012

Expectations and the smallest increase

The Dow Jones industrial average tacked on 0.5%, while the Nasdaq and S&P 500 each added 0.2%. Turnover was tracking lower across the board.
As earnings season keeps rolling, a number of leading stocks were making big moves on their quarterly reports.
Texas Capital Bancshares (TCBI) jumped 6% in fast trade, clearing a 36.71 buy point from a square-box base. The regional bank said quarterly EPS climbed 126% to 70 cents, beating views, as sales rose 32% to $102 million. It also scored an upgrade to buy from Sterne Agee.
SolarWinds (SWI) was up 18% in huge turnover after gapping above its 50-day line to an all-time high. The software maker said quarterly EPS grew 43% to 30 cents, topping forecasts and accelerating from a 21% jump in the fourth quarter of 2011. Revenue, including acquisitions, jumped 39% to $59.7 million. SolarWinds has lifted off support at its 10-week moving average.
O'Reilly Automotive (ORLY) was up 5% in strong volume and carved a new high before giving up some gains. The car parts retailer said quarterly EPS gained 37% to $1.14, ahead of estimates, as revenue jumped 11% to $1.5 billion. Its guidance was roughly in line. The stock hit a new high early Thursday, but has given up gains. It's well extended past its last buying range.
On the downside, Nu Skin Enterprises (NUS) shed 8% despite topping views. Before the open, the skin care products firm reported that its Q1 profit climbed 32% to 74 cents a share vs. expectations of 70 cents. Revenue grew 17% to $462 million, also above estimates. But Nu Skin sees Q2 earnings coming in at 79 cents to 83 cents a share, below expectations of 85 cents.
Celgene (CELG) gapped below its 50-day moving average, losing 4% after reporting disappointing Q1 results. The biotech earned $1.08 a share, up 30% from a year ago. But it missed views by a nickel. Sales rose 13% to $1.27 billion, below expectations and the smallest increase in 11 quarters. It was also the fourth straight quarter of sales growth deceleration.
In economic news, pending home sales jumped by a much better-than-expected 4% in March. Economists had expected a 0.5% gain. New jobless claims declined by 1,000 to a seasonally adjusted 388,000 last week, worse than forecasts for 375,000.

Thursday, April 26, 2012

Experiment in economic policy

Investors Business Daily opines that “Big government threatens our well-being with irresponsible health care “reform,” higher taxes on entrepreneurs, a tax-filled cap-and-trade energy bill, a host of new business-strangling regulations and trillion-dollar deficits as far as the eye can see.” Then they go on to say: “In late July, economist J.D. Foster of the Heritage Foundation put it succinctly: ‘This is no longer an experiment in economic policy. The results are in: Keynesian stimulus does not work.’ This GDP report doesn’t change that conclusion a bit”.
It is difficult to be more pessimistic than that. However, they do state that we have “stepped back from the abyss.” and that “our only hope going forward is the private economy. Though hindered by massive government intervention in housing, banking and industry, it’s still the most resilient in the world. Given the list of problems they cite, it is difficult to reconcile the optimism and pessimism contained in the piece. I suspect that we will slip back into recession in another quarter or so. I found little reason or justification for their, admittedly muted, optimism.

Sunday, April 22, 2012

The stock cleared

The S&P 500 snapped a two-week losing streak, but the Nasdaq failed to do the same. Top-rated stocks also showed some mixed action. Some marquee names further weakened, but a few of them managed gains amid choppy market conditions.
Apple (AAPL) logged a second straight weekly loss. The stock is now in its first test of its 10-week line since it cleared a cup-with-handle base in January. But its pullback came in heavy trading, which is not ideal.
The bellwether has had a long, steep ascent and has been above its 10-week line since December. Apple reports after the market's close Tuesday.

Most understand economics only experientially

The bailout fiasco is just now starting to show up for the act of desperation that many suspected it was. Instead of allowing markets to resolve a severely over-leveraged and distorted economy, the government decided to try to “bluff” its way through one more time. This strategy has been one used for almost 5 decades. Each time the credit stimulus required is bigger than the last. Each time the distortions to relative prices is made worse. Each time the misallocation of resources becomes greater. Each time the credit levels of individuals and government expand. Each time inflation becomes a bigger problem. Finally, a time comes when malinvestment and credit burdens are too large to be supported. It is probable that we have reached that point. To appreciate how far we have come regarding the abuses of credit creation, one need only note that since the Federal Reserve was created in 1913, the dollar has lost about 96% of its purchasing power. Most of that loss (probably in excess of 90%) has occurred since 1980.
There are still many that believe that government actions will get us out of our predicament. They won’t. When we come out of this mess, it will be in spite of these actions. They will serve to make the problem worse and cause it to last much longer. Japan has been employing similar stimuli for two decades, and its economy has still has not recovered.
As time passes, it will become apparent to all but the dullards that these interventions were non-helpful and actually harmful. Most understand economics only experientially. Events as discussed in the following post by Rolfe Winkler today are what will continue to surface with the passage of time and provide enough instances for the experiential learners.
Besides being a terrible decision that will cost taxpayers dearly, the article also talks about the unintended consequences of drawing deposits away from smaller, solid banks to the weaker GMAC. The unintended consequence is to weaken the stronger banks.

Monday, April 16, 2012

Overall price inflation was modest

The Fed's April Beige Book was just released.
According to the report, the economy grew at a "moderate to modest" pace, but a rise in gas prices could hurt consumers in the near term.
The last Beige Book released in February showed economic activity growing steadily throughout the country.
A little more on fears of rising energy costs:

Overall price inflation was modest in most Districts. However, contacts in the Cleveland, Richmond, Atlanta, Chicago, Kansas City, and Dallas Districts cited rising transportation costs due to higher fuel prices. Minneapolis and Dallas noted that airlines have raised their fares to offset higher fuel costs. Richmond reported that rising fuel costs were a serious problem for both land and ocean shippers, while intermodal transportation firms in Dallas said that they had increased prices in response to higher fuel costs. In Atlanta, higher transportation costs were passed through to consumers without much difficulty. In contrast, contacts in Cleveland, Chicago, and San Francisco said it was difficult to pass through higher costs to consumers. Input costs for manufacturers in Boston, Cleveland, and Kansas City rose somewhat, but with little pass-through. Price pressures have eased somewhat for manufacturing firms in Philadelphia. Higher prices for construction materials narrowed profit margins for contractors in Kansas City.

Prepared by the Federal Reserve Bank of Cleveland based on information collected on or before April 2, 2012. This document summarizes comments received from business and other

The world oil economy

Natural gas in North America broke below the $2.00 barrier today, for the first time in ten years. It’s important to remember that, unlike oil, natural gas does not trade at a converged, global price. Accordingly, a million BTU in LNG form currently trades for over $9.00 in the UK, and over $15.00 in Japan. Such low prices for natural gas unquestionably give the US a competitive advantage. But, it will take a resurgence in manufacturing and related industrialism to full capture the price disparity. After all, the US is still very much an oil-based economy.
That said, energy transition will indeed continue–and even accelerate. It is simply unavoidable that any physical process, which could be switched to natural gas from oil, will be overlooked in this economy. Given that the world oil economy is contending with prices for a million BTU in the $17.00 to $20.00 range, we should begin to see an arbitrage that captures the N.A. natural gas advantage at $2.00 per million BTU. How appropriate therefore that the Oil and Gas industry itself should get the ball rolling, in this regard. See this Reuters story – Drillers dropping diesel for cheaper natural gas:
North American oil and gas companies are trying to take the sting out of low natural gas prices by using it instead of costlier diesel fuel to drive their drilling rigs… Apache Corp, the largest U.S. company focused solely on oil and gas exploration and production, is in the process of converting its first rig to run on power generated by liquefied natural gas (LNG). Canada’s Encana Corp’s already has 15 of its more than 40 rigs driven by gas, and plans to convert even more.
I’ve written extensively about the long, and economically painful process of energy transition but it now seems likely that the first five years of such a disruptive transition is now behind us. In the next phase, a longer period which should take at least another 10-15 years, we will see oil cede its primacy first to coal. This hand-off from oil to coal is already very much underway. Natural gas will then start to compete against coal more forcefully by mid-decade, and then later in the decade the fast rate of growth in renewables–taking place from low levels in the background–will break out to the upside and gain significant share of global primary energy supply.

Business investment spending

Bill Dudley, the president of the New York Federal Reserve bank, indicated that he is most likely supporting additional action by the Federal Reserve to speed up the economy.

In remarks at an event in Syracuse, New York on Thursday morning, Dudley argued that "recent growth rates are barely keeping up with our potential."

"The incoming data on the U.S. economy generally has been a bit more upbeat over the past few months, "Dudley said. But it is "still too soon to conclude that we are out of the woods."

Some of the growth in sales and job creation in the first three months of the year may have been due to the mild winter pulling forward hiring and economic activity, Dudley said.

Bill Gross: One of Our U.S. GDPs Has Gone Missing

[The last fifty years] produced a persistent increase in asset prices vs. nominal GDP that led to an average overall 50-year appreciation advantage of 1.3% annually. That’s another way of saying you would have been far better off investing in paper than factories or machinery or the requisite components of an educated workforce. We, in effect, were hollowing out our productive future at the expense of worthless paper such as subprimes, dotcoms, or in part, blue chip stocks and investment grade/government bonds. Putting a compounding computer to this 1.3% annual outperformance for 50 years, produces a double, and leads to the conclusion that the return from all assets was 100% (or 15 trillion – one year’s GDP) higher than what it theoretically should have been. Financial leverage, in other words, drove the prices of stocks, bonds, homes, and shopping malls to extraordinary valuation levels – at least compared to 1956 – and there could be payback ahead as the leveraging turns into delevering and nominal GDP growth regains the winner’s platform. …Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets – while still continuously supported by Fed and Treasury policymakers – is likely at its pinnacle. Out, out, brief candle.

Tuesday, April 10, 2012

The outcome for taxpayers will be the same

Would you invest in a financial company that is going bankrupt? Actually, you already have! While you may have been an unwilling investor in FNM, you are continuing to invest every day, like it or not. Your “investment” is also increasing every day in Freddie and the FHA, both on similar trajectories. Welcome to the world of Alice in Wonderland where the solution to a credit-caused bubble is more credit.
The pressures from this nonsense continue to build. The fact that the US government is insolvent doesn’t seem to matter. Our government, the wounded and cornered animal, will do anything to survive. In this case, survival is keeping the game going as long as you can. But this game is Russian Roulette and taxpayers, knowingly or not are participants. No one knows whether the next revolution of the chamber will produce a click or the FINAL BANG.

Most understand economics only experientially

Thursday, April 5, 2012

The current economic crisis

A rosy assessment by Bloomberg. Their assessment of growth is reasonable; the statement that “… government stimulus helped bring an end to the worst recession since the 1930s…” is highly unlikely. It appears to be both an early and foolish call. During normal recessions, it is typical to have an intervening quarter or two of growth and then return to negative numbers.
This is no ordinary recession. There can be no recovery until the private sector (more properly called the productive sector) starts growing again. The public sector (better called the non-productive sector) produces virtually nothing, although it can appear to “cause” growth because of the manner in which GDP is defined. The government has no money of its own. It gets money either by taking it from the productive sector or by printing it. To get money from the productive center, it either coercively takes it in the form of taxes or sells bonds. Either way, the productive center has less funds to use. The government cannot produce growth in this fashion because of the dollar for dollar trade-off. Their spending makes us poorer in the sense that they do not spend the

Smooth transition in markets

Below is today’s press release from the Fed. I have emboldened a couple of key statements.
“With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.” While this statement may be true (probably less so than we are led to believe) at the moment, ignore it. It is a “CYA” statement that provides cover for the Fed to continue pumping the economy. This statement or its equivalent will probably be in the Fed’s statement until a month or two before rampant inflation is obvious to everyone.
“The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt. In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010.” This statement is inconsistent with the prior statement. It is either untrue or a diversion. There is no “smooth transition in markets” possible. While it might be possible that the Fed does actually honor this statement in a strict sense, they will merely shift their pumping to a different vehicle. To stop pumping now would mean a collapse of the mortgage market and the economy that will result in a Great Depression.
It is difficult to discern whether the Fed is merely being duplicitous or just plain wrong in their reading of the economy. After all, they have a pretty good track record for both.
If you believe what is in the statement, then I would get out of the stock market immediately. If not, then it is possible that the financial market fantasy can continue for awhile. Regardless of which you believe, be very careful. For me, I want no part in long positions in traditional stocks or bonds. This Ponzi scheme cannot go on much longer.

The differences in the absolute amount of total obligations

For some who closely follow the economic situation, it is obvious that we are headed for a disaster. There can be no happy ending. It will be a tragedy! Only the timing and shape are unknown. However, most disagree, believing this crisis is merely another recession like so many before. How can there be such a discrepancy in beliefs? Is the former group merely populated by a type of loose wingnut, spouting their own form of Armageddon Economics?
I don’t consider myself a wingnut (of course it is likely that no wingnut does), yet I do fall into the first camp. About four months ago I undertook the task of teaching a course entitled “Surviving the Crisis” at the University of North Carolina in Asheville. The class was a group of talented and eager middle- to upper-age students, mostly retirees with highly diverse backgrounds. The course was dominated by “non-wingnuts,” members that believed that, yes things were bad but no worse than other downturns in their lifetime. Fortunately for me, I did not have to present my case in 1 – 2 hours, but was able to lay it out over six weeks and 12 hours of class time plus much internet

Forecast such things

Paulson, Bernanke and Geithner have horrible forecasting records. Anyone forecasting, leaves himself open for a certain amount of embarrassment. Yet these people persist in pretending that they are capable of managing the economic condition of the country. That is truly scary!
Now we have the latest bit of evidence of their prowess. Look at this statement (one of many in a detailed report) made by Frederick Mishkin when he was on the Federal Reserve Board: “… they clearly illustrate that Iceland is a well run, advanced Nordic country that has little in common with emerging market countries, a fact important to recognize when we start discussing financial stability in the next section.” Shortly thereafter, Iceland inconveniently and totally collapsed into financial rubble.
Perhaps it isn’t Bernanke; perhaps it is his aides that are so wrong. Actually it is neither. No one can accurately forecast such things. That they are wrong is not surprising; that they have the hubris to pretend to know these things is what is amazing. Frederick Hayek’s Nobel acceptance speech entitled The Pretence of Knowledge has much to say both about the problem and professional hubris. Perhaps this speech should be required reading by all Washington economic and other policy dunderheads.

Monday, March 19, 2012

The current economic crisis

The return to risky behavior is already underway

Hope and Change in the Banking System seems to be “hope” that the system can get through this economic cycle while “change” is non-existent. “Too big to fail” creates incentives for risk-taking that would not occur in a true free market. Taxpayers underwriting risk and backstopping failure ensure that firms will take on more, rather than less, risk.
Legislated rules need to be imposed to contain excessive risk-taking based upon taxpayer guarantees. While a truly free market could handle this better than legislation, there appears to be zero hope for that occurring. Thus, a reinstatement of Glass-Steagall or its equivalent is necessary. Without some type of legislation, we are merely waiting for the next crisis to occur. With it, crises will still occur, but they should be more manageable.
The return to risky behavior is already underway.

You might as well label JP Morgan the new Lehman Brothers because they are operating like an investment bank. So much for those bailouts helping the average American. The media really needs to scrutinize how these companies make their earnings. They are simply using hot and easy money to double down in the Wall Street casino on the taxpayer dime. No reform has happened since the collapse of Wall Street because these banks own our politicians.

Saturday, March 17, 2012

This threat looms ever larger with the passage of time

Julian Robertson, legendary investor, expressed what I believe to be the critical immediate problem facing the US (and the rest of the world). With my emphasis added, he said the following:

I prefer to run scared through here. I think that if the Chinese stop buying our debt, it is virtually the end of the financial world as we know it. The conventional thinking is that they will continue buying. But I don‟t think it’s logical to assume somebody will continue to buy our paper which declines in value. Our dollar is declining in value, and it’s been pretty shocking over the last four or five months. The politicians who are so tough on businessmen and so critical – they and the Federal Reserve caused us to be in this predicament. What really caused me to predict the problems we had in 2007 and 2008 was that we were spending so much and no one was balancing the budget. No family can keep doing that forever, no corporation can keep doing that forever and no nation can continue doing that forever. We did it on all three fronts – and it blew up in our face.

Robertson speaks of what happens if/when the US can no longer depend on the “kindness of strangers” to fund our deficits. If/when our benefactors stop lending us money, both Treasury bonds and the US currency will collapse. As he alludes , bonds and currency are merely symptoms of underlying problems. While many believe that Blanche du Bois (the United States) will be able to bypass what Robertson fears because strangers will continue to support us, I do not. Furthermore, unless and until we remedy the underlying problems (government spending that cannot be supported by taxes, weakness in the private sector, etc.), this threat looms ever larger with the passage of time. At this point, there are no signs of the US even addressing these problems. Government projections (probably highly optimistic) for the remainder of this decade show deficits 2-3 times larger than any prior to last year.
Our kind strangers are not altruists, have their own needs for funds and their own political/national objectives. The frightening part of this entire situation is that we literally have no control over the short-term outcome. We have lost most of our economic clout, are viewed as profligate and probably have lost much of our political clout. We appear to be following the path of Britain when it lost its world leadership. Whether we fall to what arguably approached third-world nation status for Britain before recovering to a much smaller role in the world or not is moot. Our role as economic leader appears to be quickly slipping away. Even so, geopolitically we will remain relevant so long as we are in possession of ICBMs, sort of like Russia today but without the natural resources.

Friday, March 16, 2012

It invites anarchy

This swamp is too big and too far gone to be drained by electing “the other guys.” There are no other guys; they are all the same. I’m not sure what the answer is, but the wise words of Justice Brandies should have served as a warning and ultimately may become prophetic:
“In a government of laws, the existence of the government will be imperiled if it fails to observe the law scrupulously. Our government is the potent, the omnipotent teacher. For good or ill, it teaches the whole people by its example. If government becomes a lawbreaker it breeds contempt for law: it invites every man to become a law unto himself. It invites anarchy.”
Scary times with even more thrills ahead I am afraid.

At least from a monetary perspective

This is a piece that I wrote in response to a request for a guest post over at ZeroHedge. It ran there yesterday garnering some nice attention and a diverse range of comments beneath.
Based on some of those comments, this article represents nothing more than my attempt to find an explanation that matches the data.

My central thesis to this crisis, developed a few years before it even hit, is that the economic troubles are the symptoms, while the money system itself is the cause. My views on this are expressed in the opening of an article that I initially penned in 2006 but updated in 2008:

Within the next twenty years, the most profound changes in all of economic history will sweep the globe. The economic chaos and turbulence we are now experiencing are merely the opening salvos in what will prove to be a long, disruptive period of adjustment. Our choices now are to either evolve a new economic model that is compatible with limited physical resources, or to risk a catastrophic failure of our monetary system, and with it the basis for civilization as we know it today.
In order to understand why, we must start at the beginning. While it was operating well, our monetary system was a great system, one that fostered incredible technological innovation and advances in standards of living, two characteristics that I fervently wish to continue. But every system has its pros and its cons, and our monetary system has a doozy of a flaw.
It is this: Our monetary system must continually expand, forever.

The article above provides the big-picture backdrop that drives my long-term vision and thinking. I raise it now so that you’ll understand that I principally view the economic world through a monetary lens.
The hot topic of the day is “Inflation or Deflation?” and the camps are firmly divided into groups of inflationistas and deflationistas. When asked which camp I am in, I reply “Yes.” Some would say that puts me in the confusionista camp, but I actually have an explanation for why are living in a world encompassing both.
From a technical perspective, we are absolutely in one of the most powerfully deflationary periods in history, yet, besides housing prices and a few over-produced consumer goods, we find that stocks, bonds, and commodities are all well-bid at the moment.
While we can ascribe some of this to the artificial wall of liquidity (come to think of it, is there any other kind?) currently being thrown into the financial market(s) by the Fed, it leaves hanging the question of why that money is not being completely swallowed into the bottomless black hole that the deflationist camp says lies at the heart of our current financial system.
And they are right; there is a black hole at the center. If we treat the credit doubling that occurred between 2000 and 2008 (from $26 to $52 trillion) as a normal bubble that will follow the same pattern of decline as numerous historical bubbles, then we might reasonably predict that some $26 trillion of debt will somehow “go away” over the next 6 years. This is indeed a massive black hole.
Yet everything just keeps perking along. What gives?
The answer, I believe, requires us to ask a Zen-like question along the lines of, “What is the sound of one hand clapping?” That question is, “If nobody recognizes a defaulted debt on their balance sheet, does it exist?”
Suppose, for the sake of argument, that there is a world in which banks are allowed by their regulators to pretend their default losses simply do not exist. And, even more outlandishly, some of these banks are allowed to sell heavily damaged loans to their central bank at nearly their full original price.
What does “deflation” mean in such a world? Not much, as it turns out. At least from a monetary perspective, because money is not being destroyed at nearly the rate that would be expected or predicted by the size and rate of the defaults.
This is the world in which we currently live. Trillions in probable and provable losses quietly exist, out of sight, on the balance sheets of the Federal Reserve and other financial institutions. If they ever come out of hiding and onto the books, I think the deflationists will be proven correct beyond all doubt.
But let me ask this: What prevents the authorities from simply storing them out of sight forever? Or at least long enough to allow the wave of liquidity to work its inevitable magic? So far, much to my great surprise, they’ve managed to do exactly that, with hardly a squeak from the mainstream press (although the blogsphere is on the job, as usual). I am now wondering if they cannot keep this up indefinitely.
So from a purely monetary perspective, money can only be “destroyed” if banks and other financial institutions are compelled to recognize the losses and take a hit to capital. If the loss is not recognized, no money is destroyed. At least it is not recognized as gone.
Perversely, when a bank sells a ruined loan ‘asset’ to the Federal Reserve, it is a double shot of money to the system – the money initially created upon the issuance of the original loan, which is still out there in circulation, and a second bolus when the Fed creates money out of thin air to buy the failing ‘asset’ from the bank. One blob of money into the system when the loan is made, another when it is bought by the Fed. One loan, two blobs of money. Many have failed to recognize this feature of the Fed’s asset purchase programs.
So from this perspective, we could even argue that by employing the ‘pretend and extend’ strategy, coupled with an aggressive Fed purchase policy, it is possible that more money is being created than destroyed right now. Which means that from a strictly monetary perspective, I am not yet sold on the idea that money is being destroyed at the rates sometimes implied by the deflationary arguments.
Also, the data is not really in support of that notion either:

Of course, this money needs willing lenders and borrowers, which brings us back to the matter of price deflation.
Out in the real world, where consumers and producers exist, the bursting credit bubble has severely cut off consumers’ access to and desire for new credit, and producers have dialed back excessive capacity and cut their prices in order to attract business and survive.
There is no doubt about this process, but here I would argue that falling prices are currently as much a matter of supply and demand as they are a monetary issue. In other words, the price deflation that we are currently seeing is not a pure monetary phenomenon.
Which means I think we are in a bizarre hybrid world, where deflation should be the order of the day, but it currently is not, because its impacts are being held in abeyance by the simple expedient of pretending the losses do not exist.
My current outlook calls for productive capacity to continue to fall out in the real world, even as the Fed conjures more money into existence in the make-believe world of ‘high finance.’ (What are they smoking over there?).
Is this not a recipe for eventual inflation? More money, but fewer goods and services? History says ‘yes.’
All that said, I would not disagree with the notion that there’s another year or three of grinding along (where stock and bond prices are concerned), possibly down, but maybe not, before the monetary/goods imbalance comes charging out of the chute ready to throw off the unwary and trample them in a blistering round of inflation.
But it could be sooner than that. Or later. The point here is that we really don’t know, and because our monetary system operates on faith, it means that we have to be prepared for the fact that a shift could happen at any time. Nobody can predict when a school of fish will suddenly turn to the left. Who knows what final trigger will cause a critical minority to suddenly determine that they’d rather hold things other than paper?
For now, while I understand and appreciate the deflationist argument, the only thing that would convert me fully to that camp would be a sudden return to rigorous application of honest accounting. If you derisively snorted at that last sentence, then we share the same assessment of the likelihood of that happening any time soon.
In order to answer the main question of this article, we regretfully have to turn to Dadaism* to develop an appropriately absurd non-sequitur:
“What is the sound of one hand clapping? Insanely high stock and bond prices.”

* Dada was a protest by a group of European artists against World War I, bourgeois society, and the conservativism of traditional thought. Its followers used absurdities and non-sequiturs to create artworks and performances which defied any intellectual analysis. The founders included the French artist Jean Arp and the writers Hugo Ball and Tristan Tzara. Francis Picabia and Marcel Duchamp were also key contributors.
The Dada movement evolved into Surrealism in the 1920′s.

Thursday, March 15, 2012

The Future of the Dollar

Here is an outstanding, must-read regarding the dollar and economy. Warning, it is long and more technical than some other articles you have been referred to, but worth investing some time to fully understand. In my opinion, the issues discussed in this article are key to understanding our current situation and the manner in which it resolves.
It is hard to imagine a happy future for the dollar, and I was going to say that before Robert Fisk published his The Demise of the Dollar, in which he describes secret talks among central bankers and finance ministers of various countries on how to move away from trading oil in dollars.

Is Fisk’s report true? I have already been told once today that the story was a bit too “conspiratorial” to be taken seriously. The expected official denial followed quickly.

But top officials of Saudi Arabia and Russia, speaking on the sidelines of International Monetary Fund meetings in Istanbul, denied there were such talks. The two countries are the world’s largest and second-largest oil exporters.
Asked by reporters about the newspaper story, Saudi Arabia’s central bank chief Muhammad al-Jasser said: “Absolutely incorrect.” He repeated the same response when asked whether Saudi Arabia was in such talks.

The pols have chosen to cover up the problem

The disgraceful and unsustainable government sham continues. Rather than face up to problems, the government tries to hide them and create another credit bubble. This extend and pretend strategy cannot work although was easily predicted. Previous posts dealt with what was happening. This one, US Government Has Become Fannie and Freddie, is one example.

Political cowardice and the need to cover-up criminal activity made such predictions easy. Rather than face up, politicians and the Fed are trying to bluff their way through. This approach cannot work because the government is bankrupt and nearly out of options. Trying to add more credit to the system is like changing the title of an old movie and then being surprised when the ending is the same. There is no exit that doesn’t involve pain. Recognizing that and dealing with it involves the least economic pain. Avoiding the problem involves the least, short-term, political pain.
The pols have chosen to cover up the problem, hoping it goes away. In poker terms, markets hold 4 aces and the pols have a busted hand but think they can win the pot by bluffing. No chance! Unfortunately their all-in play will bankrupt the government and the country. The sources of new money to sustain this Ponzi scheme are drying up.
What we are witnessing at this point is a cornered and wounded animal, desperate to survive and willing to do ANYTHING to do so. Accounting gimmickry, cover-ups, lying about how bad the situation really is and other measures to perpetuate the scam are not working. As things become more desperate, more dangerous tactics will follow. This ending will not be pretty and will have historical ramifications that will reverberate for decades.

Former Fannie Chief Credit Officer Says FHA Is $54 Billion Underwater
In keeping with the warnings presented by Kyle Bass warned that the entire housing bubble is now being ported over to the taxpayer’s balance sheet, Edward Pinto, a former chief credit officer for Fannie Mae claims that the Federal Housing Administration will likely require a major taxpayer bailout “in the next 24 to 36 months” as it is likely to incur $56 billion more in losses than it can withstand.
For those that think the NINJA loans are a thing of the past, think again – the Fed is now actively encouraging just those same reckless standards that brought America to the brink:

The FHA program’s volumes have quadrupled since 2006 as private lenders and insurers pulled back amid the U.S. housing slump, Pinto said. The trend has left the agency backing risky loans and exposed to fraud in a “market where prices have yet to stabilize,” he said. The program insures loans with down payments as low as 3.5 percent and has no formal credit-score requirements.
The FHA Commissioner, David Stevens, is keeping to his side of the story, which is that everything is being properly accounted for, and there is no risk in the future of the Administration. Don’t expect this story to change until the next time the handout hat startrs getting tossed around legislators. In the meantime, the deterioration in loan standards keeps accelerating:

About 14.4 percent of FHA loans were delinquent as of June 30 and 2.98 percent were already being foreclosed upon, according to the Mortgage Bankers Association. The combined percentage for all mortgages was a record 13.16 percent, according to data from the Washington-based trade group, which said in releasing the figures the share of FHA loans past due is being suppressed by the large amount new debt.

Insurance policy against both inflation and deflation

Deflation could be the biggest threat to the economy, but gold — usually an inflation hedge — is reaching new highs. That’s because smart investors aren’t playing the inflation trade, they’re buying currency crisis insurance.
With the amount being spent by the public sector, with the huge amounts of leverage still in the system, there’s a palpable fear that America won’t be able to meet its obligations. Relative to GDP, the amount we’re borrowing to finance deficits makes us look irresponsible.
When such economies hit a wall, investors make a run on the currency, typically moving their assets to a stronger currency, like the dollar.
But this time the problem is the dollar, along with other leading paper currencies, all of which are threatened by profligate fiscal and monetary policies. So some investors want out of the system entirely. Gold, as my colleague Neil Collins noted earlier, is a way to do that.
The gold market is small enough that a decision by a handful of money managers to increase their asset allocation from, say, zero to 5 percent can move the market. All the gold ever mined would fit aboard an oil tanker; its total weight of 125,000 tons amounts to a few hours’ output for the U.S. steel industry.
But economists tell us that inflation isn’t a risk now. Are they wrong? No and yes.
The conventional way economists view inflation is to look at things like “output gaps.” When the economy falls below a level of output it previously achieved, it is said to have unemployed resources. If you think of inflation as workers demanding and getting higher wages, which leads to higher prices for the goods and services they produce, then inflation isn’t a threat.
So economists tell us more borrowing and money printing won’t be inflationary as long as people are unemployed.
One problem: Their models ignore the fact that peak output was artificially inflated by a credit binge. Borrowing more to sustain an unsustainable level of spending borders on insanity, yet that’s precisely what such economic models tell us we need to do.
There’s an extra variable these models don’t account for — the Chinese and all major lenders to the United States. They don’t much care if our employment rate is below desirable levels. At a certain point, they may recognize that the United States is acting like a banana republic and choose to stop lending.
When that happens, we might see a “sudden stop” event: Capital inflows to the private and public sector cease as everyone races to get out of dollars.
Eric Sprott, CEO of Sprott Asset Management has $4.5 billion under management, $2 billion of which is invested in physical bullion — silver and gold — stored at banks in Canada. Another large chunk is invested in gold stocks.
He views gold as an insurance policy against both inflation and deflation. Central bank quantitative easing policies mean “we’re printing paper currency like crazy,” so he doubts the long-run value of fiat currencies.
On the flip side, if central banks pull back, you could enter a deflationary spiral, essentially a banking collapse, in which case “your deposits wouldn’t be returned to you. Better to have physical gold in your control.”
Most economists and investors still labor under the illusion that there’s a way out of debt that doesn’t involve a drastic reduction in the paper value of wealth. Smart investors aren’t so sure and want at least a portion of their assets out of the financial system.
A dollar crisis isn’t necessarily coming tomorrow, so there’s no guarantee gold’s price will keep going higher. Still, gold is a decent insurance policy against economic Armageddon.

Institutions and incentive structures

Arguably Macroeconomics is not economics. It deals with aggregates, statistics and mathematical models that purport to explain the behavior of the economy. But economics is not about aggregates, it is about human behavior. The building block for meaningful economics must be the individual, not some aggregate called Consumption or Investment. These aggregates are nothing more than the outcomes of millions of individual decisions. Aggregates do not make decisions, they result from decisions. They are statistical constructs only, often useful to summarize history. To the extent that they have correlation, (the incorrect premise of macroeconomics is that they are causally related), the correlation results from stability at the micro level. Institutions and incentive structures provide the framework that influences individuals. If these are stable, then aggregate outcomes will appear to be stable over time. But there is no causal relationship among aggregates that can be managed as if it were some giant machine.Yet, that is the basis for macroeconomics. If we “input” more Consumption, the “output” of the machine will increase. If we increase Government Spending, it will increase GDP. If we increase the Money Supply then …… Such is the world of macoreconomics. Unfortunately the underlying premise of macroeconomics, causality, is at best correlation. Macro management of an economy is based on a false premise.

An example of how the micro level affects the macro level is apparent in this piece that hit my email. Whether the story is true or not is immaterial. It demonstrates the thought processes of individuals when their incentive structure is changed. This behavior, magnified across all decision-makers (consumers and businessmen), is indicative of how aggregates are affected. Past correlations will not hold as a result. Policy makers in Washington will once again be “surprised.”

The Employee Meeting:
I would like to start by thanking you for attending this meeting, though it’s not like you had much of a choice. After all, attendance was mandatory. I’m also glad many of you accepted my invitation to your family members to be here as well. I have a few remarks to make to all of you, and then we’ll retire to the ballroom for a great lunch and some employee awards.
I felt that this meeting was important enough to close all 12 of our tire and automotive shops today so that you could be here. To reassure you, everybody is being paid for the day — except me. Since our stores are closed we’re making no money. That economic loss is mine to sustain. Carrington Automotive has 157 full time employees and around 30 additional part-timers. All of you are here. I thank you for that.
When you walked into this auditorium you were handed a rather thick 78-page document. Many of you have already taken a peek. You were probably surprised to see that it’s my personal tax return for 2008. Those of you who are adept at reading these tax returns will see that last year my taxable income was $534,000.00. Now I’m sure this seems rather high to many of you. So … let’s talk about this tax return.
Carrington Automotive Enterprises is what we call a Sub-S – a Subchapter S corporation. The name comes from a particular part of our tax code. Sub-S status means that the income from all 12 of our stores is reported on my personal tax return. Businesses that report their income on the owner’s personal tax return are referred to as “small businesses.” So, you see now that this $534,000 is really the total taxable income – the total combined profit from all 12 of our stores. That works out to an average of a bit over $44,000 per store.
Why did I feel it important for you to see my actual 2008 tax return? Well, there’s a lot of rhetoric being thrown around today about taxes, small businesses and rich people. To the people in charge in Washington right now I’m a wealthy American making over a half-million dollars a year. Most Americans would agree: I’m just another rich guy; after all … I had over a half-million in income last year, right? In this room we know that the reality is that I’m a small business owner who runs 12 retail establishments and employs 187 people. Now here’s something that shouldn’t surprise you, but it will: Just under 100 percent … Make that 99.7 percent of all employers in this country are small businesses, just like ours.
Every one of these businesses reports their income on a personal income tax return. You need to understand that small businesses like our s are responsible for about 80 percent of all private sector jobs in this country, and about 70 percent of all jobs that have been created over the past year. You also need to know that when you hear some politician talking about rich people who earn over $200,000 or $500,000 a year, they’re talking about the people who create the jobs.
The people who are now running the show in Washington have been talking for months about raising taxes on wealthy Americans. I already know that in two years my federal income taxes are going to go up by about 4.5 percent. That happens when Obama and the Democrats allow the Bush tax cuts to expire. When my taxes climb by 4.5 percent the Democrats will be on television saying that this really isn’t a tax increase. They’ll explain that the Bush tax cuts have expired .. Nothing more Here at Carrington we’ll know that almost 5% has been taken right off of our bottom line. And that means it will be coming off your bottom line.
Numbers are boring, I know … But let’s talk a bit more about that $534,000. That’s the money that was left last year from company revenues after I paid all of the salaries and expenses of running this business. Now I could have kept every penny of that for myself, but that would have left us with nothing to grow our business, to attract new customers and to hire new employees. You’re aware that we’ve been talking about opening new stores in Virginia Beach and Newport News . To do that I will have to buy or lease property, construct a building and purchase inventory. I also have to hire additional people to work in those stores. These people wouldn’t immediately be earning their pay. So, where do you think the money for all of this comes from? Right out of our profits .. Right out of that $534,000. I need to advertise to bring Customers in, especially in these tough times. Where do you think that money comes from? Oh sure, I can count it as an expense when I file my next income tax return . But for right now that comes from either current revenues or last year’s profits. Revenues right now aren’t all that hot … so do the math. A good effective advertising campaign might cost us more than $300,000.
Is this all starting to come together for you now?
Right now the Democrats are pushing a nationalized health care plan that, depending on who’s doing the talking, will add anywhere from another two percent to an additional 4.6 percent to my taxes. If I add a few more stores, which I would like to do, and if the economy improves, my taxable income … our business income … could go over one million dollars! If that happens the Democrats have yet another tax waiting, another five percent plus! I’ve really lost track of all of the new government programs the Democrats and President Obama are proposing that they claim they will be able to finance with new taxes on what they call “wealthy Americans..”
And while we’re talking about health care, let me explain something else to you. I understand that possibly your biggest complaint with our company is that we don’t provide you with health insurance. That is because as your employer I believe that it is my responsibility to provide you with a safe workplace and a fair wage and to do all that I can to preserve and grow this company that provides us all with income. I no more have a responsibility to provide you with health insurance than I do with life, auto or homeowner’s insurance. As you know, I have periodically invited agents for health insurance companies here to provide you with information on private health insurance plans.
The Democrats are proposing to levy yet another tax against Carrington in the amount of 8 percent of my payroll as a penalty for not providing you with health insurance. You should know that if they do this I will be reducing every person’s salary or hourly wage by that same 8 percent. This will not be done to put any more money in my pocket. It will be done to make sure that I don’t suffer financially from the Democrat’s efforts to place our healthcare under the control of the federal government. It is your health, not mine. It is your healthcare, not mine. These are your expenses, not mine. If you think I’m wrong about all this, I would sure love to hear your reasoning
Try to understand what I’m telling you here. Those people that Obama and the Democrats call “wealthy Americans” are, in very large part, America ‘s small business owners. I’m one of them. You have the evidence, and surely you don’t think that the owner of a bunch of tire stores is anything special. That $534,000 figure on my income tax return puts me squarely in Democrat crosshairs when it comes to tax increases. Let’s be clear about this … crystal clear. Any federal tax increase on me is going to cost you money, not me. Any new taxes on Carrington Automotive will be new taxes that you, or the people I don’t hire to staff the new stores I won’t be building, will be paying. Do you understand what I’m telling you? You’ve heard about things rolling downhill, right? Fine .. then you need to know that taxes, like that other stuff, roll downhill. Now you and I may understand that you are not among those that the Democrats call “wealthy Americans,” but when this “tax the rich” thing comes down you are going to be standing at the bottom of the mud slide, if you get my drift. That’s life in the big city, my friends … where elections have consequences.
You know our economy is very weak right now. I’ve pledged to get us through this without layoffs or cuts in your wages and benefits. It’s too bad the politicians can’t get us through this without attacking our profits. To insure our survival I have to take a substantial portion of that $534,000 and set it aside for unexpected expenses and a worsening economy. Trouble is, the government is eyeing that money too … and they have the guns. If they want it, they can take it.
I don’t want to make this too long. There’s a great lunch waiting for us all. But you need to understand what’s happening here. I’ve worked hard for 23 years to create this business. There were many years where I couldn’t take a penny in income because every dollar was being dedicated to expanding the business. There were tough times when it took every dollar of revenues to replenish our inventory and cover your paychecks. During those times I earned nothing. If you want to see those tax returns, just let me know.
OK … I know I’m repeating myself here. I don’t hire stupid people, and you are probably getting it now. So let me just ramble for a few more minutes. Most Americans don’t realize that when the Democrats talk about raising taxes on people making more than $250 thousand a year, they’re talking about raising taxes on small businesses. The U.S. Treasury Department says that six out of every ten individuals in this country with incomes of more than $280,000 are actually small business owners. About one-half of the income in this country that would be subject to these increased taxes is from small businesses like ours. Depending on how many of these wonderful new taxes the Democrats manage to pass, this company could see its tax burden increase by as much as $60,000. Perhaps more.
I know a lot of you voted for President Obama. A lot of you voted for Democrats across the board. Whether you voted out of support for some specific policies, or because you liked his slogans, you need to learn one very valuable lesson from this election. Elections have consequences. You might have thought it would be cool to have a president who looks like you; or a president who is young, has a buff body, and speaks eloquently when there’s a teleprompter in the neighborhood. Maybe you liked his promises to tax the rich. Maybe you believed his promise not to raise taxes on people earning less than a certain amount. Maybe you actually bought into his promise to cut taxes on millions of Americans who actually don’t pay income taxes in the first place. Whatever the reason .. your vote had consequences; and here they are.
Bottom line? I’m not taking this hit alone. As soon as the Democrats manage to get their tax increases on the books, I’m going to take steps to make sure that my family isn’t affected. When you own the business, that is what you’re allowed to do. I built this business over a period of 23 years, and I’m not going to see my family suffer because we have a president and a congress who think that wealth is distributed rather than earned. Any additional taxes, of whatever description, that President Obama and the Democrats inflict on this business will come straight out of any funds I have set aside for expansion or pay and benefit increases. Any plans I might have had to hire additional employees for new stores will be put aside. Any plans for raises for the people I now have working for me will be shelved. Year-end bonuses might well be eliminated. That may sound rough, but that’s the reality.
You’re going to continue to hear a lot of anti-wealth rhetoric out there from the media and from the left. You can chose to believe what you wish .. .but when it comes to Carrington Automotive you will know the truth. The books are open to any of you at any time. I have nothing to hide. I would hope that other small business owners out there would hold meetings like this one, but I know it won’t happen that often. One of the lessons to be learned here is that taxes … all taxes … and all regulatory costs that are placed on businesses anywhere in this country, will eventually be passed right on down to individuals; individuals such as yourself. This hasn’t been about admonishing anyone and it hasn’t been about issuing threats. This is part! of the education you should have received in the government schools, but didn’t. Class is now dismissed.

Wednesday, March 14, 2012

Contemporary unchecked finance

Doug Noland of Prudent Bear tackles the flaws in credit and interventionism practiced by our government and concludes: “… it is my view that a flawed Credit apparatus, ill-advised government intervention, and dysfunctional market dynamics ensure economic maladjustment gets worse before it gets better.” His commentary on the current state of economic thinking and what it will produce appears below.

The Governator and the Market Operator I’ll begin with an excerpt from Bill Gross’s latest Investment Outlook:
“But California’s problems, while somewhat unique and self-inflicted, are really America’s problems, and not just because the California economy is 15% of national GDP. While California’s $26 billion deficit is not directly comparable to the federal gap of $1 trillion-plus, they both reflect a lack of discipline and indeed vision to perceive that the strong growth in revenues was driven by the same excess leverage and same delusionary asset appreciation that was bound to approach cliff’s edge.”
It’s contagious. Both at the state and local level and in Washington, policymakers “lack discipline and indeed vision…” It is said that “bull markets create genius.” I’ll suggest that the downside of the Credit cycle fashions lousy policymaking. I feel for the “Governator” and the California legislature, and I feel for our new President and members of Congress. They confront the harsh post-Bubble reality of no win circumstances – wearing big bullseyes on their backs in an age of slings and arrows.
As much as I respect Bill Gross – and can’t take strong exception with much of what he has been saying and writing of late – I just can’t find it within myself to move on. Newer readers might be unfamiliar with my long-standing – and one-way debate – with the McCulley/Gross view of the financial world. They have over the years been leading proponents for the popular consensus ideology that I have labeled “inflationism.”
It is a basic tenet of Credit Bubble theory that if the system inflates the quantity of Credit it will be spent. Credit Bubbles are fundamentally about a lack of discipline – one could say a confluence of undisciplined behavior. Credit Bubbles evolve specifically because of undisciplined monetary system management, undisciplined lending, undisciplined borrowing, undisciplined investment, undisciplined speculation and, at the end of the day, undisciplined spending throughout. And there are some absolutes: Inflated mortgage Credit, home price gains, and elevated incomes will absolutely inflate the propensity for undisciplined consumption. Inflated tax receipts will absolutely inflate government expenditures – in California, Washington D.C., and all across the country. The discipline problem goes way back but commenced within the bowels of the Credit system.
Mr. McCulley, in particular, was a vocal proponent for post-technology Bubble reflation. This reflation doubled total mortgage Credit in about six years and unleashed Monetary Disorder all over the world. In the process, this historic Credit inflation inflated asset prices, incomes, corporate profits, and government receipts. The state of California was at the epicenter of this massive inflation. Going back to fiscal year 2002-2003, California general fund revenues were about $71 billion. By the beginning of the 2007-2008 year, the state was budgeting for general revenues of $101 billion.
In percentage terms, state revenues inflated about 40% during the five-year boom. And with receipts rising each year, of course legislators were going to extrapolate and increasingly inflate state spending. There’s no mystery here. Keep in mind that in typical Bubble economy form, much of the rising expenditure was the result of rising costs all along the chain of state services. Those campaigning earlier this decade for aggressive monetary ease to fight deflation got, not surprisingly, more than they bargained for.
In hindsight, it is amazing to contemplate the complete and utter lack of vision that afflicted policymakers throughout the golden state and all across the country. How could they not perceive that sophisticated Wall Street financial leveraging and resulting asset Bubbles were only temporarily inflating their coffers? When seemingly everyone bought into the notion of endless prosperity, why couldn’t they have kept their heads? Just because everyone believed the enlightened Federal Reserve had forever mastered the business cycle, why couldn’t they have been more skeptical? And that the economic community, the regulator community, the Federal Reserve and the marketplace all missed this Credit Bubble dynamic is, apparently, no excuse. As I have often written, I sympathize with post-Bubble policymakers.
It is a tenet of Credit Bubble theory that politicians – given the opportunity – will inflate. There is ample history illuminating the dangerous propensity to run the government printing press. Contemporary analysis gets more complex because of the nature of private-sector Credit and the penchant for government (explicit and implicit) guarantees. During the boom, “money” was burning a hole in policymakers’ pockets, but it was Wall Street and the GSEs commanding the electronic printing press 24/7. By far the most precarious absence of discipline and vision belonged to those Operating in and accommodating this historic private-sector Credit Bubble.
I disagree with the policy of massive deficits. Yet the California and U.S. budget quagmires are the direct consequences of the bursting of the Wall Street/mortgage finance Bubble. And as much as greed and leverage have provided easy scapegoats, responsibility lies first and foremost with the nature of contemporary unchecked finance and flawed “activist” monetary management (trumpeted, not coincidently, by our era’s preeminent market Operators). And as much as the consensus view believes that previous financial maladies have been largely rectified, I see a continuation of the same malignant Credit system dynamics. In short, massive government intrusion into the market pricing of Credit continues to fuel economic maladjustment and Bubble dynamics.
Why did Wall Street issue Trillions of ABS, auction-rates securities, CDOs, and private-label MBS? Because they could. Why did the hedge funds and others leverage so egregiously? Because they were making a bloody fortune and the marketplace was more than ok with it. Why did the GSEs increase their MBS guarantees by $400 billion over the past year, and why did the Treasury issue $1.9 Trillion of Treasuries the past twelve months – and will likely do only somewhat less over the next year? And why are cash-strapped state and local governments borrowing so aggressively these days? It’s because the marketplace continues to readily accommodate Credit excess. Who is demonstrating a lack of discipline and vision – the borrower or the lender? The “Governator” or the market Operator? Is this the way the market pricing system is supposed to function?
Why is the marketplace inherently incapable of disciplining the egregious borrower – whether mortgage debt during that Bubble or government debt today? First, there are no inherent system restraints on Credit creation. Recalling the mortgage finance Bubble, recent massive increases in the supply of government debt have been met with a collapse in borrowing costs. Second, the marketplace perceived that fiscal and monetary policymakers were backstopping mortgage Credit during the boom. Today, the market is confident that policymakers are firmly behind the Treasury and agency securities markets. Borrowers are undisciplined for one reason: the distorted market mechanism not only fails to discipline them – it accomplishes the exact opposite.
I could ramble on for pages on the myriad costs associated with unchecked, undisciplined and mispriced finance. Mr. Gross touched upon a key cost, noting today’s uncompetitive California and U.S. economies. This is a key aspect of Bubble economy distortions. The dangerous flaw in inflationism dogma is that the Federal Reserve and policymakers can manipulate the cost and quantity of Credit with positive systemic results. In reality, the consequence of increasingly bold policy activism over time include a more distorted and unbalanced economic structure, as witnessed today. And it is my view that a flawed Credit apparatus, ill-advised government intervention, and dysfunctional market dynamics ensure economic maladjustment gets worse before it gets better.

stock and bond markets

To paraphrase Houston Command Central: America, The Ego Has Landed. And not smoothly.

Today’s Copenhagen announcement was a political disaster heard around the world. It further raises issues concerning the image and competency of the President. Regardless of one’s politics, another failed Presidency is not good. Given the current geopolitical and economic situation, it might be especially dangerous as discussed earlier. Unfortunately the Copenhagen fiasco along with the disastrous job report today enhance the perception and probability of a failing Presidency.
One wonders at the level of stock and bond markets. How much longer can Alice-in-Wonderland financial markets continue in light of continuing deterioration in economic and political fundamentals? The Ego landing does not make it easier for markets to continue to levitate.
A harsh political evaluation was offered today by the American Thinker (a conservative website):

Thomas Lifson
Dude, where’s my charisma?
In a huge slap in the face for Barack, Michelle, and the Oprah, Chicago was the first city eliminated from Olympic consideration.
It turns out the world is getting sick of Mr. Know It All. The President of France openly mocks him, and now the Olympic Committee is unimpressed with his wonderfulness.
He is having even a worse day than David Letterman. He made it all about himself. Ben Smith of Politico wrote before the decision:
Obama’s pitch to the International Olympic Committee this morning is very much about his and America’s identity, and not the IOC’s sometimes transactional politics, raising the stakes for the decision:

We stand at a moment in history when the fate of each nation is inextricably linked to the fate of all nations — a time of common challenges that require common effort. And I ran for President because I believed deeply that at this defining moment, the United States of America has a responsibility to help in that effort, to forge new partnerships with the nations and the peoples of the world….
Richard Baehr adds:
It would be hard to exaggerate how humiliating is the IOC vote with Chicago going out in the first round, with the lowest score of the 4 cites. So much for the theory that the world loves America more under Obama.This is a huge embarrassment for Obama, given he shoed up for the presentation. Obviously, he neither can count, or control votes on the IOC, the way he may in the Congress. This will not help him with any part of his domestic agenda. A key part of his message has been that he is not Bush, and presents a different America to the world. Andrew Young won the 1996 games for Atlanta during the first Bush presidency. Obama could not do it for Chicago.
Ed Lasky adds:
He has done zero since elected — except cause some damage internationally.
Stimulus bill was cooked by Congress, not him. Health Care: stalled; Card Check: stalled; Cap and Trade: stalled.
He has empowered unions and the left wing-which is causing businesses to postpone investment and hiring. I have a radiologist friend who told me his practice and the hospital re postponing purchase of equipment because they have no idea how much they will earn in the future.
How is that for health care “reform”?

Commercial banks’ balance sheets

We got exactly what I expected, a kind of wishy-washy, “hedging our bets” statement from the Fed. You have to remember that Bernanke was Greenspan’s right hand man for much of the bubble days of the ‘90s and early ‘00s, so the guy is an expert at walking both sides of the line when it comes to policy and public statements.

For instance, the Fed announced it would keep interest rates between 0% and 0.25% for an “extended period.” No surprise there. As I’ve noted previously, 80%+ of the $200+ trillion in derivatives sitting on US commercial banks’ balance sheets are related to interest rates.

For the Fed to hint at raising rates (let alone raise them) would kick off a systemic implosion that would wipe out the very guys the Fed has been bailing out. Suffice to say the Fed won’t be raising interest rates now or anytime too soon (within the next 3-5 years, unless inflation destroys the dollar).

The Fed also announced it would be slowing its purchase of Mortgage-Backed Securities (what I call the Fed’s “cash for trash” program). The Fed has stated previously that it will buy $1.45 trillion in mortgage-backed securities from US banks and that this program will end by the end of 2009. However, last week the Fed said it will be extending the program (but not the amount of money spent) until the first quarter of 2010.

Again, this is not much of a surprise. The Fed performed a similar act with its Quantitative Easing Program (extending but not increasing the amount). However, given the increasing public outcry about the Fed’s balance sheet, this issue of buying toxic debt (and the mortgage backed securities the Fed is buying are nothing if not that) may become a hot topic in the near future. If there is ever a successful audit of the Fed’s balance sheet, kiss the big banks’ equity (and share prices) good-bye.

The Fed did announce that it would let its Quantitative Easing program end in October. If you’re not familiar with this program, it’s basically a fancy way of saying that the Fed has been buying US debt in order to finance Obama et al’s massive deficit.

This particular development is key. A little known fact (and one totally ignored by the mainstream media) is that the Fed accounted for nearly half of all Treasury purchases in the second quarter ($164 billion out of $339 billion). In fact, the Fed bought more Treasuries than the next three largest purchasers combined!!

The Fed’s purchases outnumber foreign holders (foreign governments), US households, and Primary Dealers (mega banks) combined. One should also note that foreign holders reduced their purchases of US debt from $159 billion in 1Q09 to $101 billion in 2Q09 (a 40% decrease).
In simple terms, these numbers indicate that if it were not for the Fed, the US Treasury market would have almost assuredly had numerous failed auctions in the second quarter. It also shows us that foreign holders (China, Japan, etc.) are reducing their purchases of US debt at an incredible rate. This tells us two things:

1) China and pals are putting their money where their mouths are: refusing to service our debt as they did in the past
2) Treasuries will have to become a lot more attractive (higher yields) for foreign investors to start buying again
I’ve often stated that the Fed will have to sacrifice stocks or the US dollar. If the Fed does in fact end Quantitative Easing in October (as it has stated it will in last week’s FOMC), then we’ll see what the market really thinks of US debt as an investment class. It’s clear from the above data that foreign holders want higher rates (yields) in order for them to start buying more heavily. However, as I’ve stated before, the Fed cannot afford higher interest rates without blowing up US banks.

Keep your eyes on the Treasury market going forward. This could very well be the next major crisis brewing. It will certainly be our first taste of how a market operates without life support courtesy of the Fed.

I’m guessing the results won’t be pretty.

When interest rates are held artificially low

A recovery in the economy can only occur via recovery in the private sector. Much of what has been hailed as “green shoots” results from government stimulus. It is not clear what is being stimulated other than reported GDP, because there are few signs of private sector recovery. One area that has received enormous stimulus is the housing market, even though its reported numbers are still dismal.

In the mortgage issuance area, the private sector has disappeared (see previous post by Chris Martenson). Is this because banks are unwilling to lend? Is it because there are no creditworthy borrowers? The answer to both of these questions is a resounding No! Then why is this happening? The government has driven down interest rates so low in a (foolish) attempt to support housing prices that they have made it unattractive for banks to risk money at these rates. In that sense, the government is subsidizing low interest rates with taxpayer money/risk. Private firms make mortgage loans at interest rates commensurate with risk. When interest rates are held artificially low, there are few loans that meet this requirement. Another way to state this is that the government is taking on risks with your money that prudent investors would not take on with their own money. It is precisely that strategy that gave us the Fannie and Freddie debacle. This is not rocket science. The results are predictable and inevitable as evidenced by the following quote:

Government-guaranteed home mortgages, especially when a negligible down payment or no down payment whatever is required, inevitably mean more bad loans than otherwise. They force the general taxpayer to subsidize the bad risks and to defray the losses. They encourage people to “buy” houses that they cannot really afford. They tend eventually to bring about an oversupply of houses as compared with other things. They temporarily overstimulate building, raise the cost of building for everybody (including the buyers of the homes with the guaranteed mortgages), and may mislead the building industry into an eventually costly overexpansion. In brief in the long run they do not increase overall national production but encourage malinvestment.

The above is a nearly perfect description of what happened in our housing market. Perhaps it could be marginally improved by adding references to “liar” loans and negative amortization loans. But this excerpt was written by Henry Hazlitt in 1948 as a prediction. Its veracity was as true then as it is today. Now it is, as Yogi might say, “deja vu all over again.” We are in the process of repeating the same mistakes. This time the vehicle will be the FHA and the Fed. The results will be just as painful for taxpayers as Fannie and Freddie were (and continue to be).

Tuesday, March 13, 2012

Effectively confiscating gold

Mish has a take on the Arthur Burns memo to President Ford regarding gold price suppression that is worthwhile. Mish downplays its current significance, suggesting that markets ultimately are stronger than governments. He does provide a valuable caution that all gold investors should heed:

The fear should not be of government to government agreements that can never work in practice, but rather a fear that governments may tax gold sales profits at some phenomenal rate, thereby effectively confiscating gold a second time.

Such a “confiscation” would be relatively easy to impose on ETFs like GLD or SLV. It would be more difficult to impose on physical gold itself.

Future buying power of the dollar

In a post dealing primarily with Bill Ackman’s hedge fund, gold as a holding or non-holding is discussed. Ackman holds none, but his position does not appear to be at odds with others.

One last paragraph we want to focus on is Ackman’s brief mention of the risk to one’s purchasing power. Due to quantitative easing and money printing by the Fed, he acknowledges that there are concerns about future buying power of the dollar. Ackman highlights that many investors have turned to gold to hedge these risks, but not Pershing Square. Instead, they have decided to fight this risk by owning “high quality businesses that have pricing power due to market position and/or business model, and/or that earn their profits globally.”
This is interesting to see his stance on the matter as we can’t really recall him addressing it before. You’ll remember that David Einhorn and Greenlight Capital made a large gold investment and now are storing physical gold. Additionally, John Paulson’s hedge fund Paulson & Co bought gold via GLD (the exchange traded fund) to hedge their share class denominated in gold. It’s interesting to see each fund manager’s individualistic approach and hedging vehicle of choice. However, the main thing to take away from all of this is the fact that they see inflation as a potential threat in the future and are trying to mitigate this risk accordingly.

The entire economy/stock market

“New Normal,” a term coined but not yet copyrighted by the principals at Pimco, is bandied about to describe the prospects for the economy and financial markets. It is undefined and hence irrefutable. It provides a glib way to state the obvious: the future will differ from the past. Its definitional elasticity ensured its widespread acception.

A more appropriate term might be the “New Abnormal.” While this term could be criticized in the same manner, it offers one significant advantage. It more strongly implies lack of continuity with the past. This “advantage” is in the eye of the beholder. If you are the common investor, this message is the one that should be absorbed. If you are part of the sell-side hucksters of Wall Street, you prefer the current euphemism, because it is wonderfully clever. It conveys the obvious – things have changed – in a somewhat soothing way. Optimism (the purpose of the sell-side) is promoted in the sense that “understanding” will be enable you to “manage” the future. It turns lemons into lemonade. It advances the “Lipstick on a Pig” tactic from boiler rooms to the entire economy/stock market . It is pure Marketing genius.
Despite the “genius”, I am not buying this “used car.”

More modern macroeconomic models

The econometricians and empiricists “explain” the effects of the stimulus

Is the American Recovery and Reinvestment Act of 2009 working? At the time of the act’s passage last February, this question was hotly debated. Administration economists cited Keynesian models that predicted that the $787 billion stimulus package would increase GDP by enough to create 3.6 million jobs. Our own research showed that more modern macroeconomic models predicted only one-sixth of that GDP impact. Estimates by economist Robert Barro of Harvard predicted the impact would not be significantly different from zero.

The natural tendency of government

We are embroiled in a great debate over health care reform. There are two aspects of the debate that are often not identified. The first is whether healthcare is a “right.” The second is the best way to deliver healthcare. When one does not separate the two issues, one biases the solution.

While I do not agree that healthcare is a right (you cannot morally produce a “right” for some by violating the rights of others), let us assume for the moment that it is so deemed. Then the issue becomes how is this “right” best delivered. It seems that the US has answered the first question and now struggles with the answer to the second.
It is the natural tendency of government to want to run things, hence we have the preoccupation with the single payer system or a competing government insurance company. The latter, using the concept of competition and government, is oxymoronic. Is there anyone outside of Washington DC that believes the government at the Federal or local level can run anything efficiently? The empirics regarding this issue are devastating — social security, Amtrak, medicare, medicaid, financial system regulation, the school system, potholes in the streets, the post office, infrastructure maintenance, the court system, garbage collection, department of motor vehicles, etc. etc. ad nauseum. One might reasonably argue that everything government touches deteriorates.
Back in the days of the Cold War, a joke that was popular in Europe went something like this: QUESTION — What would happen if the Soviet Union took control of the Sahara Desert? ANSWER — Initially no changes would be apparent; eventually there would be a shortage of sand.
Doug French has written a timely article that provides real-life context for the joke. His illustration focuses on Venezuela, although thousands of other illustrations could be provided.

They have reduced their purchases

Interest rates on Treasuries must increase. China, India, Russia and many other countries have admonished us on our profligacy. They have reduced their purchases and rearranged their holdings to the short-end of the curve. At the same time our funding requirements have soared. Official projections (probably understated) indicate these excessive funding needs will be with us for at least a decade. This situation is not sustainable much longer. J. D. Steinhilber expands upon the issue.

Tuesday, May 8, 2012

Sunday, May 6, 2012

Friday, May 4, 2012

Thursday, May 3, 2012

Wednesday, May 2, 2012