Planet Yelnick

Battling the Great Recession: More Powerful Weapons, Much Bigger Mistakes

Guestblog - enjoy!

Bad times have a scientific value. These are occasions a good learner would not miss. – Ralph Waldo Emerson

For years, the Great Recession has affected a number of families in the United States.

The economic meltdown has forced private sectors to reduce their workforce. That, or employees have decided to find jobs elsewhere. The recession, though considered “a period of dark times”, is a wake-up call.

With the rising unemployment rate, what else is in store for you? How will you survive?

Recession and Weapons of Mass Destruction

Although the war with Iraq did not directly cause the recession, it had somehow magnified its degree.

According to the Center for Economic and Policy Research (CEPR), while the war did impose serious costs on the economy of the United States, it cannot be entirely blamed for the Great Recession.

The root cause is the collapse of the housing sector.

However, continually spending for ammunition and other military equipment had added to the economic meltdown. This drastic move has gradually drained resources, and has reduced the number of jobs available.

Now that America is slowly building itself from the recession, though the job market has not fully regained itself, the possibility of the employment rate dwindling may discourage you to look for jobs.

What do you now do in the midst of the crisis?

The answer cannot be more obvious: You go back to your roots, do what you love best, and earn from it. Simply put, be an entrepreneur.

Thrive in your Business, Survive the Great Recession

Despite the improvement in the economy, you cannot deny that the recession may still be pulling down the employment rate. You can save your money, cut back on resources, and then you can get by. But then, a more positive approach lies in learning from what happened.

It now becomes clear for families that unemployment lingers.

Don Peck, in his article “How a New Jobless Era will Transform America”, laments the fact that people might not yet feel a sense of normalcy even if the Great Recession seems to be taking a backseat.

However, he says that innovation can allow an economy to rise and create more jobs.

Tiffany Meyers of Entrepreneur shares the same sentiment. Instead of feeling low, change the way you think.

Use the aftermath of the recession as your springboard to create your startup business and make innovations.

As Emerson said, learn from the bad times. Julie Meyer, one of the most influential women in Europe, believes that entrepreneurs can lead a country out of recession.

She says that “there’s a new social contract emerging which is around the individual” and that “everybody is aware of the high unemployment in the group coming out of universities.”

Stephanie Johnson, 32 and a mother of three, was displaced from her job as a graphic artist for a local newspaper.

During the recession, her problem was how to feed her children. She did save what was left of her earnings, and she refrained from shopping online.

However, she figured she could not live that way forever, especially when her kids were growing up.

After the recession, Stephanie used a portion of her savings as capital and made organic bath products. It used to be a hobby for her, but the recession prompted her to become a fulltime entrepreneur.

Ultimately, the recession has taught her to use her capacity to fight against unemployment.

It is not a question of how the Great Recession will transform America, but of how you will transform your nation.

Wrapping Up

The decision to start your own business may seem intimidating at first, and you might even think of investing in IPO’s to create your brand and establish your credibility.

Do not be afraid. Remember that you are more powerful than the Great Recession and that through your efforts; you can emerge from the economic rubble.

Who knows?

You might even save America from another recession in the future.

About the Author

Bill Achola is a financial publisher who owns a fast-growing, dynamic and innovative investment blog that empowers investors to make the right decision. Check out his blog where he writes and talks about best investing strategies at http://traderushreview.us.com.

 

Interest Rate Hike - Will They or Won’t They?

This is a guest blog by Farnsfield Research on of the most critical issues to investors, what will the Fed do? Enjoy!

With the numbers showing close to full employment, the Federal Reserve may be preparing to move on raising short-term interest rates in June. The short-term interest rate has been near zero since 2008.  The Labor Department reported an increase of 295,000 non-farm payrolls in February, and the past four months have seen fast-paced job gains, dropping the unemployment rate to 5.5 percent. The question on everyone’s mind is “Will they or won’t they raise interest rates in June?” Let’s take a look at what leaders are saying.

Janet Yellen
Federal Reserve Chairwoman Janet Yellen is still exercising caution about raising rates. She reported that the March 17-18 meeting of the Fed will see a patient approach even though robust numbers seem to signal a rate increase is coming. She talked about hints, but no significant wage growth when addressing the Senate Banking Committee recently. Officials are concerned about inflation running under their two percent inflation target and want to see what happens with output, employment, and inflation before any changes are made.

Scotiabank Economists
Scotiabank economists are saying the Fed will hike rates in June in spite of concerns about inflation. They say the risks that market watchers are citing, such as collapsing oil prices, are not a big enough threat to the U.S. economy to delay a mid-year rate increase. Scotiabank feels lower fuel prices could actually help inflation by encouraging consumer spending, creating more incentive to raise rates.

John Crudele
New York Post columnist John Crudele disagrees that the indications point to a mid-year interest rate increase by the Fed. He says the economy isn’t doing as well as the newer numbers might seem to indicate. He warns that because the dollar has recently risen against a range of currencies, companies doing business overseas will struggle and the U.S. government will have to pay more to borrow money. CNBC commentator Ron Insana agrees with Crudele and doesn’t think the Fed will raise rates at all this year because of a weakening world economy.

John Williams
San Francisco Federal Reserve Bank President John Williams urges a rate increase, saying that waiting too long is riskier than starting a gradual increase now. He says mistakes now could mean the need for a bigger sudden rate hike later, which would have dire consequences on economic recovery. He supports his position by pointing to the 1965 economy, which had similar low inflation and economic growth as today and led to an economic boom.

This is in stark contrast to Chicago Fed chief Charles Evans’ call for delaying rate hikes another year. And chief market analyst at Phoenix Financial Services Wayne Kaufman says he doesn’t think the Fed wants to go against the trend of central banks around the world lowering interest rates.

The Real Debate
The real debate about the rate hike revolves around moving too quickly and risking harm to the recovery, or waiting too long and risking inflation or a financial bubble. Federal meeting minutes have indicated officials are more inclined to wait, not willing to upset a still-fragile economy or go against a weak global economy.  

Amherst Pierpont Securities economist Stephen Stanley’s impression is that the Fed is remaining intentionally non-committal to when a rate hike would happen out of concern that financial markets could overreact. Deutsche Bank Securities chief U.S. economist Joseph LaVorgna feels the Fed is being much too cautious about markets.

Employment numbers seem to be pointing to stronger economic recovery, but economists are looking more closely. Trim Labs, CEO Charles Biderman, says the Federal Reserve won’t be able to raise interest rates this year at all because even though there’s been rapid employment growth, it’s not real growth. It was due to the end of extended unemployment benefits pushing people into minimum wage jobs.  

Do you think interest rates will be raised this June?

Author Bio:
Max D. - Max is a technical writer who regularly contributes financial topics to Farnsfield Research and other investing blogs. Max spends his time running multiple companies in the financial sector. This allows him to have a constant finger on the pulse of the industry.

Wall of Worry, Meet Flight to Quality

Bull markets climb a wall of worry, and this one has climbed a veritable Cliff of Insanity, with steep macro problems coming out of the Great Recession. So far the Bull has largely tracked increased earnings, but they are now lagging, particularly as the Dollar strengthens and profits on foreign earnings drop. In addition, many commentators have noted how the S&P correlates with the Fed Balance Sheet from QE (see chart), but that too has now ended.

What will drive stocks higher? Look no further than the Flight to Quality happening worldwide. Pundits have been surprised by the drop in US Treasury Yields after QE ended, but they shouldn't have been; the USD is rising sharply as flagging economies use Currency Wars to promote exports, driving other currencies down. One somewhat unexpected consequence is the scramble for better collateral; there is an estimated $9T USD carry trade worldwide, and as currencies drop in other countries, the need for collateral drives demand for US Treasuries and other US assets. 

What may happen? The demand for USD should accelerate, and act like a liquidity pump like QE or the Greenspan Put before it in (for example) 1998-99, which drove the historic dot-com bubble. This pump will likely spill over into US equities and may lead to yet another bubble. 

Yves Sees Forward to Gold Road to Salvation

As panic sets in, Yves Lamoureux is preparing his next bold call.  As reported here, he called the peak in gold before other pundits saw it, and made other bold calls that have him now referred to as the new bond and equities guru. Here is a copy of his Feb 8 newsletter on point: Download Lamoureux_Finally Why Gold Will Be Rigged Higher. 

His most recent views on economic conditions are summarized in this post from several weeks ago. We now have hit the inflection point he predicted. The reversal in bond rates is truly stunning:

The next phase of global volatilty is a surge of liquidity from a final central bank effort to prevent the reversal of rates and unwinding of all their efforts since the Global Financial Crisis of 2007. Yves expects this Financial Surge will float all boats, including gold. 

The pattern he saw in gold back in 2010 is now coming to an end, although not imminently. He recommending going long on the Euro and short on gold when the consensus was short Euro long gold. He remains a Euro bull for now, and will be super bullish on gold at the right time. Watch here for his guestblog when the time is nigh.  

Is Japan Signaling the Beginning of the End?

Since The Bernank spoke last week, the Japan markets have been in turmoil. Stocks have fallen over 12% in just a few days, and, most troubling, bond rates have risen sharply. See chart, courtesy Zerohedge:

Is the Bank of Japan losing control over rates? The theory of QE is that the central bank can manage rates down by purchasing bonds, but the bond vigilantes in Japan are pushing back.

In the US the fear is that the Fed will be unable to taper off QE. The Bernank's remarks last week were of a taper, and yet in the US the 10 year has spiked above 2%. There is a concern that if rates go above 2.2-2.25%, the biond portfolios will begin to rotate their mix of long and short bonds, essentially causing a spike in the ten-year which might shoot it to 2.5% - the so-called Bond Convexity. If this happens, expect the Fed to stop the taper and jump back in with (say) two months of QE in one month, to drive rates down. 

This would be quite a good buying opportunity of the ten year. It also may signal that even the Fed will face issues in trying to taper and avoid losing control over rates. 

GOLDENFREUDE: Gold as the Next Bitcoin

Amazing drop in gold this morning. First Bitcoin last week, now Gold. It hasn't declined this sharply since the prior all-time peak in 1980. One of the major goldbugs, Dennis Gartman, has written that in four decades of gold trading, he has never seen such a bloodbath.

Of course, if you follow this blog, you were well prepared, as Yves called this months ago.

It now is entering what Prechter calls free-fall territory, as it has has busted below a support level (first chart) and a technical level (second chart):

 

Goldenfreude is the pleasure of seeing goldbugs lose their shirts. A lot of prosaic punditry trying to explain this, and getting it worng. Most of the immediate selling was out of Asia, and was caused by Abenomics, the shock and awe of massive QE by the Bank of Japan. Buyers of Japanese bonds may have been leveraging their purchases by using gold as collateral, and now are liquidating to cover as the Japanese bonds plunge. The proximate cause for the two-day rush to the doors is likely Friday's China GDP report, showing a slowdown. Commodities are also taking a bath.  

This should not have been "unexpected", the common word used by mistaken punditry. We had two large gold sell-offs during the Great Recession, both driven by expectations of massive central bank intervention:

1) July 2008, right before the Lehman debacle and following on the heels of a parabolic blow off top in oil

2) September 2011, as the Euro crisis hit and central banks intervened

You cna see what the gold plunge is predicting: another bout of central bank intervention to keep the wheels from flying off the global ecopnomy. The first out of the blocks is the Bank of Japan's QE. The punditry expects the massive BOJ QE to respark inflation. Gold is signaling the opposite, of deflation.

Milton Friedman got the punditry thinking that inflation was due to the increase in base money (central bank money and reserves), but this is too simple:

1) The Quantity Theory of Money had inflation as based on quantity times velocity of money. Velocity has plummeted in the Great Recession to levels BELOW those of the Great Depression. 

2) Modern Monetary Theory has popularized the view that the quantity of money is not based much on base money, but on bank lending, as banks create the quantity of money. Put another way, banks do NOT lend out of reserves; they lend out of opportunity and then scramble to find reserves if needed.

The striking increase of bank reserves, and QE, have done little to spur bank lending; the reserves sit in the vault so to speak. Instead, QE has spurred excessive speculation in assets, what Minsky called the Ponzi Finance stage. Asset bubbles rage back and forth across commodities (oil! corn! coal! Bitcoins!), debt and margin are used to juice returns, and as each bubble collapses the velocity of money shrinks and the speculators fall back. 

Japan is now (as John Mauldin aptly puts it), a "bug in search of a windshield." Abenomics is leading to money washing back and forth across the globe, much as Hoover wrote in his memoirs about the sovereign debt crises of the 1930s. Is Cyprus the new CreditAnstalt?  This is not how a real recovery begins, but how a false recovery ends. 

Yves Sees The End of the Great Bond Bull Market - With a Risk of Hyperinflation

I have posted a number of articles of Yves Lamoureux, President at Lamoureux & Co.. In Oct 2009, he predicted the 30 yr would fall to 2.5% when most pundits - including the then-inestimable Bill Gross -expected a rise to 5%. Yves was right, and I christened him the New Bond Guru. On Friday he published his new prediction, that the Great Bond Bull Market from 1982 is now over.  Summary:

Bonds have tended to act as expected as risk preference shifted. However, bonds now have neither a credit risk premium and nor an inflation risk premium. Our proprietary model is clear: treasury paper of 30 years has the correct valuation of 3.50% and above. That is the level we would feel confident as buyers.

He makes an intriguing additonal observation, of a type of hyperinflation, but not the type that is commonly bantered about, a Wiemar-Republic style inflationary collapse. Instead, as we risk more of a deflationary environment from too much debt (deflation arising as that debt gets written off or washed out faster than central banks can print), this time it will emerge from increased credit risk in what heretofeore have been the most risk free instruments - US Treasuries. 

The harbinger of this may be Japan, which (as John Mauldin has put it) is a "bug seeking a windshield." The expected new Prime Minister wants to go to extremes of monetization to reinflate their moribund economy. As money has bailed out of Europe, it has found Japan, and the Yen has risen. Now it is being purposely weakened, and has hit a seven month low with the USD.

As the WSJ puts it:

Investors have been selling the yen since Japan's prime minister announced last week that an election will be held Dec. 16. Polls show Shinzo Abe, leader of the opposition Liberal Democratic Party, as the leading candidate to emerge as prime minister. Mr. Abe has been calling on the Bank of Japan to enforce bolder policies, including unlimited printing of money and setting reserve interest rates at zero, or even in negative territory to stimulate lending. 

The MMT view has circulated in financial circles, with the core belief that a currency issuer never need to default. This of course flouts history, where fiat currency after fiat currency has gone down in the sort of credit collapse envisioned by Yves. While it seems almost unimaginable that the USD might suffer such a fate - and it is years away from such a crisis - the Yen may become the first major currency to test the MMT approach of extreme monetization.  

Financial observers spend undue attention on stock markets.  Bond markets are an order of magnitude bigger.  It is now time to watch the bond market.  

Employment Brackets the Over/Under

The over/under is a betting level: the predicted points in a game. Last month employment disappointed, but it was blamed on weather. After that report, the catch-up level was 260k jobs in this report. We missed that by a mile. The catch-up number was lowered since then down to 196k by those mysterious "they" who set expectations. (At least in Vegas we know who the bookies are.) This report came in bracketing the over/under:

• 192k new jobs, below 196k expectations
• 222k private sector jobs, above 200k expectations

Stocks are down today, possibly reacting to an under. More on that below. The spinmeisters are out in full force, however. Just before the report the herd expected the over (60% thought it would beat). After the report the consensus of opinion appears to be this comment from CalculatedRisk:

This wasn't a great report. Heck, it wasn't a "good" report. But it was a little better than most recent reports.

At this stage in the business cycles, upward revisions are more likely going forward, so this report should improve with more data. What is less clear is if new jobs will ramp up, or just remain steady - the average between January and February is only 127K new jobs, below what is needed to keep up with new entrants to the workforce. The 192k number is a catch up from a dismal January number of 36k, which was revised up to 63k. 

The market reaction has been mixed. Bonds improved but reflect a reasonable chance of a rate increase later this year. Stocks may be reacting to a modest recovery, which makes QE3 less likely, and would remove the speculative pump under markets. On the other hand, the report shows no surge in wage inflation, meaning QE has not yet spilled over into wage inflation:

The below-the-surface issue with the report is a continued detrioration of the overall employment picture. While the unemployment rate is down, the rate of participation and the ratio of employed to population continue to fall even faster. This means statistically the unemployment rate has dropped not because of more jobs (numerator) but because of fewer workers (denominator). Without those dropouts, the unemployment rate would be 11%. 

The Fed on Commodity Inflation: What, Me Worry?

Is it inflation or speculation? The Fed Chairman spoke very plainly today, but what he left out is important. Coincidently, he spoke right after the ISM Report on expectations. Good news: manufacturing expectations are booming. Bad news: inflationary expectations are also booming.

These CPI expectations (the blue line) do not predict inflation, but a lot of folk are worried. Not Ben. He said commodities price increases are NOT a concern. 

His comments have been picked up by the punditsphere, and you can get a quick read from Barry Ritzholz thinks ("I disagree") and Cullen Roche at PragCap ("totally oblivious"). Here is Ben's view of surging commodities:

[T]he increases in commodity prices in recent months have largely reflected rising global demand for raw materials, particularly in some fast-growing emerging market economies, coupled with constraints on global supply in some cases.

Commodity prices have risen significantly in terms of all major currencies, suggesting that changes in the foreign exchange value of the dollar are unlikely to have been an important driver of the increases seen in recent months. 

The rate of pass-through from commodity price increases to broad indexes of U.S. consumer prices has been quite low in recent decades, partly reflecting the relatively small weight of materials inputs in total production costs as well as the stability of longer-term inflation expectations.

I think all three assertions are true, but hide the truth: his QE2 policies have driven up speculation, and that has driven up commodities across the board. Let's look at his assertions:

• demand and shortages have driven up prices - ok, but why would all commodities be going up in lockstep due to weather here or there, or other local causes of shortages? And why up so much when the great demand generator, China, is slowing down? As Cullen Roche opines: "There is nothing normal about cotton prices rising 200% in six months."
• prices have risen across all currencies - ok, inflation is the result of weaker currencies, and normally the whole world does not weaken at the same time in much the same pace. Also, QE2 does not 'print money' in the way people casually toss out. Still, his core assertion is too loose: prices have gone up faster in Dollar terms than Euro or Yen, bespoking Dollar relative weakness since QE2. Still, the inflation argument would have more weight if the Dollar were falling faster than it is, given how much commodities have risen. 
• commodity price rises are not being passed through - ok, so far anyway. I see blogosphere comments about official stats hiding the real inflation going on, but it is pretty clear that other than food and energy, where costs have an easier time being passed through, most industries are having a terrible time passing on the rise of input costs. This is why corporate earnings are about to run into a margin squeeze. 

Under the New Austrian School of Economics, interest rates are mechanisms to adjust business investment behavior. Normally low rates speak to longer investment horizons, but in the deflationary depressive aftermath of a credit bubble, keeping rates artificially low as the Fed is doing has the opposite effect: it spurs short-term, speculative investments over the long term. You could think of low rates as destroying the returns on sunk capital, leading to low replacement of existing plant - pretty much what has been going on during the Great Recession. 

BTW Bernanke let out his own estimates of how much he has lowered longer term rates - 75 bp. ZeroHedge extrapolated his formula across all his various QE measures:

The sum of QE 1, QE lite (the top off of QE1) and QE2 is $2.35 trillion. Using Bernanke’s formula you get a range of 4% to 5% as the approximate interest rate consequence of QE. 

That is an extraordinary number. The Fed’ ZIRP policy set interest rates at zero. QE has brought that to -4.5% (average) based on Ben’s numbers.

I don’t think that this has ever happened before in the USA. The examples I can think of in history outside of the US all ended badly. Ben has set monetary policy so that interest rates are 5-6 % below inflation. There can be only one possible result. Inflation of everything we use is going to explode. 

Maybe. The ISM reports are clear in seeing price increases on inputs across the board, and maybe American industry will not accept the margin squeeze and will try to pass it on. If so, prices should begun to push up in the next six months, and while this might make GDP tick up (see chart), it could just as well depress consumer spending:

The other explanation than coming inflation is that the speculative fervor is about to cool. We will likely see this first with oil and the Dollar. A strong Dollar reversal will unwind the speculative positions (priced in Dollars), and a break in oil will remove the biggest driver of cost-push seen by the ISM managers. 

GDP Misses, QE3 Gains, Oil Looms

We had a chance of snow on the streets of San Francisco, but the weathermen missed. We had expectations of GDP being revised up (from 3.2% to 3.3%, with whisper at 3.4%) but the economists missed. Now the reaction is coming in:

• JP Morgan lowered its Q1 forecast from 4% to 3.5%
• QE3 is now considered more likely (bolstering stocks)
• The dreaded double-dip is now back in the punditry

Quite a leap. Even with the downward revision, Q4 GDP at 2.8% was up from Q3 (2.6%) and Q2 (1.7%). CalculatedRisk provides an historical chart to show where we are in context; you will see that GDP on a quarterly basis often jumps around a bit:

Still, it remains clear that this recoverlyless recovery is much less robust than prior ones, which is even more surprising given the depths of the fall in 2008; usually after a deep drop we get a rapid pop. Just look at the pops after the double-dip in 1980 and 1982, the start of the chart. The recovery in the 1930s had multiple years of double-digit growth, while we remain below the 3.3% long-term average. 

Worse, the trendline is now turning back down, albeit we remain a ways from a double-dip. From Econoday:

What is driving the reversal seems pretty clear:

1. Oil prices
2. State government austerity

There is something else, swimming under the surface. We had been told that the consumer was back and spending was up. In this revision, a drop in the prior consumer spending estimate had a major impact on the revision; and overall real domestic spending dropped 0.6% whereas it had grown 4.2% in Q3. Purchases of durables went up in January but had been declining in Q4. The January blip was solely due to aircraft orders, which tend to be extremely volatile. 

Capital goods outside of transport actually plunged in January, down 6.9%. Sy Harding reports on Alan Abelson's column in Barron's this weekend, which quotes David Rosenberg: 

Demand for these capital expense items tells you a lot about the strength of industry. It was a prominent linchpin of 2010’s 15% gain in capital spending, which in turn helped mightily to power the recovery – such as it was. Last month’s drop in orders was the worst since January 2009, when the economy was up to its nostrils in recession. The consensus estimates for GDP, as Dave points out, are well north of 3% for the 2nd quarter – and that doesn’t quite square with the minus build in core capex orders so far this quarter.

The wildcard in the double-dip vs QE equation is oil. The turmoil in the Middle East strikes many like the Fall of the Berlin Wall, but as it works its way through, oil prices will be on edge. The impact of higher oil prices on US GDP is being estimated vigorously right now. High oil acts like a tax on consumers. One estimate is that the recent oil spike, if it sustains over 2011, will act like a $700 tax on families, lowering GDP by 0.5%:

Reuters provids an interactive graphic on oil and GDP, courtesy ZH:

One thing to keep in mind is blind extrapolation leads to poor decisions. The oil spike may be peaking, not trending. If the US were to restore drilling in the Gulf and elsewhere, the drivers of high oil prices would bend quickly, but even short of that, whatever else happens in the Middle East, they need to keep the oil flowing to feed the rioting people. Europe is apparently pushing the US to to stop the bloodshed, which is out of control by a despot trying to maintain his grip at any cost, and get Libyan oil flowing again. The start is the UN launching sanctions, and getting Qaddafi investigated for war crimes, only the second time the UN has taken that step. 

Put all of this together and 2011 looks like a slower growth than expected but not an outright double-dip, which makes QE3 questionable. Being in the muddled middle freezes decision-making. 

Inside the Numbers: ISM Reports and the Great Margin Squeeze

Richard Fisher, head of the Dallas Fed, flagged the risk of monetizing government debt and bashed the government for out of control spending. He felt the Fed was now "an accomplice to Congress' fiscal malfeasance" and came out against further Quantitative Easing (QE). He further said he would back Fed tightening at the earliest signs of inflation. 

He may be facing that prospect as early as March. The January ISM Reports showed economic activity growing at rates not seen since August 2008, which is good news, but the "prices paid" index grew even faster:

Bespoke notes how the ISM prices paid is outpacing the official inflation rate, and the last time commodiites prices rose this much, CPI rose 5%, over 3x higher than currently reported:

Pierre du Plessis looked at the inflation data and concludes that the CPI excluding housing tracks closely to the oil price with a month's lag. if oil holds up in the $90+ range through Feb, the CPI ex-housing should hit 3.5% in March:

These factoids put the Fed's policy in a vise. If QE2 has succeeded by improving economic activity, there is no need to continue it. If it has driven prices up faster than growth, it would now need to try to put the inflation genie back in the bottle by ending QE and as Fisher noted, tightening instead of loosening. 

A third factor is the drop in inventories and the rise in imports seen in December. There have been some stories of stockpiling of materials by US companies, as a reaction to rising prices; but overall inventories have dropped. This may indicate a demand problem: since pricing cannot be passed through, rather than be caught in a margin squeeze, producers are pulling back in stock. In addition, and also explaining the drop in inventories, both new orders and inventories have been trending down for most of 2010:


The Fed talks about how the "wealth effect" can spur recovery, and seems to believe the rising stock market (since the QE2 announcement last August) is responsible for increased spending. Presumably that has contributed to increased spending, especially among the well-off, but more ominously, we have see middle-class consumers increasing spending by pulling money out of savings, as shown in this chart from Econophile, who concludes that the wealth effect and reduction in savings are both ephemeral consequences of QE, not signs of a sustainable recovery:

 

So now the Fed is caught in a three-way vice:

1. they need QE to continue an apparent recovery 
2. the recovery politically undermines the need for QE
3. especially because they risk inflation getting out of control

Inside the Numbers: Unemployment

This month's report has a some serious statistical anomalies. New jobs (36k) badly missed expectations (146k) as well as whisper (180k). At the same time, the unemployment rate inexplicably dropped sharply from 9.4% to 9.0%, the second steep drop in a row (it had been at 9.8%). This is the largest two month drop since 1958 (see chart, from Bespoke). How can this be, given the dismal job growth? 

As MIsh succinctly puts it, to get the rate down in two months from 9.8% to 9.0%, the BLS simply did not count 2M workers. The workforce needs to absorb about 1.5M new workers (eg college grads), but last year the BLS says the labor force fell by a net 167k, with 2.1M former workers simply dropping out. He concludes:

Look on the bright side, at this rate we will back to full employment in no time

It should be noted that the BLS uses two different surveys for these numbers. The new hires come from business surveys, and the rate comes from household surveys. While the business survey shows 36k new jobs, the household survey showed 117K new jobs, but 504k people either dropping out of the workforce or dropping out of the population! Yes, the survey said we lost 185k people out of our working-age population. This is assuredly wrong, a statistical anomaly coming from incorporating new census data. Without this change, the rate would have dropped to 9.3%. 

Also without this change, the new jobs would have been a much higher 589k, way out of line with other surveys. Gallup does their own survey, and it has shown an increase in the unemployment rate:

Weather was blamed for the mixed unemployment report. Outside jobs were down, like construction (-32k) and transport (-38k), while inside jobs like manufacturing were up (49k), its best rise in 12 years (!!), although non-durable manufacturing dropped (-13k). If weather is to blame, the February unemployment report should beat expectations as delayed hiring catches up. Look for 260k new jobs in Feb.

The simple explanation for the fewer-new-jobs but lower-unemployment-rate is the 99ers are disappearing from the stats faster than new jobs come in. 99ers are the unemployed who have maxed their benefits (the number refers to 99 weeks of benefits), and disappear from the official stats even if they are still seeking jobs.

We saw this last month as well, and it should continue for several months as the 99ers reflect the big job losses at the start of the crisis.

In the past year, the number dropping out has increased by 2.2M, while the number of "official" unemployed-seeking-work has dropped by 1.2M even though job growth remains below the 150K monthly rate just to absorb new graduates into the workforce. It should not surprise, then, that labor participation continues to fall, now at a 26 year low:

The fate of the 99ers is supposed to be captured in the U6 number, which includes discouraged job seekers. This month the seasonally-adjusted U6 fell a huge amount, from 16.7% to 16.1%. Good news, right? Nope, a drop like this is also a statistical anomaly. The non-seasonally adjusted U6 surged to 17.3%, and is now seriously out of whack with the adjusted numbers:

As you can see from the chart, something screwy happens at the turn of the year, and it will take several months to see if the seasonally-adjusted number is too low or the non-seasonally-adjusted number is too high. The seasonal adjustments include the impenetrable BLS birth/death model (of small business, not people), which during the Great Recession showed expansion of new businesses! They get the Darwin Award for that brilliance. The BLS did a major recounting of their birth/death model in January, and it now shows business destruction where they used to show creation.

When the BLS revises past numbers down, it makes the new numbers look better.  

Another statistical adjustment is last year's job creation numbers also get readjusted in January, and this time 400k jobs were removed from 2010! Given we added only 36k jobs in January, it was as if 12 x 36k were eradicated last year, removing a year's worth of Januaries. In total, 538k jobs have now been removed from the prior two years of stats. Hence the recoverlyless recovery was worse than it was reported. 

My take on all of this is we remain in a flat period and have been for a year. Cut through the noise and the household survey showed a 117k increase in January, much less than its 297k in December but very much in line with monthly numbers over the past year, and slightly less than we need to absorb new entrants to the workforce as the population grows.  

Cutting through the stats, take a look at the trend. The revised BLS surveys show a flat 2010 that has begun to trend down, not up, although I expect that to change in February due to the weather effect: 

You can also see this in the percent change chart, comparing this recession with others:

Sadly, we remain well above where Christina Romer and the Obama Administration predicted we would be after the Stimulus:

 

What the Big Mac Index Says About Inflation

I was shocked to hear from a friend that a Big Mac in Philly now costs $7. I haven't kept tabs, being long-past my kids' Happy Meals days. The Big Mac Index must not be very happy right now. And I hope he meant a Big Mac meal not a mere sandwich. 

The Big Mac Index was a cheeky concoction of The Economist as an exercise in figuring out purchasing power parity between currencies. In its early days, everyone would make a beeline for the China price, and cluck cluck about their cheap currency.

Today it has a much better use: testing the reliability of official inflation figures. I am of course shocked, shocked! to learn that governments fiddle with their figures. As you can see at a glance from their chart, Argentina is the biggest cheater, with the US and China not that far behind:

During the height of the Great Recession, McDonald's was one of the Four Food Groups of the Apocalypse, along with Campbell's Soup, Hershey's Chocolate and Hormel Spam. With food costs rising and difficulty pushing through price increases, how are they faring now? They should be a canary on the coal mine of the Great Margin Squeeze. 

McDonald's has made menu changes since 2008, rotating to higher margin food to keep ahead of rising food costs. So far analysts expect the change in product mix to allow McD to maintain flat margins, although just in the past week (after the Q4 earnings release) more analysts have begun lowering earnings than raising. While Mickey D's has been pushing healthier food, a lot is riding on their re-introduction of the ever-popular and calory-heavy McRibs. Yum!

Oh, and I did stop by a local McD's. Out here in the Left Coast, a Big Mac is only $2.99 and the meal $5.19. I don't suppose that is a dime or two more than it has been for a while. No rampant inflation here. 

BRICs-A-Bracked

The BRICs are a' breaking, with three of four sharply down and below their 200 DMA, indicating a trend change to a protracted bear market. Russia is now largely an oil-bearing State, and belies the trend down of the manufacturing States, but would follow if when the oil bubble echo breaks. From Bespoke:

This speaks to a shift from investing in emerging markets - a major theme of the past few years - back to developed markets. Emerging markets are down 3% in January, with India down over 10%, South Africa down 9%, Indonesia -7% and Brazil -4%. Inflation, arguably exported from the US be QE2, has thrown them all a curve ball.  

Markets Shrug Off Egypt, Look to Economic Data

Markets are generally up even as the Egyptian situation worsens. This makes the financial press look pretty foolish for attributing the fall on Friday to Egypt. I commented in my weekend post that all the time a market move is said to be caused by a news event when instead it was driven by technical factors, and this is just another of a myriad of examples. Yet the punditry persist in this error. 

Much more important today were some good economic reports, including the Chicago PMI at really high levels. Tomorrow the national ISM report comes out and should show an increase in production. Also income was up, although income less transfer payments was essentially flat, meaning much of the increase is government life support. Spending was up much more than income, meaning it came out of savings, and seems to have been largely driven by rising food and energy costs, not an increase in core demand.  

Over the weekend a lot of commentary on the GDP Report came in. The most interesting is from Econophile, a former bear who has been ahead of the curve on noticing a bottoming and the start of a recovery. His take on this GDP report is that it too is due to government life support, in this case largely a consequence  of QE. He thinks the positives are largely a "mirage" and may be revised away next month 

Three Things to Know About the GDP Report

Pre-market GDP disappointed at 3.2%, below expectations (3.5%) and whisper (4%) although above Q3 (2.6%). GDP hit an important milestone: we have recovered from the drop and are back at 2007 levels. The Great Recession is over! So why did the market react so badly?

The consensus opinion points to Egypt, not GDP, but Egypt had been in turmoil for several days as the market kept blissfully rising. The financial press always try to pin a market rise or fall on some news event, when technical conditions are the more likely culprit. Lost in the noise were disappointing earnings from Microsoft, Ford and Amazon, which may have had more to do with the fall. 

The best line was that the market that was looking for a reason to correct and got it in the form of Egypt's public protests. This market had been peaking since Monday and was showing signs of exhaustion. The past few days show a Fractal Finance plateau that was bifurcated to the downside by the close (see chart, courtesy SlopeofHope):

The pattern looks ominously like last April, right before the Flash Crash. As one bear pundit put it, if the market gets smoked Monday at the open, the hedge funds may short with a vengeance.

Past Monday, the question is: does the GDP report give guidance as to the future direction of the market? Is this just a momentary overreaction to a spike in oil prices and fears of a widening Arab revolt, in which case stocks will resume their upwards trajectory, or does the GDP Report throw doubt on the recovery and thereby corporate earnings? Three key things to watch:

1. Final Sales vs Growth. Final sales were up strongly, a good sign, but overall growth is mediocre at 2.8% YoY, meaning the consumption-driven Q4 is not sustainable. The trajectory is for less growth in 2011, a warning flag for a recovery, where we should be accelerating growth right now. 
2. GDP Deflator vs Inflation. The inflation indicator the BEA uses came in very light at 0.3%, with the core PCE component at 0.4%, the lowest level since 1959! If it had come in at expectations (1.6%), real GDP would have been almost halved to 1.9%. It may be it was light due to rising imported oil, which gets subtracted; but the core GDP deflator (which the Fed prefers) also declined. This very low inflation seems inexplicable given rising food and energy prices, and is likely to be revised up, lowering GDP. 
3. Inventories vs Imports. Inventories were down, lowering GDP, and imports were down too, helping GDP. Usually nventory drawdowns are good, as they presage future production to refill, but in this recoveryless recovery, Econbrowser observes that we seem to be substituting imports for inventories. As a consequence, while they expect inventories will be less a drag on GDP as they have recently, imports should go up and exert a drag of their own. See final chart for the inverse relationship.

This report looks inexplicable, with a ying/yang across those three things to watch, and is likely to be revised downwards. Karl Denninger took a look at the core conundrum in this report (I paraphrase):

how do you get an acceleration in spending with a decrease in imports, since we are not suddenly moving all those electronic gadgets back to being manufactured in the US?

He concludes that consumption number is driven up by inflation, an increase in energy and food costs, not a large increase in units. The inflation indicator for personal consumption increased to 2.1% compared with 0.7% in Q3. (The GDP core PCE deflator mentioned above excludes energy and food.) Use that 2.1% instead of the 0.4% of the report and GDP would be less than 2% again. 

My take: the year-end optimistic reports by Goldman Sachs and others of an increase in 2011 GDP as compared with 2010, to 3.5% or higher, looks at risk. Instead, it looks like the period from 4Q2009 to 4Q2010 may have been the high water mark, and we are beginning to slow down as stimulus abates.

Yesterday's op-ed in the WSJ from economist John Taylor (who would make a really great Fed chairman), which was adopted from his testimony last week to Congress, is the best I have seen to explain the conundrum we are in: the very ad-hoc and one-time efforts to jump-start the economy has kept it in a funk, unable to heal itself:

The one-time stimulus payments to people did not jump-start consumption. The stimulus grants to states did not increase infrastructure spending. Cash for clunkers merely shifted consumption a few months forward. The Fed's purchases did not have a material impact on mortgage interest rates once changes in risks are taken into account. At best these actions had a small temporary effect that dissipated quickly, leaving a legacy of higher debt, a bloated Fed balance sheet and uncertainty—all of which slow growth and job creation.

An economy on life-support is not an economy in recovery.

QE2, Inflation and the Great Margin Squeeze

Don't confuse speculation with inflation

Global food prices are soaring. Market speculation fueled by QE2 as well as one-off events like the Great Queensland Floods in Australia and US subsidies for ethanol have driven up prices from coffee beans to prime beef, from coal to corn, and just about everything else. The WSJ reports that eateries have little pricing power, so they have to scramble to avoid a big margin squeeze.

Mish takes it a step further, noting how commodity prices have increased across most industries, especially driven by oil and energy prices. Finished goods prices rose 1.1% in December, driven primarily by a 3.7% increase in energy inputs. Finished food rose 0.8% while wholesale inputs rose 23%. Mish concludes that "every step of the way, a decreasing portion of costs are passed along."

• prices are up 15.5% for crude goods
• prices are up 6.5% for intermediate goods
• prices are up only 4% for finished goods

Even less gets to consumer prices. The great margins squeeze is on. And the rise in oil could scuttle the recoveryless recovery. (Picture courtesy Pierre du Plessis.)

This is NOT inflation. Inflation is a general rise of prices, whereas this is a rise among commodities but not end prices or wages.

Let me use an analogy. A while back I discussed "good" deflation vs "bad" deflation. The steady drop in HDTV or PC prices is an exemplar of good deflation - price drops due to the ruthless pursuit of productivity and efficiency. A general drop in prices is a symptom of bad deflation - the rise in the purchasing power of the currency. Good deflation can continue for years in certain factors of production - such as oil in the 1890s, autos in the 1910s, PCs in the 1990s and HDTVs in the 2000s - without in any way presaging or sparking bad deflation.  

Similarly, a rise in classes of prices, such as commodities, is not the same as a general rise in prices. The commodities rise is likely to spill over into inflation gauges, such as the CPI, as energy and food prices tend to get passed through. But the core CPI - excluding food and energy - is unlikely to budge much. This commodities bubble echo (an echo of 2008) can continue for months without causing or presaging any general inflation.

When it bursts, it might paradoxically accelerate deflation. In our economy, debt creates money, and commodities speculation that uses margin piles on more debt. As the positions unwind, the margin is paid off and money disappears. If the effect is large enough, it can lead to deflationary pressure. 

This is not to downplay very real inflation outside the US. China in particular is seeing the inflation monster threaten to swallow their economic miracle. Some argue this Godzilla is caused by Bernanke and QE2, and certainly the commodities bubble contributes to inflationary pressure inside of China, but the source of Chinese inflation is much more prosaic: their money supply is growing too fast, fueled by a credit bubble from Chinese banks, not the Fed. Chinese M2 is up 55% in two years, and its PPI is up 5.5% year over year. Chinese steps to quell inflation have been tentative so far, as they seek that elusive "soft landing." If inflation crests double digits, they may need to find their own Chairman Volcker to slay the inflation beast. Andy Xie, one of the best observers of Chinese financial markets, suggests that China may need to devalue the Yuan, slowing capital inflows and likely causing internal interest rates to rise. 

What the Great Margin Squeeze means going forward is pressure on domestic US profits, headwinds from rising oil prices, and the possibility of a bursting Chinese credit bubble shocking world markets.

Our Hollow GDP

"Weak Hiring Casts a Cloud" -  WSJ
"For Jobs, Signs of Recovery" - USAToday

Is the recovery finally on? Or is it all an illusion, where the increase in spending is due to transfer payments from big deficits? Let's explore the reality and the illusion. 

A lot of pundits have caught the optimism. Consider these factoids:

• Holiday retail sales highest in years
  • but it turns out it wasn't - it was a dud
• Q3 GDP revised up
• Q4 GDP on track for even higher
• GDP in 2011 revised upwards due to Tax Deal
• Latest ISM report up showing increased business activity
• Job openings rebounding (see chart)
• Commercial lending *may* be picking up

The best green shoot of them all is the WSJ story that bank lending may finally be picking up. Commercial lending to finance growth is the real key to a recovery. Yet if there is an uptick, it is barely discernable (see second chart).

The other big positive news is the Tax Deal, which puts off the dreaded double-dip by not hammering the economy with a massive tax increase.

Yet at the same time the recoveryless recovery faces severe headwinds:

• Housing - double-dipping
• Jobs - growing too slow 
• Oil - rising to dangerous levels
• Debt - used for transfer payments, not growth

Make no mistake, there are signs of improvement, and they have been trending better for the past four months - ever since QE2 was announced in late August. We saw a similar burst of optimism last year at this time. Is it real this time, or another illusion, driven by massive transfer payments, which boost GDP but not the real economy, and pile on more debt for transient spending?

Let's walk through all four headwinds.

Iceland or Ireland

It is not often in economics one can get a realtime test of two different theories, but we have one right now with how Iceland and Ireland have handled their debt crisis. Pierre du Plessis comments on a report from BCA Research that highlights the stark difference in policy to remedy their debt debacles.

Simply put, Iceland bit the bullet & repudiated the debt, plus devalued the Kroner, while Ireland kicked the can down the road & took on even more debt. Both were forced to pursue fiscal austerity, but Ireland stayed with the Euro and could not devalue their currency. How is it working out?

Iceland is growing GDP and real wages, and Ireland is dropping in both GDP and wages:

Put in stark terms, Iceland decided to protect its people rather than the global banks:

Iceland takes some very severe one-time pain as the country pays for excesses, but will emerge with a clean slate and limited liabilities for the taxpayer, while the bondholders of debt (in this case Iceland's banks) take the hit.

This is in contrast to what other nations have been doing, which is along the lines of the decisions in Ireland over the past 3 years - that is (a) first shift the debt from the banks from the private sector to the public, and more recently (b) accept bailout funds - that eventually need to be paid back - to keep the whole thing from collapsing.... but to make the global banking oligarchy fat and happy as they suffer no losses.

Ambrose Evans-Prtchard of the UK Telegraph comments how this presents a "risky temptation" to the rest of the PIIGS, to drop the Euro and repudiate the debt in order to protect their citizens from the penury of paying back the global banks. There is an odd moral justice here. When the PIIGS joined the Euro, they got a one-time benefit of lower borrowing rates and higher national wealth, which they squandered with massive borrowing to pad their welfare states rather than invest in future production. Now will they leave, take a one-time hit, and restructure their economies? 

Will the Poor Unemployment Report Kill the Santa Rally?

The Santa Rally traditionally comes in mid December, but has it already started? This year we saw the seasonal strong period get off to an early start, in September rather than the normal November, which might be a harbinger of an early start to the year-end rally. Retail sales over Black Friday and CyberMonday were "way up" year-over-year, according to SpendingPulse, continuing a trend first gleened in September of increasing spending.

Before we get drunk with excitement, like our Santa here, a little caution. Friday's unemployment disappointment included an increase in seasonal workers, up from last year, but still below pre-crisis levels, and on a seasonally-adjusted basis, still below normal. This means retailers are being cautious. 

We all should be cautious about this recovery. Employment has been flat for a year, and you can see that the unemployment is ticking up slightly (the red dots in the next chart). Normally it ticks up as an economy recovers before ticking down, as workers on the sidelines come back to seek employment faster than new hires are made. A little of that is going on, but largely we have not seen job growth other than temporary or part-time work. This remains the Recoveryless Recovery. 

We also should be cautious on stocks. We have a conundrum: possibly the early discounts pulled forward sales that normally would have happened in December; or perhaps the American shopper has now become so discount driven, we will see a pause in shopping until the retailers entice with even better discounts, giving a late surge to the holiday sales pattern. How to translate these choices into a prediction for the stock market?

Gridlock May Not Be Good as Double Dip Still Looms

There is a high expectation that the Repubs take at least one house of Congress, blocking any further expansion of the Obama agenda, and leading to gridlock for the next two years. There is a general view that gridlock is good for stocks, so a post today that looked at the data caught my eye. PragCap reported on a Fidelity analysis that shows NO positive correlation between mid-term gridlock and stocks:

Large-cap stock returns during post-midterm election years have been about the same, whether or not the outcome resulted in gridlock or harmony (i.e. one party controls both houses of Congress and the White House). Small-cap stocks, meanwhile, outperformed in years of political harmony compared to gridlock.

PragCap goes on to comment that gridlock may be bad for the economy in the circumstances we are in. The next chart shows how the stimulus at least buoyed GDP during the past 18 months, and (as I have commented) once past Peak Stimulus the shrinking stimulus is actually a drag on GDP growth that makes a coming double-dip more likely (the black line is the drag from less stimulus plus less inventory rebuilding):

There is hope that the private sector can more than overcome the drag, and expectations have been that the Q3 GDP report (which is released right before the mid-term elections) would be at least flat to Q2.

In August, however, the trade deficit widened, and it acts as an additional drag on GDP growth: the change in exports less imports is a major component of GDP growth, and a wider trade deficit means it could come in more negative relative to the prior quarter. There had been an import surge in Q2 which was largely based on slightly higher oil prices plus restocking for holiday sales, so expectations were for this component to decrease between Q2 and Q3, which would have pushed Q3 GDP growth up on this component.

Now, the NYT reports that Macroeconomic Advisors has reduced Q3 GDP expectations to 1.2%, a decline from Q2's 1.6%. Calculated Risk had expected a 2% Q3, but calculates that the trade deficit will end up about the same as Q2, meaning it will not improve GDP growth, and now estimates 1.5% GDP in Q3. 

Ironically, a poor GDP report boosts the odds of QE2, which should boost stocks until they run up enough to account for the purported benefits of QE. If gridlock results in less fiscal stimulus and less effort to fix serious structural problems (unemployment, exports, bank lending), the normal rise in stocks between the mid-terms and the next election may be less than expected. 

Double-Dip Watch: Regional Feds Report Deteriorating Business Conditions

I have been on a double-dip countdown as leading indicators continue to show that the Recoveryless Recovery is fading. I put the count on hold in early Aug as the 2Q GDP report came in ok at 2.4%. That report was quickly revised down to 1.6% and the countdown ticked one more down, but then went back on hold again as we saw conflicting data at the end of August: the regional Fed reports came in lower, but the national ISM report was surprisingly positive. This was part of the bundle of positive news that seemed to drive the start of September to a fast bullish clip. 

The regional reports are notoriously noisy, but they do come back into alignment with the national report, so I posed the test:

either the next ISM drops, or the next regional reports strengthen

The regional reports are coming in first, and are now even further out of alignment with the national report: 

• the Philly Fed report came in showing contraction for the second month in a row at a negative -0.7, higher than last month (-7.7) but worse than expected (+3.8)
• the Empire State report from the NY Fed remains in expansion but slipped 3 points to 4.1

 

This non-confirmation of the ISM report plus the fact that the leading components of ISM were trending down suggest that the national ISM report will be dropping in the next report. We may also see a revision down of the last report. Goldman Sachs expects the national ISM to go below 50, signaling contraction, within a few months. 

 

The overall reports, however, remain ambiguous. 

Industrial Production and Capacity Utilization were up in August, albeit still at low levels. 

Rail traffic has been trending up, but recently spiked down, likely reflect a holiday period not a trend change. Rail has been increasing along with imports, and imports seem to be softening. We had higher expectations for back-to-school and holiday sales that drove imports, and the slow back-to-school season led to excess retail inventories and a slowdown in new orders. BTS sales picked up late in the season based on aggressive sales and discounting. This does not bode well for the holidays but at least if retailers cleared stock, a new surge in imports for Xmas may show up in the data, including rail traffic 

 

Copper has also been rising, probably tracking the global demand for gadgets. Global production is more robust than US production, and it shows up in copper. Copper is signaling strength in the global economy. Still, copper has been volatile and production has been sideways. 

 

A Simple Explanation of the Great Recession and Why It Has Years To Go

From 1987 when Greenspan took over the Fed until 2009 when the US hit Peak Debt, the US private sector added $34T of debt while US GDP only went up by $9T. Rather than seeing this as a classic Ponzi Scheme, economists praised it as financial innovation. Steve Keen, an economist out of Australia, writes a trenchant essay on this topic entitled What Bernanke Doesn't Understand About Deflation that explains why this Ponzi Scheme is the greatest failure of the Fed and central banks around the world. 

His point can be understood this way: what an economy produces (GDP) plus the increase in private debt equals the aggregate demand for stuff. The increase in debt ahead of GDP means the country is living beyond its means, consuming more than it produces. At some point this cannot go on, and the debt begins to shrink. As it shrinks, GDP less the change in private debt equals aggregate demand. As debt shrinks the drop literally sucks demand out of the economy.

• At the peak of our credit bubble, new debt drove US demand to an astounding $18T, $4T beyond GDP of $14T
• By 2010, the decrease in debt turned GDP of $14T into demand of $12T - an absolutely brutal turnaround of -$6T in two years

From $18T to $12T in two years means a third of the wind got sucked out of the sails of the US economy. In 2010 alone demand is headed to a drop of 17% - about what happened in 1930. 

The next two years (1931 and 1932) saw drops of 27% and 24%. 

Current Data Trumps Recent Positive Indications of Recovery

The hunger for confirmation of a continued recovery led to a positive spin on the dismal GDP revision: that it beat even worse expectations. This week brings a ton of data, some of it current and some of it lagging. The few positive reports are getting touted even when a modicum of reflection would repudiate the confirmation of recovery. With this in mind, let's survey some recent news bits.

Housing: The Case-Shiller housing report was positive - but it reflects data back in June when we still had a homebuyers credit. We already know from more recent data that housing fell off a cliff in July when the credit ended. The chart which best captures where we are in housing is this view of psychology from The Big Picture:

Spending: the headline is that incomes and spending are improving. In July, incomes rose the same as June, which is encouraging, but less than May (0.3%) or April (0.5%). Spending rose faster than incomes, and in total spending is back up to 2007 levels, but growth remains relatively low and per-captia spending is still down. The trend remains downward since 2000: 

 

Incomes: The problem is how sustainable spending is when incomes remain depressed and the government transfer payments (which helped buoy spending) are abating:

 

Retail:  The back-to-school season has been slow, which has led to deep sales to bring in parents. It is thus not clear that spending will hold up in Q3. No surprise then that retail stocks are in full retreat. 

Purchasing: The regional PMI (purchasing mangers' index) reports are coming out, with the national PMI expected tomorrow. The spin is they are still positive, indicating continued expansion. Beneath this spin, however, the trend is clearly down. The Chicago PMI missed expectations coming in at a new low for 2010 at 56.7. The NY numbers also came in "decidedly weaker" than reports earlier in the year. With the Dallas report (next item below), all the Fed manufacturing surveys are in, and they all showed slowing or contracting activity:

Manufacturing: The Dallas Fed just reported continued weakness in "business conditions" at -13.5%, up from the dismal -21% of July but worse than the -10% expectations. Texas factory and production both came in at zero. New orders came in negative, which bodes poorly for the near future. The manufacturing portion of ISM is looking like it is already into contraction. PragCap reports that manufacturing indications out of the mid-Atlantic region are "decidely negative" for August. Business conditions and new order both were negative (around -7) from the Philly Fed report, pointing to the ISM index going negative in the next report:

Tech Sector: The tech sector has been doing very well in connected devices, and July chip sales were up 37%, but the growth rate is slowing. Yet Intel missed badly in its latest report, an early indication that the weak economy has caught up with it. In July it had reported strong demand. Cisco had also reported weakness, and in general across August Tech has flashed warnings. 

 

Global Warming Drives GDP Revision Up

I may have scooped The Onion with this headline. Revised GDP ay 1.6% beat the expectations of 1.3%, although fell below ZH's revised revision at 1.8%, but what caught my eye was this from MarketWatch: 

Wall Street appears to have been caught off-guard by an upward revision to electricity and natural-gas usage figures, which led to an increase in real personal consumption to 2% from the 1.6% initially projected.

A simple explanation, offered by Bank of America Merrill Lynch's Neil Dutta: households ran their air conditioners longer because of warmer-than-average temperature.     

The best news was the increase in business spending to replenish capital equipment, but the recent weak durable goods numbers suggests that trend may not continue into the Q3 number. 

The best bad news was that imports surged even more than in the prior report, to the best growth since 1984, which has a damper on GDP (the net of exports less imports is added to GDP), but that is likely stocking up for all those gadgets expected to be hot this Christmas, and is also unlikely to continue in Q3. Put into GDP numerology, real domestic purchases grew 4.9%, up from 2.9% in Q1, but real sales of domestic product grew only 1%, a drop from 1.1% in Q1. This means domestic demand is there, and if we get a drop in imports relative to exports in Q3, it might bolster the Q3 number - so look askance at predictions of a double-dip as early as Q3. 

Nonethelesss Goldman Sachs sees a slightly lower Q3 number, largely driven by inventory rebalancing still being high; as it lessens the GDP is lowered. 

The biggest risk to their revision is their assumption about fixed residential investment expanding at 27%, which seems nuts based on recent housing news. It has also been an area of over-estimation in past reports that led to downward revisions. 

 

Bernanke's speech was a bit of a dud, especially when he admitted that “central bankers alone cannot solve the world’s economic problems.” Why we would believe in Fed omnipotence is a topic for another day, but suffice to say the Fed claims it has more bullets to fire at the problem even as it confesses it is running out of ammunition. PragCap gives the Cliff Notes version:

• Bernanke sees no double dip (he also saw no housing bubble)
• Bernanke believes QE2 will “be effective in further easing financial conditions.” (Historical evidence and lending data shows that QE is a non-event)
• His two ideas that have everyone all excited this morning are: (1) changing his wording (which will do absolutely nothing for Main Street even though it might get Wall Street all excited for a few hours) and (2)he will cut the interest on reserves a whopping 25 bps (25 bps isn’t changing anything at this point Mr. Bernanke)
• Bernanke is oblivious to the fact that he has run out of ammo: “The issue at this stage is not whether we have the tools to help support economic activity and guard against disinflation. We do"

The market has ratcheted around a bit this morning, which has emboldened bulls. The expectations game applies to GDP as well as earnings(!), yet the market in the short run tends to be driven by technicals not fundamentals, so too much can be made of momentary jinks and jives due to a news event. Later I will post on the wave structure, which anticipated the sort of sideways move we have seen over the last three trading days. 

Electronics Going Gangbusters and Signaling a Coming New Tech Boom (But Not Now)

History does not repeat itself, but it does rhyme - Mark Twain

In spite of the increasing doom & gloom in economic indicators - the market clearly expects a big downward GDP revision tomorrow -  I am hearing of component shortages for consumer electronics being hastily manufactured in China. Apple is still supply constrained on iPads and iPhones, shipping every one they can assemble, and this may be impacting commodity components (like diodes and MOsSETs).  

Spot shortages may seem paradoxical when industry after industry has underutilized productive capacity, housing is in the dumpster and autos are down to under 12M a year in the US (imagine, they crested 8M in the early '50s when we had fewer than half the population). 

Yet this story of booming gadgets and busting everything else rhymes with one of the hit products during the Great Depression: radio!  People wanted to stay in touch, and radio (plus telephone service) boomed in very bad times. So too today in the demand for connected devices. Android tablets are the next big thing, with knock-off Chinese units selling as cheaply as $99 already. The demand for smartphones, iPads and Android tablets appears to be overwhelming the supply chain and causing spot shortages.

This gadget mania probably explains an interesting anomaly in economic indicators: imports are up more than exports (all those gadgets coming in from China for Christmas), and intermodal containers shipped by rail are still increasing - in fact set a record for the year - but truck traffic is flat. Speculation: imports are driving rail traffic, but exports & general economic recovery are not picking up the slack in trucking.

There is no fundamental reason this will end until market demand is saturated, which leads me to speculate that we will see the Nasdaq begin to diverge against the Dow to the upside as the fruits of the current beneficiaries of Moore's Law begin to explode into the new huge global markets for gadgets and the accompanying Cloud services. The question is when.

One spark could be a few high-profile IPOs. Apple went public in 1980 amidst the last double-dip, and Netscape sparked the dot-com boom in 1995 at a time when the market had been considered sluggish since 1987. Google failed to be that spark early in this decade, but then it came out amidst a boom in housing and private equity, right after a horrific tech bust. Poor timing for tech to rebound. 

This time around we have a new revolution brewing, and any one of the current tech darlings - Facebook, Zynga, Twitter - could be the spark to the new tech boom.  In the past, tech booms come on their own schedule, when the ongoing improvements in technology lead to sparkling new applications: PCs, Internet, now connected devices. Tech booms have tended to lead out of bad times. Case in point: the PC boom happened from 1978-83 before the Reagan Revolution and amidst terrible economic indicators.

Rumors circulate on when we will see those IPOs, with Facebook the biggee. Facebook was recently said to delay until 2012. Zynga is said to be at least 18 months from IPO, putting it also into 2012.

For other reasons that may be a good time to begin expecting the next tech boom. The timing between these booms appears to be about 12 years from end to start: 

• the transistor boomlet from 1962-66 was followed 12 years later in 1978 with the PC craze
• the PC craze ended in 1983 and the dot-com mania began 12 years later in 1995 
• the dot-com fever broke in 2000, and 12 years later is 2012 ...

It probably takes something around that timing for (a) Moore's Law to go far enough ahead to create new magical toys and (b) the fund managers who got hurt at the end of the prior bubble to retire and be replaced by green newbies. 

I do not expect it in the near term. The SOX index of semiconductor activity has been rolling over, indicating perhaps a seasonal lag or maybe a longer cyclical drop. When the next tech boom comes, it will show up first in chips, then devices, then software/services, then IPOs!

Double-Dip Watch: Uptick in Industrial Production

In this Summer of Disillusionment, where the plethora of bad news is driving a bond bubble, we had some rare good news: an increase in industrial production of 1% that beat expectations of 0.6%. Production is up almost 8% above year-ago levels, and if this pace continues, we should be back to a full recovery by next summer. This is the first positive surprise after a series of disappointing reports on retail sales, housing and building permits. Is this a harbinger of a change of trend back towards an economic recovery?

 

The report stands out against other negative news. This raises the concern that it is based on a statistical anomaly. A major component of the increase is the auto sector, and if that is carved out of the report a strange spike emerges in the data:

 

The spike comes from seasonal adjustments that may be skewed because normally July is a down month - so a lesser decline in July causes a positive blip up after adjustment. You can see in this comparison of non-seasonal numbers (red) vs adjusted numbers (blue) how a steep drop in actual production was turned into a steep increase in adjusted production:

The statistical blip is not showing up in other reports. The Empire State Manufacturing Index came out weaker than expected. The index is still positive at 7, and rose a bit from its July level at 5, but has fallen from a 32 level in April and a 20 level in June. When compared with the new orders component of the Empire State index, industrial production looks like it is rolling over towards a decline, not accelerating into a rise:

What We Should Have Done Instead of the Bailouts

Great analysis by Barry Ritholtz of how things would have turned out if we had taken an alternative approach to the bailouts and stimulus: if we had chosen the path of Sweden (which dealt with the problem) rather than Japan (which papered it over).

He is responding to Geithner's self-congratulatory op-ed in the NYT, referring to a Blinder/Zandi report on how much worse it might have been had we done nothing in 2008.  Barry says the proper comparison is not with doing nothing, but with doing something smarter than pouring money on the problem. 

Any counter-factual like this hypothetical, since we cannot replay the real world, but is useful to compare alternative policy approaches for future action. Barry uses analysis from David Weidner in the WSJ and David Leonhardt in the NYT to build the capitalist alternative to the socialist bailout:

• Bear Stearns: let it fall (it likely would have been bought by JP Morgan, as it was anyway, due to JP holding $9T of derivatives from Bear, but without a $29B government gift)
• Lehman: prepackage its restructuring, a point I have made previously
• AIG: carve the derivatives business out, rather than bailing out Goldman Sachs 100%
• Fannie/Freddie: wind down, before shoveling untold $Bs back in
• Insolvent banks: put them in receivership, clean them up, let shareholders/bondholders not taxpayers take the hit

Barry concludes we would have ended up with a functioning banking sector, a much healthier housing sector, smaller deficits, and a return of moral hazard. 

The Flight to Bonds Continues Amidst Deteriorating Economic Forecasts

Bond yields are approaching the historic lows of 2009 during the flight to quality. The rapid drop in the 10 yr in the absence of the 2008 banking crisis is truly historic. Since the April high in stocks all the mid-term Treasuries have raced down in yields (chart from EWTrends):

We may be approaching the end of a 30 year bond bull market, from the highs of 1980s to the potential lows of 2010. This chart from SeekingAlpha shows the trend:

The author raises the caution flag that a protectionist movement may be near. Seems a bit alarmist, but the Chinese currency, which began its float again to great fanfare, has now dropped for five straight days and is lower than it was then!  Congress is now, once again, raising the spectre of retaliation. 

A more prosaic explanation for the rush to bonds is a rise in fear, fear not of another banking crisis but of an economy rolling over again, this time (the fear story goes) with no weapons left to restart it. 

GDP forecasts are being slashed. Goldman joins JP Morgan and Deutsche bank in lowering the coming Q2 revision to the low 1% range, and increasing double-dip odds to 25-30%. Looking forward, ZH reports that a "Philly Fed" forecaster sees Q3 dropping from expected 3.3% to 2.3%, and slower growth in 2011 and 2012. Chances of a negative Q4 are rising. Please refer to the charts in the ZH link for details. 

Japan's GDP came in worse than expected, and led to a plethora of stories of how China has now overtaken it to become the world's second largest economy. Well, not quite, but perhaps by the end of the year. Europe's leading indicators have also rolled over, signaling a coming slowdown. 

The normally bullish Califia Beach Pundit reports that container traffic out of LA is showing signs of a slowdown even as imports are surging. (See first chart below.) While they see that import surge as positive, it may be due to elevated expectations of holiday shopping, expectations that are not being met. There have been a flurry of news stories of how retail is slowing and the dismal back-to-school sales are (they hope) merely delayed. The govt report can be downloaded here. 

 

Another poor sign is the rolling over of semiconductor sales based on a leading indicator. Since gadgets have been doing well, this is an ominous sign. 

 

Given the low rates, corporations are jumping into the bond market. Even junk bonds issuances are increasing as investors scramble for yield. This suggests that all is not fear. Corporations are said to sit on record cash, giving junk bonds a allure of relative safety. 

The question for investors is why buy at these low rates? There is less reason for a flight to quality today than two years ago. 

The wave pattern strongly points to a bottom coming in bonds, and then a bounce (in yields). The Monday STU notes that the gap up in the morning may be an exhaustion gap. Bullish sentiment towards Treasuries is now 98%, approaching the incredible 99% on Dec 16, 2008, right before the all-time high. 

One play is to buy the 30-yr. The recent Fed "QN" announcement targets the 2-10 yr Treasuries, which have dropped the most. The 30-yr may follow. The argument that inflationary expectations are keeping the 30-yr high are likely missing the dynamic that the Fed's intervention is driving the mid-term rates lower. Right now being long the 10 and short the 30 is a likely arb play that may be keeping the 30 yr lower (higher yields). On the other hand, the intervention of the Fed has paradoxically made the 30 yr less sensitive to interest rate changes than the shorter term instruments. Hence the 30 yr may not move if inflation kicks in, while the 10 yr will move more if deflation kicks in. 

Corporate bonds should also be looked at cautiously. The widely held belief that corporations are sitting on hoards of cash needs to be tempered by the even larger hordes of debt they hold. Just as corporate cash is at an all time high, so is corporate debt: $2.6T of cash but $7T of debt. 

Better Data Shrinks Q2 GDP to Under 1%

The Trade Deficit came in much worse than estimated when the GDP number of 2.4% annualized was released ten days ago: -$50B vs estimate of -$42B, an $8B drop from May's -$42B deficit. This is the worst trade deficit since Oct 2008. It is likely that JP Morgan will revise downward again, from 1.3% to 0.9%. 

The Stimulus is now becoming a drag, as it has passed peak spending and is decreasing each quarter; as is inventory rebalancing (see chart courtesy Goldman Sachs). Goldman sees the drag as peaking at -1.7% in 2011. Absent some sort of tax cuts (not increase next year, as is now baked in with the expiration of the Bush tax cuts), they are close to joining the double-dip camp. As it is, they have reduced their 2011 GDP estimates by 0.9%.

Double Dip Countdown: T-5 After Fed Punts

The countdown is getting closer to the double dip: 10 - 9 - 8 - 7 - 6 - 5, restarted after we put the countdown on hold last week. The Fed concedes that after an unprecedented stimulus worldwide, the US economy has never recovered and is beginning to slow again. This does not mean it will go negative, but when the economic cheerleaders face reality, it means things are worse than reported. 

Already GDP, which was reported at 2.4%, was downgraded (by JP Morgan) a couple of days later due to a poor durables report, and now has been downgraded by them again to 1.3% due to a poor wholesale inventory report. Tomorrow international trade comes out, and JP will be at it again. They note that the GDP gets reported at the end of the month, with estimates for items that come in a week or two after. They think the estimate of international trade was "extreme", setting up another downwards revision tomorrow. 

The other disturbing news is more leading indicators heading south. The US LEI is heading down, although not yet signaling a second recession. The Global OECD indicators are turning over and in some cases in negative territory. David Rosenberg's Euro bearish counterpart, Albert Edwards, reports that the Conference Board indicator (excluding a yield curve input) is now in negative territory (see next chart). He pulls out the yield curve since the short-end is artificially low due to ZIRP (zero interest rate policy). He concludes that market participants will soon realize that the US is Japan of ten years ago, and will follow a similar path of deflation and zero growth. 

The Fed took a partial step today which has caused a flurry of "QE's" to wing through the blogosphere, like "QE1.5" instead of the $1T "QE2" urged by Goldman. The best is "QN": Mish calls it Quantatative Nothingness, but more kindly call it Quantitative Neutrality, since the policy is really neutral: instead of tightening by allowing the agency paper they bought in QE1 mature (and thereby lowering the Fed's assets), or expanding their assets through Goldman's QE2, the Fed stayed flat by saying it will recycle the returned cash into Treasuries. 

 

Sadly, while QE1 held rates at the long end down, it didn't do much to restart lending. Remember that in our fiat currency regime, the Fed doesn't print money but cajoles the banks to lend, which creates money. Despite the low rates, housing is in the dumpster (at the lowest levels since 1963) and consumer loans continue to fall. Here is David Rosenberg's take: QE is a "push" phenom, and where credit demand is collapsing, the Fed is pushing on a wet noodle. 

 

The credit markets responded with the biggest drop since the crisis, with rates also in the dumpster. Over at SeekingAlpha they conclude that the Fed's move is largely symbolic, since they are running out of ammunition. 

 

Mish in his Quantitative Nothingness post today looks into the yield curve, and finds it flattening, especially in the middle (seven-year). The five year is approaching its record lows of 2009, but the 30 year barely moved - hyper inflationary fears after the current policies fail? Or perhaps there is an arb play going on, to buy the mid-term bonds and short the long bond. 

The Fed tends to move cautiously, so the most astute comment of the day came from over the pond in the Globe & Mail: that the Fed is showing it will take whatever steps are necessary to prevent deflation, but it will do so in a measured way when necessary. The next step might be to monetize State pensions, which face a huge and growing shortfall. They had been designed with 8% returns in mind; but in the New Normal that is hopelessly optimistic. As the pension actuaries face up to the shortfall that a 4-5% return environment creates, the States will be forced to either pull back their commitments or put more money in to the pension plans, further withdrawing spending from the economy. Since the Fed's low rate policies and QE have dropped returns, it makes sense they figure out how to bolster the pension shortfall - but doing so simply pulls more focus away from a real recovery. 

Double-Dip Watch: GDP Report Was Mixed UPDATED

I have been running a double-dip countdown but Friday's GDP report was ambiguous as to the imminence of the double dip even as it was generally greeted as confirming a second-half slowdown and bringing the double-dip in closer. Hence rather than tick the countdown down I will put it on hold and see what the mixed signals mean. 

UPDATE: JP Morgan says that the Friday GDP number of 2.4% annualized will be revised down to 1.7% after new data on non-durable goods that came out Monday. [Other updates in italics below]

The Street's view was of slower-than-anticipated growth with smaller-then-forecasted increase in personal consumption. Goldman predicted even lower growth, so it came above their expectations, but below the median. Still, put this in perspective:

• Early this year predictions were for 4% growth in Q2
• A month or so ago predictions were lowered to 3%
• Last week the consensus became 2.5%

So we already have a second half slowdown, even before the second half starts - a slowdown in expectations. And doubtless the Q3 predictions will be lowered as well, since the key takeaways are discouraging:

• Inventories are slowing: Inventory rebalancing was increased in Q1, but more than final sales, and was lower in Q2, indicating inventories are about to go from a positive to a negative in GDP
• Personal consumption is slowing
• Residential investment will drop: it was boosted by the homebuyers credit

Still, almost all components were positive:

Another mixed message from the report: the Great Recession has been worse even greater than thought. GDP going back to 2006 was lowered, and the dip in 2008 was deeper than previously reported. In effect, we were already treading water back in 2006, before the recession officially began, and have now had 3 1/2 years of slow to negative growth. On top of that, the cumulative drop in GDP was deeper even as the recovery out of the dip is slower. 

 

Personal consumption was also lowered in prior years, and as The Big Picture summarizes, the key contributors to Q2 GDP growth were government largesse, while personal spending was below expectations. A toxic cocktail for Q3 and beyond, as the Stimulus ebbs, the States face huge budget disasters, and the consumers are saving again.  

 

All was not bad, however, which is why the report is best characterized as mixed. Bright spots:

• 21.9% rise in spending on equipment and software. 
• 4.1% rise in real final sales, up from 1.3% in Q1.

Unfortunately, these categories are not enough to make up for the shortfall in inventories and residential investment. Pending home sales fell to a record low in June. Much of the rise in real final sales was due too a surge in imports, up to 29% from 11% in Q1, while exports were up only 14%. As a consequence, real final sales of domestic production only expanded at 1.3%, barely up from 1.1% in Q1. Also, the great increase in business spending, which we would want to bolster production, probably is not for those purposes. We have too much capacity, and companies are sitting on cash rather than expanding. I suspect that the increase in software mirrors what we saw in the Great Depression: companies hoarding cash since they lacked good places to invest for growth, and spending it instead on productivity tools such as IBM punchcards (then) and new PCs (now). Hiring machines instead of people. 

Other mixed news comes from outside the report, and could support a GDP growth of 3-4%:

• GM just reported a 25% increase in auto sales*, while Ford and Toyota rose only around 3% .. overall auto sales were up 9%, a good sign
• Global chip sales up 45%
• ECRI's growth index fell further, to -10.7% from -10.5%, but their index rose a bit 
• The National PMI index fell, but less than expected, from 56.2% to 55.5%. A reading above 50% indicates expansion, so no recession indicated, but the trend is down. (See chart below.)
• The Chicago PMI came out higher than expected, at 63%; up but still below April's number

* GM sales increase is artificial since it was in bankruptcy the first part of July a year ago.

 

Optimism aside, other indicators beyond ECRI also point down, including the latest from the Consumer Metric Institute, which is definitely pointing down:

My take: the mixed report has some glimmers of hope, and we might see more inventory building than expected due to anticipation of a good holiday sales season. This is apparently what drove the surge in imports. The impact would be a positive Q3, although maybe in the 1.5-2% range, and a positive Q4, seasonally at a higher annualized rate. The double-dip may emerge in Q2 next year at the earliest. 

Beware Extrapolating from One Data Point

CNBC had a robust session on the housing data Monday morning, concluding that housing had bottomed and the bounce was on! Their single data point: a 23% bounce in June over May. No mention that:

• this was the worst June on record (back to 1963)
• May got revised downward 11%, a pretty steep change
• the 23% gain in June was elevated due to the May reduction
• April got revised downwards, too, by 15%, an even steeper change
• June was 17% below a year ago, June 2009
• June was the second worst month on record
• May was the worst, the all-time record low (back to 1963) for any month 

To the contrary, a commentator asserted that "housing bottomed in the first quarter of 2009." He must have failed math. Maybe now he can make the claim, after the two worst months on record. Some discussion that it follows a really poor May, which plummeted after the homeowners credit expired for new homes in April. The perils of government intervention. A reversion to the mean snapback was to be expected in any event. More data at Calculated Risk, a great source on housing.

CNBC was not alone in this irrational extrapolation. Bloomberg reported:

Sales of U.S. new homes rose in June more than forecast following an unprecedented collapse the prior month, a signal the worst of the slump triggered by the end of a government tax credit is over

A different but equally misleading error shows up at the normally reliable Pierre du Plessis blog. I think it inadvertent, since he is exploring an interesting issue. The ECRI indicator has dipped below -10%, which has always signaled a recession. The inputs to ECRI are a black box, but Pierre uses correlation with the S&P to argue that ECRI really tracks the S&P more than a cluster of leading indicators. Or maybe it is the S&P which tracks ECRI's indicators? It makes a huge difference, since the hoary old saw is that "the market predicted six out of the last three recessions."  ECRI may be more accurate than the S&P.

A third data point getting a lot of press is the Chicago Fed's Index, which shows a decline in June. In my most recent Double Dip Countdown post, I noted how the Empire State (NY) and Philly reports had shown a slowing of growth, but not a decline. The Chicago survey is national, and the decline is a bad sign - yet still just one datapoint, and one that needs to be understood: a decline means growth below the historical trend, not an outright contraction. The three-month moving average has gone to -0.05, but it needs to get below -0.72 to reliably signal a double-dip. 

 

A final pair of datapoints come from the regional Feds. The Dallas Fed Manufacturing Index, which was suppose to improve from -4 in June to -2.5 in July, instead fell to -21, the lowest level since July 2009. The Richmond Fed also reported a drop from 23 in June to 16 in July. Again, these drops do not signal contraction, just a slowdown in growth in manufacturing.

Individually, these single factoids can be used to create a bullish or bearish picture. Taken as a whole, they show consistent evidence of a second half slowdown, if not a double dip. 

1937 All Over Again

It's deja vu all over again - Yogi Berra

Bernanke's comments last week elevated to public view a debate over the Bush tax cuts expiring next year. Most of the rate cuts affect people below $250,000 in earnings, so letting it lapse as is would breach one of Obama's core campaign promises. The Sunday NYT headlines a big fight brewing over this. The problem of letting it lapse, however, is much more economic than political, and affects the future path of the stock market.

The Original Double-Dip

The lapse of the cuts amounts to a large tax increase in the middle of a recession, a lesson we should have learned not to do. Back in 1937 FDR tried to return to normalcy after his re-election in 1936, and instead threw the economy back down in a large W shaped recovery - the original double-dip recession. (See chart from WSJ.) 

The cluster of mistakes:

• new social security tax ('37)
• "soak the rich" tax ('36)
• surtax on undistributed profits ('36) 
• increased bank reserve requirements ('37)
• letting a bonus to veterans lapse ('37)

Of these mistakes, three were tax increases. 

The Potential Impact of Tax Increases

Christina Romer made her economics reputation on the impact of taxes on growth, and she "cringes" at the thought of repeating the mistakes of 1937. She became Obama's head of economic advisors, and her policy brief on the 1937 problem can be downloaded here. It is an interesting read since she suggests that fiscal stimulus has a modest impact, while monetary and tax policy have a much bigger impact; and yet the current policies of the administration are the opposite: heavy on fiscal stimulus, sanguine about the coming tax increase, and nearing the end of monetary stimulus. Her reputation-making conclusion on taxes is that each 1% increase in taxes causes a 2-3% decrease in GDP - a huge negative multipler of around 3x (download her paper here):

My purpose is not to rehash the debate over the mistakes of 1937 - there is plenty of that going around. It is useful to appreciate, however, that what passes for conventional wisdom - the Keynesian view of the 1930s as one of a hapless Hoover and a stimulative Roosevelt - is itself revisionist history: Hoover had ramped up Federal spending to deficits of 4.5% of GDP, and FDR kept that relatively constant, averaging 5.1% in the first three years of the New Deal. The economy swung in much broader strokes between 1932 and 1936 than such a minor difference would indicate. 

What is clear is that the New Deal did not get us out of the Depression. Unemployment was still above 12% in 1937, and got back to 19% in 1938. Also, government spending did not decrease in 1937, although the deficit did shrink (see chart). The degree to which we fell back down after modest changes in policy throws into question the New Deal narrative, and how effective its fiscal stimulus really was. Certainly it has an impact; but it may not fix things. 

This seeming failure to explain the swings in the '30s by fiscal stimulus alone has led many revisionists (beginning with Milton Friedman) to consider the contraction in credit (monetary policy) as a much bigger driver of the 1937 double-dip than any slackening of fiscal stimulus. Yet one of the most troubling analogies to 1937 and today is the dearth of business and consumer lending. Keynes of course called this the Liquidity Trap. Even if the Fed's low interest rate and QE policies of today are theoretically expansive, the monetary fix is not working, and the fiscal stimulus did not work to get us past the Liquidity Trap either. Worse, the recent FinReg bull already has tightened credit even more - for example, the criminalization of rating agencies (a little plum slipped into the bill at the last moment) has caused Ford to have to pull a bond offering as the agencies have stopped rating instruments pending clarity on the new rules. 

I wonder if FinReg will go down in the revisionist history of the future as the equivalent blunder in its effect to Smoot-Hawley in the 1930s: the tipping point to a disastrous contraction. 

Despite the revisionists, Romer's view that to withdraw stimulus now would repeat the mistakes of 1937 represents the conventional economic wisdom.

The Diminishing Impact of Fiscal Stimulus

In some respects our current environment is very much like 1937:

• Back then, the banks sat on high reserves rather than lending - as now
• Back then, the interventions and meddling of the New Deal (so-called Regime Uncertainty) froze corporations from investing, and they sat on huge stocks of cash - as now
• Back then, the low rates of return made it dis-economical to invest in new plant - as now

In other respects, however, we stand in a very different place:

• In the first wave down from 1929-1933, the over-capacity built by the bubble in the 1920s was worked off, and both production and capacity were in better alignment in 1937 than today
• Growth from 1933-36 was double-digit (above 10%), whereas our growth off the bottom has been in the low single-digits, and we still have very poor capacity utilization
• Although Hoover and FDR ran 5% deficits, the overall size of the Federal spending and debt (as a percent of GDP) were lower then than now

Perhaps most profoundly, back then the economy had not been on continual fiscal and monetary stimulus for decades as we have now. Back then we may truly have had a "multiplier effect", where incremental spending from borrowing led to 1.6x returns; whereas now, as I have analyzed recently in the Peak Debt post, we may be approaching a point where incremental fiscal spending has very little impact on growth. We borrow $1 for each dime of growth so to speak, digging a deeper grave. (See chart, courtesy The Economist.)(For more on multipliers, read this.)

We are in effect in a wartime economy in terms of stimulus, without the war. 

And it is not working very well. The political opposition to more stimulus is mounting, just as it did back then (see cartoon). Given an ebbing of stimulus, a tax increase with its 3x de-multiplier would likely push us into another double-dip, especially with Bernanke running out of monetary weapons. 

 

The Impact on Stocks

The WSJ updated their take on 1937 with a discussion of how closely the stock market has tracked the 1937 market (see chart). (This link works without WSJ subscription.) In the two weeks since this chart, the market has continued very close to the 1937 market, and seems poised for the Summer Rally seen in August 1937. Interesting is the timing has shifted right by three months, so adherence to this pattern would see a rally into the November elections:

While the market is a fractal, a one-time event like 1937 should not be considered a precise roadmap to 2010, but at least it shows how a market reacted in a somewhat similar situation. If policy mistakes drive us into the double-dip, the crushing drop after the summer rally is very likely to repeat itself: another 50% drop from the summer high, which I guesstimate at Sp1150 +/- 20 pts. That targets below Sp600, which means below the Mar09 lows. Ouch.

Compare 1937 to 1929 (next chart), and you see the mismatch to 1929. After the crash of '29, we bottomed in November and had a five month rally that went back 50%, then began the sickening slide to the 1932 bottom. After the crash of 2008, we bottomed in November and had a five week rally, then fell to a deeper low in March. Off that low we had a 50% rally, but it took much longer, almost 15 months.

 

Doug Short has run a constant series of charts comparing various crashes, and even if you line up the bottoms in 1929 and 2009, the 1929 analogy breaks:

 

This time delta between the 1930 bounce and the Hope Rally has caused the Elliott Wave Theorist to opine that we are unfolding in the same way, just at 1/3 speed. This points to an ultimate bottom in 2016, 3x the time of the drop from '30 to '32. Curiously, the Kondratieff Wave 'false plateau" that preceded the credit bubble in 1929 took 8 years, whereas our recent Great Moderation took 25 years - also a 3x. 

While an interesting speculation, this simplistic approach does not really fit Fractal Finance. The 1937 analogy seems to fit better, although imperfectly.

The Road to Recovery

We are left with a troubling question: what policy moves can we count on to get us back to normal? Until we get on that path, the stock market cannot be expected to return to a secular bull market. What policies "work"?

To borrow a phrase from Clinton, it depends upon what the meaning of "work" is. 

It is loosely said that the Great Depression ended in 1942 with World War II. Most of the 7M unemployed were absorbed by the military, which grew to 8.6M. The draft ended unemployment, but was not a recovery. GNP rose, but not for the private economy: consumer spending declined, goods were in short supply, civilians were essentially forced to save, and business investment fell. To think it "works" to "fix" the economy by borrowing huge amounts to produce lead & steel that are wasted in the jungles of the Pacific or the beaches of Normandy is abject nonsense. 

Even worse are those who wonder where the war is that will get us out this time. Economic debacles tend to end in war, but is not something to be sought just because it might "work".

Many of the justifications for massive stimulus in peacetime claim they "work" as long as we avoid a slide back down. But what if this is not sustainable? It does us little good to try to bridge across a GDP chasm with government life-support if we plunge back down when the life-support is withdrawn. The scary part of 1937 was that the changes in stimulus were modest, and the plunge was huge. At best we end up like Japan, a terminal patient: 20 years of an L-shaped recovery, ever increasing debt, taxes soon less than interest on the debt, and a day of reckoning that is not much further off.  Japan seems beyond the point of no return.  A good slide presentation on this point can be downloaded here. 

 

Now compare the Japan chart to the next chart, which shows the CBO's forward projection of US debt, and comes with dire warnings over the US's unsustainable path of increased deficits ... we are turning Japanese if we continue on this course. It does not "work" to put us on a path of terminal life support. 

 

The common sense conclusion is a policy bundle "works" if we return to a sustainable path of recovery in the private sector. It doesn't work if we just kick the can down the road. If we slide into a double dip this time too, the Keynesian solutions will have failed again. We will have to find a different set of historical analogies to help us out than the New Deal. 

The 1946 Solution

The one analogy year which has so far been overlooked is the remarkable turnaround in 1946. There was grave fear of a return to the Depression after the war. Keynesians and central planners gave dire warnings of the "Depression of 1946" - the one you have never heard about - and urged a continuation of New Deal policies and central management of the economy. These suggestions were completely rejected, and the Depression of 1946 never happened. Instead, the US ended the New Deal: it stopped meddling in the economy, slashed spending by 2/3, canceled war contracts, and ran a budget surplus to begin paying back the huge war debt - the exact opposite of the current convention wisdom. The speed with which government controls over the economy were removed validated the confidence of the private sector and emboldened investors. Rather than return to double digit levels, unemployment among the huge influx of veterans remained under 4.5%. Unshackled from the New Deal, the private economy roared back. 

The 1946 story has been recently popularized by Jason Taylor and Richard Vedder in a Cato Institute paper called  Stimulus by Spending Cuts: Lessons From 1946 that has run around the blogosphere. The 1946 "Shock of Peace" (a Shock of "De-Stimulus") worked quickly. 

While economists, including Nobel winners, are picking up on the policies of 1946 if not the meme itself, and debating the merits of the 1946 analogy, it has not yet emerged into the political debate today about what "works" except as some sort of latter-day Reaganism.

Perhaps the reason is the prescription seems too extreme. Given how heavily the US budget is stuck on entitlements, how would it get cut by as much as 2/3 as we saw in 1946? It may be inevitable that we have to do this, given the unsustainable direction we are currently pursuing, but it would entail more "Change" than the current political leadership could envision (consider for example this speech from James Galbraith). Hence the politicians would rather believe in "Hope", kick the can down the road, and wait for the patient (the US economy) to die before tackling the disease. 

There is a plan floating around to make these big changes, and it starts with tackling the big four expenditures (see chart): defense, social security, medicare and medicaid. Without any endorsement of the particulars of it, it at least is an exemplar of how we could do today what they did in 1946, making deep cuts in spending while maintaining the safety net, freeing the economy to grow again. 

The initial post on the plan is here. 

Weekend Bits

When the market bumps along a trading range, it frustrates bull and bear alike. I think we are about to sprint up in the Summer Rally. First, let's look past the news, which is mixed at best: 

• ECRI below 10% signals double-dip but UK showed surprising GDP strength avoiding double dip
• Some banks failing EuroZone stress test, but Euro remains bumping up near $1.30, further depressing Euro recovery
• Bernanke seeming to back off monetary stimulus in favor of fiscal, which has huge implications for the double-dip. 

For ECRI fans, here is a good chart by Doug Short which shows we have entered recession territory, accompanied by analysis of what this has signaled in the past, which I can summarize as: the Fed bailed us out of negative ECRI indications previously by lowering rates, but they cannot go any lower this time

 

Unemployment shows we are still in a jobless recovery, and it may be structural since we rely so much on production overseas rather than filling our factories. As David Rosenberg opines, the bad news is good for bonds, and can be good for stocks in the short run. How good? 

We may now be in the proverbial Summer Rally, and it may be short but sweet. Consider this chart from EWP:

It says we remain in the Big Tease, and the market is about to run up fairly strongly into the turn of the month towards Sp1150. The Big Tease has us still in a wave 2 corrective mode since the Flash Crash, an "expanded flat" where the B wave breaches to a lower low but reverses: the bounce up to Sp1131 was wave A, the drop to Sp1011 was wave B, and we remain in wave C. Given waves (I) and (II) as shown above, we would now be in wave iii of (III) of C, and should now run fast. To support that view, EWP notes how we have been rising in 5 wave moves and declining in 3 wave moves, indicating the direction is up. This would be the happy Summer Rally.

Of the major pundits, Neely thinks we are in the middle of the his wave B and hence the least predictable part. He has wave A being the run from Feb5 (1045) to Apr26 (1220), and the Flash Crash and its aftermath as a wave B triangle. Leg A down was the Flash Crash, leg B was the bounce to 1131, and we remain inside leg C.

Prechter's service had a high-odds count earlier this week that got blown up yesterday. Tough business being a pundit. Their special STU yesterday held to Sp1100 as a barrier, but we breached it today. Their alt count allowed for that, and today they posited their continued view of a nested 1-2 i-ii. The inside wave ii has gone 78%. Theoretically it could go back 99% and go really close to 1131, but practically it shouldn't be much beyond 78%. Hence they may have to fall back on their other alt count, which is similar to the Big Tease, albeit they expect the final wave to end around the June high at 1131. 

Curiously, if it does push to 1131 level and then drops, rather than setting up the dreaded 3 of 3 down, it might instead signal an inverted head & shoulders with an upside target of 1250. The head & shoulders is often seen and seldom realized. A number of bloggers today also anticipate a leading diagonal, again a rare pattern which some pundits (Neely) do not recognize. Here is the inverted h&s chart at Slopeof Hope:

 

I am working on a posting a discussion of 1937, which seems to match the current economic climate better than 1929, 1987, or a plethora of other analogies that fly around the blogosphere. A good summer rally and then a terrible plunge match the market pattern in 1937. 

Double Dip Countdown: "6"

The count down is getting closer to the double dip: 10 - 9 - 8 - 7 - 6: ECRI's growth index is now at -9.8% after a pretty big drop from -8.3% last week (which was revised this week to -9.1%; even the revisions are making the case for a double dip). It is hovering right above the -10% level that David Rosenberg has shown from past examples has always predicted a recession ahead (42 years of data). We should crush through that next week, but that is now just a technicality; Rosenberg gave the -10% level as an easy line in the sand; -9.8% also in the past 42 years always predicted a recession in about six months, which puts it in 1Q11. 

 

Another major leading index is from Consumer Metrics Institute, and it is showing even worse conditions that ECRI. The CMI index is in contraction mode and dropping (blue line is 2010):

 

Manufacturing had been looking like a V-shaped bounce, but recently has weakened: both the Philly Fed and Empire State surveys have turned down and are approaching the zero line (which means contraction):

 

Shipping indicators are looking weaker as well: imports surging but exports lagging means we are back to consumption exceeding production:

• The containers out of LA/Long Beach and NY/NJ are continuing to grow, which is consistent with seasonal trends (this is the period of inbound shipments to stock up for back-to-school and holiday sales). Inbound is up 30% over a year ago, and is up 1% (essentially flat) over two years ago. Exports increased 7.7% from a year ago, but remain down 13% from two years ago. This means expectations are for a stronger Christmas but our exports are slackening, a bad sign that is consistent with weakening manufacturing domestically. 
• The Baltic Dry Index is falling so hard it led to a delightful headline: Market Going Down With The Ship? The BDI is used to track Chinese activity across the oceans, and the predictions of a sharp slow-down in 2H10 have increased, suggesting after restocking for the holidays imports will begin to drop.
• Rail cars had been trending up, but recently dipped below 2009 levels and are 20% below 2008 levels (see chart). When looked at more broadly as including intermodal traffic, the trend had been up but is flattening. This would be consistent with a rolling over from recovery to a second dip, but does not predict it. 

Ed Harrison of CreditWritedowns notes that the bearish pundits other than Rosenberg are playing down the double dip: Stephen Roach says only 40% likely, and Nouriel Roubini is at 20%. He thinks they are expecting a late inning save by the Fed or by more fiscal stimulus. While fiscal stimulus is looking less likely, deflation is now emerging, and that might force the Fed to begin QE2, a another round of quantitative easing, a topic is discussed in the Peak Debt post. 

The CPI fell for the third straight month in June, dropping -0.1% after -0.2% in May and -0.1% in April. The CPI is now flat for the past 8 months and down -0.3% for the past six months.

 

Mish notes how the powers-that-be tend to exclude food and energy and talk about the core rate, but this is not really valid, since those matter hugely to the people affected. As he puts it, people tend to note each penny's rise in gas prices, and ignore the drops. When gas is going up, the cries of hyperinflation! ring out; but when they drop, the silence on deflation is deafening. 

The core rate is even more misleading on real estate: it uses an imputed rent, not real housing price changes, which of course have been dropping more than the CPI shows. Oddly enough, as natural gas prices rise, the imputed rent drops; and as it falls, the imputed rent rises. The BLS assumes rent is constant and they impute a windfall in the rent due to rising heating costs. Even though a survey of real rents will quickly show they are falling with housing prices, although not as fast, since natural gas has also fallen, the imputed rent has actually gone up, keeping CPI afloat. Nuts! 

In any event, this chart shows how the CPI of all items peaked about the time the Stimulus peaked in spend rate, and has been dropping since:

What is going on behind the curtains is an historic contraction of consumer and small-business credit: the Consumer Metrics Institute notes how consumer credit has decreased in 15 of the last 16 months, and the drop in April is the second largest in history, after the drop the prior Nov (2009). The cumulative drop is the largest since 1944, when FDR pushed consumers to buy war bonds rather than borrow and spend. This contraction is part of an overall deleveraging of the private sector (especially in real estate), and is causing the total debt in Dollar terms to drop off its peak of $53T. That decrease in total debt is happening faster than government borrowing is making up, leading to deflationary pressures. As the next wave of mortgage defaults hits next year, this deflationary tendency should become very strong. 

The Fed may feel forced into QE2 to stave off the inevitable slide into deflation. Keynesian Cheerleaders like Krugman find the Fed's silence feckless. If they initiate it - perhaps to backstop Muni's, since they already have backstopped Treasuries and Mortgage-Backed Securities - it might delay the onset of the double dip. 

Peak Debt

There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved. - Ludwig von Mises

The Government Bubble has burst. This is the last bubble, after housing (2005), stocks (2007) and commodities (2008). The Tea Party spirit has infected concerned citizens worldwide as part of the Global Political Awakening, a term coined by Zbigniew Brzezinski to describe the effect of technology (television and the Internet) on the global community. The awakening has been a reaction to transnational elites and manifests in many ways locally. In the West it is leading to a pullback from stimulus and a return to fiscal austerity. 

The recent G20 meeting was a repudiation of Obama's call for more stimulus. Before the meeting, Geithner revealed the US agenda, to encourage the rest of the world to stimulate so as to improve US exports. After the meeting, although Obama tried to spin it as a success, the G20 communique roundly rejected any further stimulus, with a target of halving deficits by 2013 and reducing debt-to-GDP levels by 2016. 

We are all Greece now (see picture): austerity measures are being put in place well beyond Ireland, Greece and Spain, and now include the UK, Germany and France. The German efforts are focused on more than deficit reduction; they plan to cut spending as well as debt. 

China has been tightening for a while, and the effects are beginning to be felt: slower car sales, softening manufacturing, beginnings of a collapse in property sales, and rising risk to Chinese banks. The Baltic Dry Index, which measures ocean shipping costs and is driven by Chinese activity, has continued to fall: down over 50% and falling for 31 consecutive sessions. It is now back to March 2009 levels and seems headed to the generational lows of the Lehman crisis in Sep 2008. 

Even the lone holdout, the US, is having difficulty pushing the Stimulus Agenda forward. The Senate blocked Stimulus III and seems unlikely to bend. The House has tried a Stimulus Lite bill to extend unemployment through November (mid-term elections - get it?) but that too is likely to fail in the Senate. 

The US may still pass the financial regulation bill (FinReg), although even that is a bit uncertain with the passing of Senator Byrd, Democrat. (And in a truly odd moment where politics make strange bedfellows, or perhaps he just has a tin ear, the first Black President, Obama, spoke at Byrd's funeral, even though Byrd was notorious for being a leader in the Ku Klux Klan and for leading a filibuster against the 1964 Civil Rights Act.) Despite characterization as a major change in regulation, so far the banks which are TBTF seem to be unconcerned. The FinReg bill has been denuded of most of the major changes (eg. derivatives, proprietary trading), turning it into vacuous soundbites without teeth. 

The FinReg bill will have the perverse result of further freezing credit to consumers and small businesses. Instead of setting rules, it primarily sets up new regulatory bodies who will take several years to promulgate new rules. Community banks and business credit to consumers is expected to stay frozen during that period, exacerbating the credit crunch that is stifling the growth of American business. 

There was some recent blather about an improvement in consumer credit, but this was due to a new reporting requirement, not any change in the real world. (Tea Partiers like to describe the government as incompetent; but it is also ceaselessly dishonest.) As this chart from the Fed shows, consumer credit continues to fall:

 

A report today on consumer credit was stunning: it fell in May by $9B, almost $7B more than expected; and that blather about a rise in April mentioned above was revised from a $1B rise in April into a $15B drop instead! The apparent flatlining seen in the chart above did not happen; instead we kept falling and the April flatline at the end of the blue line is now a huge drop. Consumer credit is back to March 2007 levels and has fallen for 18 of the past 20 months. The only holder of consumer credit which had any growth was .. (envelope please) .. the US Government. Once again all that is going on this economy is government life support, and that is no longer capable of withstanding the drop in the private sector: 

 

Karl Denninger dissects this report into charts that show consumer spending broken into revolving (credit cards) and non-revolving (cars, etc.). The YoY drop is revolving is quite steep:

 

The drop in overall consumer credit of both sorts is also clear:

With Peak Debt comes the spectre of deflation. Since credit (debt) creates money, a tightening of credit and lack of lending can lead to a fall in money aggregates. The FinReg bill combined with the shrinking of debt worldwide will shrink the money supply as well as lower the velocity of money. The money supply has been growing slower, and on some measures actually shrinking; Peak Debt might send it negative on all measures. This is the formula for deflation. The Keynesian Cheerleaders such as Krugman are oh so worried about it now that we are hitting Peak Debt.

There is confusion around the Fed's emergency measures last year which created a $1T increase in bank reserves - why isn't that hyper-inflationary? The Fed has patiently explained what they did but this seems to be largely ignored in the blogosphere, and so this 'hyper-inflation!' meme keeps circulating. At the risk of grossly oversimplifying, consider that one of explosive risks during the Fall of 2008 was inter-bank lending. A lot of checks wing back and forth between banks, and rather than physically move cash reserves around, they lend to each other. With Lehman cratering, the risk of counter-party insolvency loomed large. If some banks went under, all those inter-bank loans with them would go down too. In order to keep the checks circulating, the Fed used various methods to assume the inter-bank risk, creating reserves in the Fed but not creating new money - simply assuming existing liabilities. (This is not inflationary, simply prudent central banking.) Money of Zero Maturity (MZM) jumped $1.5T, but total debt did not - instead it peaked at $53T just as the crisis hit and began declining on the Fed's moves:

 

A little broader explanation (than just inter-bank lending for checks) of why the new reserves created no inflationary spike  is as follows:

How is this possible? It's a direct consequence of the massive intervention by the Federal Reserve: it took problem loans and structured bonds onto its own balance sheet, removing them from the likes of Lehman, AIG, Bear Stearns. In exchange, the central bank essentially "printed" money, i.e. obligations of the US federal government. Many of those bonds have since proved to be worth a lot less than the money printed in exchange, and many of them are entirely worthless.

The increase in MZM in 2008-09 was $1.5 trillion, the same as total debt. Net-net, therefore, zero. Obviously, no 10X multiplier effect came into play here, since the Fed's money went to replace debt gone bad and not as high-powered money to make fresh bank loans.

The US is about out of weapons to throw at deflation. The final play is more quantitative easing (QE) where the Fed buys up Treasuries and other financial assets, putting fresh money into bank accounts of US agencies. A target of $5T is being bandied about. Not all Fed directors are on board to set sail on QE2. 

The problem with QE2 is the marginal productivity of debt makes it of limited if not negative value. I have posted versions of this chart several times, and it shows the same phenomenon: for each new $ of debt, we get less and less increase in GDP. We are now approaching a point of no return, where we get zero improvement for every $ of debt. If you ponder this for a moment, you realize we could borrow ourselves into a hole so deep only default would get us out: more debt with no increase in production to pay for it.

With the Fed's QE1 a sinking ship, how would they do QE2? Ed Harrison speculates they would Federalize the muni market to keep our Greeces afloat (Cal, Ill and NY in particular). The Fed has already tried QE with Treasuries, MBS's from Fannie and Freddie, and similar agency paper. 

QE2 would also mirror what is happening in Europe. The ECB is buying sovereign debt to bolster its Greeces, and although its stated policy is to sterilize those purchases by selling Euro bonds (buying sovereign bonds puts money into the system; selling bonds sucks it back up), it has had at least two failed auctions where it couldn't sell enough to cover its QE purchases. This may be its policy, disguised to avoid spooking the bond vigilantes; or it may reflect diminished appetite for Euro bonds. The Bank of International Settlements put out a warning about QE, that trying to cushion austerity with purchases of bonds to keep rates down risks continued speculative bubbles and misallocation of capital. 

Canadian Real Estate Imploding?

Coming on the heels of weakness in Australian property markets, evidence is pouring in of a housing bust in the frozen north: Statistics Canada reports a 10.8% drop in building permits. In addition, home sales in June fell 30% in Vancouver and 42% in Calgary. These trends may be blips and reverse, but the sharpness of the drop mirrors the US experience in 2006. 

The commodity countries like Canada and Australia trade on Chinese growth. With China tightening, a fall is not surprising. Home sales in China itself were down 50% in May. More predictions are coming in of this tightening popping the Chinese housing bubble.  As Ambrose Evans-Pritchard reports:

Standard Chartered has told clients to prepare for a fall in property prices of up to 30pc in Beijing, Shanghai, Shenzen, and other large cities in China as the delayed effects of monetary tightening begin to bite.

Australian Real Estate Bubble Bursting?

The land of Oz is called the Lucky Country, and it could not have been clearer during the past two years as the Great Recession barely touched the shores down under. In the past two months, however, the real estate market has taken a sharp dip, and may be signaling the beginnings of trouble. Could there be danger lurking just below the surface?

This drop has been essentially ignored in the global business press as the travails of the Euro, the fall of stocks and the repudiation of Obamanomics by G20 have led the headlines. Softness in the Oz property market began earlier this year as the central bank raised rates, causing a slight drop in price of 2.7% in Q1. Recently home sales have dropped and a glut of homes has emerged in major cities, including Melbourne and Brisbane, although not in Perth, the center of the resource river to China. 

The tenor of these stories is still positive, and it seems the newspapers down under got more animated over a rainfall of drunken parrots than the potential drop in housing. Such should be expected in a Lucky Country - bad news needs to slap them in their faces to be taken seriously. But I have heard anecdotal evidence of sharp drops in the 15-20% range, such as from this recent comment, and the softening of the market is leading to predictions of a "record fall in house prices" in Q3 and Q4. A similar fall is also seen for the other Lucky Country, New Zealand. 

There have been warnings, such as a warning reported in early May in The Australian. The most interesting debate has been between the Roubini of Oz, Steve Keen, and plenty of glass-half-full property pundits. Keen has been very visible in Australia warning of a housing bubble as early as 2008, and has suffered the Chicken Little fate of being premature in his calls. He lost a bet on the price collapse and had to endure his Walk of Shame recently. He may now be getting ready for the last laugh, as his predictions seem to be starting to be realized. 

Keen notes how Jeremy Grantham just pricked the Oz real estate bubble, and uses the following chart to show how bubblicious Oz property has become: 

It is clear that Oz property has been on a tear, but the cause is not the Lucky Country so much as playing catch-up with US mortgage debt levels. Since 1990 Australians have increased mortgage debt as a percent of GDP three times faster than the US, and have now reached similar levels to those of the peak of the US bubble in 2006. It is clear that not all the drunks are parrots - the whole country has been on a bender:

Steve Keen attributes the rise in part to gimmickry of each new Prime Minister: first the Hawke government (Labour) in 1988 pushed an incentive for homebuyers that spiked sales; then the Howard government (Liberal) repeated this in 2001 (not, however, as a way to launch his new government since he had been in power for a while by then, but as part of post-dot-com reflation policies), and now Rudd (Labour) began his short regime with a similar giveaway to create happy voters following the change of government: 

 

The last twelve months have shown, however, an accelerating fall in loans to homeowners (vs landlords), meaning real demand is falling below actual supply. Rudd's incentive last year cleared out the buying interest, and along with those drunken parrots the sky may be beginning to fall on the Australian property owners:

Double Dip Countdown: "7" UPDATED

We continue to count down to the double dip: 10 - 9 - 8 - 7.  The unemployment report today shows that the slowdown is accelerating. Jobs dropped 125k, and because the workforce fell faster by 652k the unemployment rate actually improved to 9.5% (see chart).

 

Taking out the census workers, we actually increased by 100k, but a tell of the poor state of the economy is that temp workers only increased by 20k, the smallest in a while. Temp workers typically lead permanent hiring by four months. Not happening. While the numbers fall within expectations, Goldman's take is "much weaker than headlines suggest." You can see how after steady improvement during the Hope Rally, we have now had a fairly large drop to negative in one month:

 

The BLS runs a separate Household survey, which tends to be more volatile (larger swings) but has been more positive for the past six months than the widely-repported Establishment survey. It also tends to be a better leading indicator. For June, it too disappointed, with a 322k drop. The normally optimistic Califia Beach Pundit is morose in interpreting the next chart: 

Looking at the trend in both, using Dec. '09 as the low, the two surveys show a total of between 600K (establishment) and 1 million (household) jobs have been created in the private sector this year. The truth probably lies somewhere in between; jobs probably are up this year at an annualized pace of about 1.5%, and that's not very impressive. In good times, jobs rise 2-3% per year.

 

UPDATE: a recurring issue with the BLS numbers is their birth/death model (of companies, not employees!) which may be misleading during this period because it is based on models from the Great Moderation. Mish in particular has been harping on how the B/D model can be distorting matters. Today Jesse's Café Américain comments on the B/D model, noting how it created 146k imaginary jobs. Jesse also has calculated he seasonal adjustments used by the BLS, and finds them surprisingly small and hence not distortive (note: I think that is fair except during this last holiday sales season, where the adjustments expected too many temp workers and so was depressed leading into Xmas and optimistic leaving it).  Jesse comes up with a look at the seasonally-adjusted unemployment numbers without the birth-death model, and finds things are much worse than the BLS would lead us to believe:

One *might* conclude that without the temporary Census jobs and the Imaginary Jobs from non-existent small businesses consisting largely of unemployed people turned consultant, there has been no recovery in net job creation.

 

One way to parse through the data and get passed these imaginary jobs and other adjustments is to look at total employment. Using BLS data from May and June, we have now lost 652K plus 386k people seeking work, or closing in on 1M in fewer in the workforce in just two months, a huge plunge. These people didn't die or retire; they gave up looking. Perhaps many are at the aged end of the workforce, nearing retirement, but what about new college grads? Roughly 6m grads in 2010 (college and high school), a significant group of which should have entered the workforce. Instead, teenage jobs added in June is the lowest since 1951. Ouch. This chart from CalculatedRisk shows how we are bouncing along the bottom of employment:

 

In addition, total workforce is dropping again after a brief bend up:

 

No surprise that the weekly ECRI indicators continue to drop, now down to -7.7%. At this pace (a percent a week) it will confirm a coming double dip in three weeks, when we get below -10%. 
 

 
Most telling is that factory orders fell more than expected, showing the recovery is withering on the vine. Manufacturing had been a bright spot, but orders just dropped the most since March 2009, and manufacturing expanded at the slowest pace this year. With housing in the biggest drop ever, autos slowing, stimulus ebbing and inventories back in balance, what is left to drive growth? Europe is tanking and China is slowing, so no help from exports. 

While all the indicators are showing slowdown, not a dip to negative, their trend down says we will soon dip. Projecting this out shows skimming the treetops in Q4 and a dip in Q1. 

Double Dip Countdown: "8"

The surprise was not that GDP got revised down from initial 3.2% and first revised 3% to 2.7%, but that it was no longer consider "unexpected." While the punditry still talks of a "slowdown" and a "muddle-through economy" the broader expectations are coming to grips with the double dip. The main driver of the revision down was weaker than previously estimated PCE (personal consumption), dropping from 3.5% to 3% growth. Inventory was revised upwards a bit, and contributes over 2/3 to the GDP growth, but business spending was reduced from 3.1% to 2.2%. Since inventory rebalancing is expected to drop in Q2, this bodes very poorly for the next report. GDP growth has now dropped in half between Q4 (5.6%) and Q1 (2.7%). 

In comparison, GDP grew between 7-9% for five consecutive quarters after the 1980 double dip recession. GDP grew in the double-digits for four years after the 1932 bottom. 

ECRI dipped closer to the -10% level, which has signaled a recession 100% of the time for the past 42 years, dropping from -5.8% to -6.9%. Lakshman Achuthan, managing director of ECRI, now says a slowdown is inevitable, but found a way to add a dose of optimism:

After falling for six weeks, the uptick in the level of the Weekly Leading Index suggests some tentative stabilization, but the continuing decline in its growth rate to a 56-week low underscores the inevitability of the slowdown

ECRI is now back to the level of Dec 2007, when the recession started. 

 

An interesting debate on CNBC this morning (around when the Brazil-Portugal game sputtered to a 0-0 tie) on Stimulus vs Austerity sputtered out as well but got across the point that this isn't really a policy choice; governments always try to spend their way out of problems until austerity is forced on them. Last night the US Senate abandoned efforts to continue extending benefits to unemployed and cash-strapped State governments. The most relevant impact to the double-dip is that this worsens crumbling State finances. 

Politically, the US may be at the turning point and joining Germany, England and China in pulling back from continued stimulus (although Obama is likely to keep pushing for stimulus until the mid-term elections). It is doubtful the US calls for G20 to stimulate will have much credence. The Fed too seems to be frozen at a time when the money supply is gong the wrong way for a recovery. 

Curiously, consumer confidence rose, and is at its highest since Jan 2008. As you can see from this chart, it remains at a low level. I am constantly amused by people who argue that "restoring confidence" is all that is necessary for a recovery. Confidence is at its highest at the peak (2000, 2007 and I daresay 1929) and at its lowest at bottoms) - the consumer remains a lagging indicator. It is also always argued that as confidence returns, money comes out of mattresses and gets spent; but other than a blip around tax refund time this year, we have been seeing lagging PCE. It may be when government transfers money that appears as a windfall, it gets spent, but hard-earned money tends to be saved or spent more prudently. 

 

More relevant is that corporate profits continue to rise, and significantly profits beyond the banks that are TBTF. This of course supports the Hope Rally, assuming it continues (the report is of Q1 not current profits). Profits are a coincident indicator, and sometimes lagging, as rapid cuts in spending can temporarily boost profits amidst worsening economic conditions. Hence the good news on profits is not inconsistent with a future double-dip. 

 

Instead, the indicators that suggest the double dip are all speaking loudly: housing, unemployment claims, consumer spending. They then get picked up in ECRI and other leading indicators, all of which are dipping. You can pick out green shoots here and there, such as durable orders falling less than expected, but even there we are seeing a dip in the growth of tech and consumer electronics (iPhones and iPads notwithstanding). 

A final discussion out there is whether the yield curve is signaling recession. Mish has been showing this chart as the warning sign. It clearly shows there are no inflationary expectations in the US economy. Instead, it shows what happens when an attempted reflation fails. 

 
Gary North analyzes this, explaining why an inverted yield curve normally signals recession: higher rates out the curve are required to hedge against inflation, but as short term rates are raised to curtail inflation, the curve inverts and a recession follows. In this case, the Fed is holding down short term rates and the fear is of deflation. The obvious failure of central banks to reflate means that in the private market short term rates will rise, leading perversely to a liquidity shortage. Lenders compound this by buying bonds to lock in the longer term rates, driving rates down. Hence, this time around the inverted yield curve is produced by fear: 

• business borrowers fear of inadequate capital, so they pay up in the short end
• lenders fear a recession with falling rates, so they lock in the long end

As a consequence, the CMI indicator which tracks the demand side of the economy, is dropping and signaling contraction. Their explanation of the impact of continued government interventions and gimmicks is priceless:

[I]t has instead, unfolded so far as a mild but persistent kind of contraction, more like a 'walking pneumonia' that keeps things miserable for an extended period of time.

 

Double Dip Countdown: "9"

The Double Dip Countdown ticks down as the ECRI leading indicators have dipped even lower into negative territory, falling from -3.7 last week to -5.7. This is only the second negative reading and it will take a sustained drop to signal a recession, but the previously dismissive tone of the director of ECRI, Lakshman Achuthan, is showing heightened concern: "We're definitely rolling over."  The -10 level is considered conclusive of a coming recession.

 

Global industrial production is up but continues to roll over. China (yellow line) is flat, Japan (red line) soared from a deep drop but is now clearly turning down, the Eurozone (dark line) still looks like it is improving, and the US (blue line) is rolling over and approaching zero to negative growth. Production is still positive, but a few more ticks and the US will be negative.

 

China is saying it will allow the RMB to float a bit, which might spark a stock move early this week - futures are up strongly on the announcement - but then they announced no change as of Monday. This might just be a bit of posturing before the G20 meeting, but it is interpreted as a vote of confidence in the global recovery despite the warning signs of a turn down coming. In any event, Chinese increase in exchange rates coming on top of labor unrest and higher wages further confirms my post of several weeks ago that the era of cheap labor is ending in China. The Chinese are likely to move slowly, but looking beyond any vote of confidence, this will put another damper on global production.

A good discussion of the implications of this move is here. Marginal exporters may suffer or go under - as I have discussed previously, many of them run on 2% margins, extremely tight - but a stronger RMB makes imports cheaper. Watch the AUD tomorrow - it might pop due to expectations of increased raw ,material exports to China.

Double Dip Countdown

A double-dip recession is unusual. We may have had only one - in 1980 and 82. We had a double dip depression in the '30s, but the dips were five years apart, and the whole period is more of one slow slog of government life-support and a moribund private sector than a happy recovery and a fall back. It shows up in this unemployment chart - we never got employment back to pre-Depression levels until after the war. The question right now is will we have a double-dip in the Great Recession? 

 

The buzz to start this week was of the second coming of the double-dip, set off by David Rosenberg. What spooked him was the ECRI index falling below zero (see next chart, courtesy Pragmatic Capitalist). When ECRI drops below -10 (from its current -3.5), it has signaled a recession 100% of the time. Rosenberg ranks the odds at 80% of the double-dip. ECRI's indomitable leader continued his optimistic take, saying that while the drop "assures a significant slowing in US economic growth in the coming month, the recent weakness has not lasted long enough to signal a new recession threat." Others have backed his stance, saying it is premature to call the double dip or this is not a recession signal but a reaction to the sharp rise off the bottom. Fair enough, but the countdown has begun.

For the stats minded, here is a look at its record of prediction. The recent decline is the largest before any prior recession. Also, ECRI tends to be late in predicting a recession. Other leading indicators are also rolling over, such as the Conference Board LEI, which at least shows a slowdown:

 

Morgan Stanley holds out for just a slowdown, arguing primarily that global growth is rebounding. Indeed, there is some glass-half-full optimism even over in Europe, where the UK just raised GDP estimates for next quarter - ironically due to the Euro crisis and a cheaper Pound - but lowered their 2011 estimates. The same goes for Germany and a cheaper Euro, where the expectation is it helps more than austerity in Club Med hurts. Still, the OECD indicators for the global recovery are all rolling over to slower growth. Peaks are evident in the US, Japan and Germany, and are now showing up on the UK, France and Italy. Worse, China too is rolling over:

 

The poor retail report Friday also casts doubt on the recovery. It was the biggest decline since last September, and if we remove Cash4Clunkers, the biggest since March 2009, over a year ago. It may be that it reflects distortions from the first-time homebuyers credit, which caused a surge in April and thus may have led to the largest sector drop, a drop of 9.3% in May of building materials; but other sectors were down as well, including general merchandise and clothing. Auto sales are also looking weak, as fleet sales are up much more (32%) than individual sales (13%) in the first part of 2010, leading George Pipas, an analyst of Ford, to opine that consumers are back to deferring big purchases due to economic uncertainty. Savings had dipped a bit, but savings has gone back up, suggesting that a flood of tax refunds and other government checks may have temporarily boosted retail around April 15. That is now over. 

 

If we look at other GDP factors, two elements which had boosted GDP are now lagging: the inventory surge is now over, and State spending from stimulus is also on the downswing. State sales taxes are also likely to shrink, as we see in Texas, putting further pressure on State spending. The impact on GDP may be a 1/4 point, and comes on top of a drag of 1/2 point from the lower Stimulus and a further drag from the loss of the 1.3% inventory adjustment on Q1, making Q2 in the range of 2% lower than Q1. 

John Hussman gives us five leading indicators of a coming recession:

1. Widening credit spreads (check!)
2. Flat yield curve (almost there!)
3. Falling stocks (check!)
4. Moderating ISM growth (check!)
5. Moderating employment growth (check!)

The countdown to the double-dip is on. 

ObamaCare Killed the Recovery

Fascinating analysis shows that the V-shaped bounce off the bottom and steadily improving unemployment was stopped in their tracks by the introduction of ObamaCare. Even before it passed it started to kill the recovery. Could it be that the expected increased burden of adding an employee scuttled hiring plans? 

If we had stayed on the prior trend, we would be in a clear jobs recovery in three months (Sep 2010). Now it trends out three to three more years.

That Sinking Feeling: G20 Busts the Government Bubble

The Keynesian Cheerleaders have met their moment of truth: gas or brake? Geithner went to plea for more stimulus from Europe and Japan, betting that more deficits now will produce growth and future taxes to pay down the debt. The Europeans have hit their limit and politely told Geithner where to go. 

The Government Bubble has just burst.

Hungary is about to join the PIIGS with unsustainable debt, and the Euro has broken below the recent trading range and is below $1.20 - down from $1.50 not so long ago. The next support is around $1.16-1.18. It is in a wave 5 down and could easily overshoot these levels. 

All the rescue plans have been for naught, as the wolfpack continues to call the bluff of the finance ministers. Now even the core countries of Europe are seeing spikes in their CDS spreads. This witty video from Australia gets across the point that investors have figured out: indebted nations cannot bail out the broke nations. 

While the sudden surge in core country CDS spreads may abate, it appears we have crossed a very critical threshold: belief in the wisdom of assuming debt for temporary stimulus. The Illusion of Stimulus has been punctured. The Keynesians have no clothes. 

There is anger brewing over the failure of Keynesianism: people feel like they have been sold down the river with false promises of easy money in order to line the pockets of overpaid public workers, nefarious bankers and corrupt politicians. 

There is no one in the blogosphere better at projecting that anger than Karl Denninger, who rants that the attempt to re-ignite private credit growth has failed. By his calculation, we borrowed 12% of GDP last fiscal year, and are on track to do it again this year - levels well above the 5-6% of Hoover and FDR in the Great Depression. With the backlash against this growing, the US may be forced to pull back to a more sustainable 3-5% level. That drop of around 8% will come out of GDP by the way it is calculated, whether it is a drop in spending or a massive increase in taxes, icing the coming double-dip recession.

With total government debt at 130% of GDP in the US (including State and local debt as well as unfunded future obligations), this point was inevitable here as well - our leadership simply has not been prepared to come to grips with the dimensions of the problem, blindly having faith in Keynesian prescriptions. 

 

Obama's Summer of Disillusionment is upon us. His cool, collected style is now viewed as a profound failure of leadership. Already his most visible gushers of support have begun to publicly air their disappointment (Maureen Dowd, Tom Friedman, Frank Rich, even Chris "I get a tingle down my leg" Matthews). James Carville rebukes him for his failures with the oil spill. Quietly, his army of true believers are bailing. 

What happens now is laid out by Karl: we are entering an Austrian-Economics style debt-deflation spiral, and there is no longer anything the government can do to prevent it. 

The size of potential fall in private debt is well beyond the ability of the government to fill ($52T of total debt vs $13T of Federal deficit). We were at about half that total amount of debt just a few years ago when the Greenspan Bubble began ($26T vs $52T), and we may be headed back that far. Bubbles tend to retrace to their start. Hang on to your hats. And wallets.

That Sinking Feeling: Underwhelming Unemployment Underscores the W

When a Keynesian Cheerleader says a double-dip is now 50-50, you know the recovery is in trouble. Robert Reich so opined on CNBC this morning. Clearly the recovery is not a typical V shape, and it now appears headed to a W.

Before the unemployment report, the pundits were predicting a good report, with BNP Paribas stretching to 645K. Goldman's Hatzius, whose prior predictions were pretty good, got caught touting a 600K number. It came in at 431K, below both the Goldman 600K and the consensus 536K. The key to watch is not the total, skewed by the census number at 411K, a whopping 95% of the total (see chart courtesy Innocent Bystanders), but the private payroll number, which came in at 41K, well below the consensus of 180K. 

There is evidence of systemic fraud in the census hires being hired and fired and rehired, but this should not affect these numbers as they are based on surveys. The fraud seems to be for the benefit of supervisors who must have some sort of incentive pay based on hires. What a mess. But just as the census hires should be redacted to look at the underlying strength of the economy, when they start getting laid off in droves the firings should be added back. It is the private sector trend which is critical to projecting a recovery, or not. 

The 41K private jobs is a drop from the prior month's 231K (which was adjusted down to 208K) and a reversal of five months of improvements. The moving average is around 150K. 

In addition to the 411K census, there were 31K temporary jobs, meaning permanent jobs actually came in a negative 11K. Also, the birth/death model estimated 215K jobs, meaning arguably this report should have come in a negative 226K. 

The unemployment rate fell to 9.7% because the total workforce fell from 65% down to 62.5% of the population, well below the normal level of 67% for the past 20 years. This decline comes from people leaving the workforce. Usually during a real recovery people return to the workforce and the unemployment rate paradoxically rises. We saw that last month. This workforce decline is bad news for a recovery. 

 

The best summary of the employment situation comes from Calculated Risk and the following chart. It shows how much deeper and longer our current plight is, and how the apparent bottom of the last five months appears to be rolling back down to a double-dip in employment:

 

That Sinking Feeling: M3 Falling at 1930s Pace

This should not be happening: the US money supply is falling hard. We have stimulated, liquidified, pumped, swapped, backed, TARPed and done about everything years of academic analysis of the Great Depression told us to do. Ambrose Evans-Pritchard (AEP) of the UK Telegraph penned US Money Supply Plunges at 1930s Pace that headlines: 

The M3 money supply in the United States is contracting at an accelerating rate that now matches the average decline seen from 1929 to 1933, despite near zero interest rates and the biggest fiscal blitz in history

This plunge has no precedent since the Great Depression. The fall seems due to debt deleveraging, which is accelerating, without any corresponding new commercial debt issuance. Credit remains frozen. In a fiat currency economy, debt creates money, and write-down of debt reduces the money supply. 

In a growing panic, the Obama administration is now thinking of throwing more stimulus onto the fire of debt deleveraging. This risks repeating the mistake of Japan, pushing public debt even faster to dangerous levels. The IMF is already quite concerned over US fiscal policy:

Under the Obama administration’s current fiscal plans, the national debt in the US (on a gross basis) will climb to above 100pc of GDP by 2015 – a far steeper increase than almost any other country

Ironically, Ben Bernanke, the student of the Great Depression, built his reputation on credit, and follows what AEP calls "creditism", explained here, an untested theory that disavows the seminal work of Milton Friedman on how Fed mistakes in the early 1930s exacerbated the Great Depression - and ignores M3 and other money supply measures. Creditism has failed to restore the velocity of money, which would be a consequence of restoring normalcy to credit. Bernanke may now try to adopt an explicit inflation target, which may crash markets (bonds and stocks). He cannot "go off gold" and reflate the currency (see chart, courtesy Jesse's Cafe Americain). He may, indeed, have run out of magic bullets. 

In the 1930s the rapid deflation in effect reset the system. This time Bernanke is trying everything he can to avoid deflation. Yet:

The Fed has been largely ineffective at doing anything but fattening bank cash flows by squeezing savers and allowing banks to collect generous margins on the performing consumer loans they do have. The bailout money sits in bank coffers, withheld from an economy that now depends on loans for its very survival

There has been a lot of reaction to AEP's dramatic headline. The most common is the plunging money supply is foreshadowing a double-dip recession. There is increasing data from sources like the BEA that show slower GDP growth, and have been interpreted to predict negative GDP as soon as Q3.  ECRI's leading indicators have also been slowing, and had the biggest plunge in a long time in mid-May. While they are still showing positive growth, the fall is ominous. It is dropping at a rate that would make it negative 5% or more by Q3, an area consistent with forecasting a recession. 

 

M3 was dropped by the Fed in 2006 due to its sensitivity to portfolio balancing, making it over and under-shoot. There are more money supply measures than M3 - AEP chose the most dramatic. Also, Jesse points out that Eurodollars are often left out of these calculations, and that the Fed often is jerky in managing money aggregates - pedal-to-the-metal than back off and see if the car takes off. So momentary hysteria over M3 may abate if the Fed reverses its course. The other M's have plunged in rate of growth, but not yet gone into negative growth on a year-over-year basis. Does this discredit AEP? No - the other M's have seen a recent drop in total supply, like M3, and this means their YoY growth is destined to run below zero shortly. This drop in M3 is now showing up in other economies, such as Australia, indicating there is more to it than momentary Fed clumsiness. Here is a chart which shows money metrics growth falling, albeit not yet below zero:

One of the lessons of the 1930s is the Fed tightened prematurely in the summer of 1931, responding to the collapse of the Creditanstalt bank, Britain leaving the gold standard, and an international banking crisis that caused the Fed to try to protect the US gold supply from a run (see chart courtesy Jesse).   

We may be making adifferent but equally tragic mistake this time around: we are backstopping the wrong banks and letting Main Street whither on a drought of credit. We are in thrall to the theories of an academic elite that lack worldly experience, have spent their careers pampered by commissions, conferences and cushy positions, are captivated by their big bank sponsors, and have never left the incestuous little world of elite universities, Wall Street advisory positions, and government jobs. 

Fallout From The Crash: GDP

The Eurozone bailout requires austerity to take down its benefits. This will decrease GDP. While much is made of Germany benefiting from a lower Euro with improved exports, a lot of the exports are intra-Europe: about 35% go to the PIIGS, and another 30% to the rest of Europe. As their trading partners weaken, the lower Euro simply drops the value of German exports that remain outside the Eurozone. 

We already see the PIIGS begin to take austerity measures, as well as other countries (ZH provides this handy chart):

• Spain announced public wage cuts to drop the deficit from 11.9% to 6%
• Portugal has moved twice to reduce the deficit from 7.3% to 4.6%
• Ireland had already made moves
• Even France announced a budget freeze at inflation levels

Deflation has shown up in Spain and increases worries over negative Eurozone GDP in Q3. Ireland expects a big drop this year (7.7%) and another drop next year (2.7%) due to getting the horrific deficit under control. EU GDP rose only 0.2% in Q1, up slightly from 0.1% in Q4. It won't take much to send it down into the double dip.

Goldman Sachs calculates the drag from austerity at -0.49% and the benefit to Germany at 0.49%, a wash. Still, this is very rough, and they have been projecting 2% GDP growth in Europe, while the last two quarters came in around a tenth of that at 0.2%. Their back-of-the-envelope calculation could easily tip negative. 

In addition, the whole world is slowing. Even before the crash, the OECD released its leading indicators, which "pointed to a slowdown in the pace of economic activity."  The slowdown is led by China, which has been slowing its torrid growth since it began its stop-and-start measures to put a lid on inflation and an overheated recovery. 

The US had a disappointing Q1 report, which Goldman Sachs estimates was essentially zero growth absent temporary factors (stimulus and inventory rebalancing), and they project a poor report in Q2 with the same 0% underlying growth. Given these temporary factors fade in 2H10, they will act as a drag on GPP of -0.5% in 3Q10 worsening to -2% in 3Q11. 

It will take growth in employment and corresponding growth in spending to counter this drag. I have commented that while employment growth in Q1 was promising, it is largely based on suspect statistics. There was a lot of delight at the recent retail report, but looking at the part of retail used to calculate GDP (excludes cars, oil and building materials), retail has turned down after rising since March 2009:

The recent increase in consumer spending has been largely attributed to dipping into savings and spending government transfer payments, since earned income has not increased. 

A third possible source for spending is coming from a new angle on mortgages: "strategic defaults," to simply squat in houses without paying, expecting a workout. This is a consequence of bank forbearance on foreclosures, and has sparked a whole underground movement to squat and thrive. Troubled homeowners are being advised to sit tight. Strategic defaults are now trending towards significant levels, 12% of all defaults in Feb. 

It remains an urban legend - to squat & spend - but the magnitude of potential extra cash is pretty large at $8-12B/month, or over $100B/yr:

Leading indicators remain mixed, although ECRI is slowing as is ADS, which has now trended to negative. This morning the Conference Board surprised when its index went negative. Small business continues to have severely restricted credit, and has ticked down after a brief spike of better conditions in Q4. The one bright light has been industrial production, which has looked like a V-Shaped recovery, but it too is flattening:

 

Fallout From The Crash: Unemployment

Lost in the noise last week was the unemployment report. Weekend pundits gushed how we turned the corner. Have we?

Art Cashin dissects it this morning:

• For the last eight weeks, Initial Unemployment Claims have averaged 450,000 per week. So, over the last four weeks [the month counted], 1.8 million people were laid off. How does that fit in with the claim that 290,000 new jobs were created? The obvious answer is that it doesn’t
• The CES Birth/Death adjustment added 188,000 of those jobs. Birth/Death does not refer to people but to businesses. The BLS guesses how many new companies opened versus how many closed their doors. The BLS then uses that guess to guess again how many jobs those business created or lost
• Another 66,000 of the new jobs came from census hiring
• Another 26,000 of the new jobs were non-census temporary

Let’s recap:

• A guess produced 188,000 of the jobs, 66,000 were census and 26,000 were temporary. 
• 280,000 of the 290,000 “new jobs” were either temporary or the result of guesswork.  

Some turn. Some corner. 

A contrary view comes from the other BLS survey, the Household Survey, which has more skew in it, but has been consistently showing more gain in employment than the Establishment Survey. 

 

We Have Begun the Endgame of Greenspan's Experiment With History

The Wolfpack Fund is likely to fail. With the $1T Wolfpack Plan, the central banks are "all in" and have no more pieces to shuffle on the board. The wolves can concoct short positions faster than Europe can create money via the magic of synthetic CDSs. When Soros called the Bank of England's bluff in 1992, he had to play with real money. Now he plays with derivatives.

Wolfpack is the endgame of a series of moves by Greenspan (and Bernanke) since 1987, to flood liquidity against any banking panic: Mexico, Asian Flu, Russia, LTCM, Y2K, dot-com, 9/11, housing, TARP, TALF and QE. 

The moves became known as the Greenspan Put, the assumption that he would bail you out of risky deals. It reached its ultimate expression in the period that I call the Greenspan Indian Summer, the bubble from 2002-2007 that staved off Kondratieff Winter for the moment. Greenspan knew he was playing with history. 

Greenspan's Indian Summer ended with the Mother of All Margin Calls, a post of mine on June 15, 2007, predicting the end of the bubble and the top in the market. Where this might lead is to a new global reserve currency, but that is still a ways off. 

Right now the Euro is at risk, not yet the Dollar. After a period to sort out the new plan, the Euro should fall and the Dollar should rise. As this next chart shows, the Euro popped over the weekend and faded back down today. The bluff may be called quickly. 

Credit Writedowns cites Marc Chandler (the global head of Brown Brother Harriman’s top ranked Currency Strategy Team) for noting that today was still a wait-and-see attitude: the panic is gone but bonds from the "peripheral euro zone" have not returned to normal. Marc believes policymakers are repeating the mistakes of the '30s.

Behind Wolfpack is the potential for European QE and Eurozone inflation. The plan is supposed to avoid QE via sterilization:  when central banks across Europe buy toxic sovereign debt (putting Euros into the bondholders' accounts), the ECB is supposed to sterilize the issuance by selling quality bonds, likely German Bunds (pulling Euros out of the market). But if the toxic debt is bought at too high a value, the buyers will take a bath that the ECB will try to cover, putting excess Euros into the system. Euro inflation will push it even lower against the Dollar. 

What is unclear is how fast this will play out. If markets are back to where they were last Friday by the end of this week, the bluff has been called and the momentary hope will fade. What this means for stocks and bonds I will cover then, but right now note two points from the very interesting STU this evening:

1. "The world does not have enough revenue to service the debt built up over the past seven decades"
2. The unfolding crisis will be "too big too bail"

In one of those moments EWI calls Beautiful Pictures, the bounce today retraced almost precisely 61.8% of the drop off the Apr26 high, typical for a wave 2. The alt count of an extended fifth with a zigzag (= sharp) bounce has played out, not the wave 3 down with a fourth wave triangle bounce. The implication is more upside before the next big drop. 

A reader (VB) notes in a comment that Neely has found the retracement after an impulse down with an extended fifth often retraces more than 61.8%, in effect bouncing more given the violence of the drop. The next levels after 61.85 (Sp1162) are 2/3, 70.7% and 78.6%, or Sp1170 - 1187. Another way to count this is to end the big drop right before the 'bots drove it down, or at Sp1090 instead of Sp1065. This gives slightly different endpoints of Sp1177 - 1192.

Will this play out quickly? The STU points to a morning observation from Bianco Research: if you think of today as driven by the Euro TARP, the US TARP days were when it was leaked and then when it was forced down the throats of the banks. The first bounce lasted one day; the second two days. The market declined for six more months. 

In the mother of all ironies, traders playing a capitulation low on Thursday may be hoist by their own fat finger: the bullish blather that "this was all a glitch!" may mean the normal capitulation by the bears did not occur. This meme is well explored here and here by Trader's Narrative, a site with penetrating debunking of popular fancies in the market, which concludes: "according to the McClellan Oscillator, the market will make a significant low later this week."