The big inflation scare. Paul Krugman, NYT.
read it all, but key excerpt:
First things first. It’s important to realize that there’s no hint of inflationary pressures in the economy right now. Consumer prices are lower now than they were a year ago, and wage increases have stalled in the face of high unemployment. Deflation, not inflation, is the clear and present danger.
So if prices aren’t rising, why the inflation worries? Some claim that the Federal Reserve is printing lots of money, which must be inflationary, while others claim that budget deficits will eventually force the U.S. government to inflate away its debt.
The first story is just wrong. The second could be right, but isn’t.
Now, it’s true that the Fed has taken unprecedented actions lately. More specifically, it has been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices.
But these aren’t ordinary times. Banks aren’t lending out their extra reserves. They’re just sitting on them — in effect, they’re sending the money right back to the Fed. So the Fed isn’t really printing money after all.
Mortgage markets lock up. Mish.
Understanding inflation-indexed bond markets. John Campbell, Robert Shiller, Luis Viceira; NBER.
A return to a nasty external dynamic. Tim Duy.
Troubled bank loans hit a record high. Floyd Norris, NYT.
First-ever global housing-led recession. Dr. Housing Bubble.
subtitle: One out of Eight American Mortgage Holders either Late or in Foreclosure on their Mortgage: 66 Percent of Mortgages Prime but what does that mean if Prime is now Defaulting at High Rates?
May economic summary in graphs. Calculated Risk.
*** The shadow banking system and Hyman Minsky's economic journey. Paul McCulley, PIMCO.
note: very good overview of Minskian theory as it played out in real-time; but, taking it a little easy on the Fed and now-colleague big Al, aren't you, Paul? no criticism of low rates for too long, or of Al's refusing to heed his own colleague's advice about mortgage lending standards, although a bit of veiled criticism, couched more as regret, that regulators drank the same Kool-Aid as did the investors and the rating agencies
Even Bloomberg openly ridiculing Tim Geithner now. and Bloomberg's vendetta with Geithner/TALF continues. Zero Hedge.
gotta check out the Bloomberg panels!
Taking responsibility. Gregory Knox, via The Big Picture.
note: I never worked in the auto industry, but I did work in a couple unionized environments; what Knox says about electricians acting all high-and-mighty, and about guys working slow during the week so as to get into weekend double-pay overtime hours, and about telling the newbies to slow down so they don't show up the old farts all ring very true for me in my past experiences working both in a pulp-and-paper mill and in a municipal hydro line crew.
Saturday, May 30, 2009
Thursday, May 28, 2009
Worthwhile Reading - May 28
How long will this glut continue? Signals suggest a while. Rebecca Wilder.
Bond carnage, muddled inflation thinking, and Fed options. Yves Smith, naked capitalism.
Treasury matrix. Zero Hedge.
Shadow market may undercut housing rebound. CS Monitor.
Only 30 percent of foreclosed homes are currently on the market nationwide. Could the backlog of hundreds of thousands of empty or rented homes swamp recovery?
Quarterly Banking Profile. FDIC.
summary:
Net Income of $7.6 Billion Is Less than Half Year-Earlier Level
Noninterest Income Registers Strong Rebound at Large Banks
Aggressive Reserve Building Trails Growth in Troubled Loans
Industry Assets Contract by $302 Billion
Total Equity Capital Increases by $82.1 Billion
excerpts:
The high level of charge-offs did not stem the growth in noncurrent loans in the first quarter.... Despite the rise in the level of reserves relative to total loans, the industry’s ratio of reserves to noncurrent loans fell for a 12th consecutive quarter, from 74.8 percent to 66.5 percent, the lowest level in 17 years.... Total assets declined by $301.7 billion (2.2 percent) during the quarter, as a few large banks reduced their loan portfolios and trading accounts.... The decline in industry assets and the increase in equity capital meant a reduced need for funding during the quarter.
Bond carnage, muddled inflation thinking, and Fed options. Yves Smith, naked capitalism.
Treasury matrix. Zero Hedge.
Shadow market may undercut housing rebound. CS Monitor.
Only 30 percent of foreclosed homes are currently on the market nationwide. Could the backlog of hundreds of thousands of empty or rented homes swamp recovery?
Quarterly Banking Profile. FDIC.
summary:
Net Income of $7.6 Billion Is Less than Half Year-Earlier Level
Noninterest Income Registers Strong Rebound at Large Banks
Aggressive Reserve Building Trails Growth in Troubled Loans
Industry Assets Contract by $302 Billion
Total Equity Capital Increases by $82.1 Billion
excerpts:
The high level of charge-offs did not stem the growth in noncurrent loans in the first quarter.... Despite the rise in the level of reserves relative to total loans, the industry’s ratio of reserves to noncurrent loans fell for a 12th consecutive quarter, from 74.8 percent to 66.5 percent, the lowest level in 17 years.... Total assets declined by $301.7 billion (2.2 percent) during the quarter, as a few large banks reduced their loan portfolios and trading accounts.... The decline in industry assets and the increase in equity capital meant a reduced need for funding during the quarter.
Wednesday, May 27, 2009
Worthwhile Reading - May 22 - 27
Where has the money gone: the state of Canadian household debt in a stumbling economy. The Certified General Accountants Association of Canada.
*** Liquidity drowning the meaning of inflation? Leo Kolivakis, Pension Pulse, with plenty of excerpts from other sources. must read.
We cannot inflate our way out of this crisis. Wolfgang Munchau, FT.
Government Motors is born. Karl Denninger, The Market Ticker. reflections on what the government's handling of the priority of auto-makers' creditors may imply for govt debt.
Consumer confidence, or consumer hope? MarketWatch.
David Rosenberg: "600-840 on the S&P". Tyler Durden, ZeroHedge.
Has the U.S. recovery begun? Martin Feldstein, Project Syndicate.
conclusion:
The positive effect of the stimulus package is simply not large enough to offset the negative impact of dramatically lower household wealth, declines in residential construction, a dysfunctional banking system that does not increase credit creation, and the downward spiral of house prices. The Obama administration has developed policies to counter these negative effects, but, in my judgment, they are not adequate to turn the economy around and produce a sustained recovery. Having said that, these policies are still works in progress. If they are strengthened in the months ahead – to increase demand, fix the banking system, and stop the fall in house prices – we can hope to see a sustained recovery start in 2010. If not, we will just have to keep waiting and hoping.
A recovery without credit: possible, but... Stijn Claessens, M. Ayhan Kose, Marco E. Terrones, voxeu.
update: the authors look at past recessions in OECD countries that are associated with either a credit crunch, house price bust or equity price bust and conclude that a recession can end before the credit crunch; frankly, while i find this topic/issue interesting to think about, I find this kind of analysis to be a good example of crappy economics; in particular, what the authors fail to even note, much less study, is (a) what happens in recessions associated not with any one of the three other phenomenon, but with all three at once, (b) what happens when the recession is not isolated (in a single country or region) but is global, or (c) the level of debt at the time of recession, which could be crucial given their assessment that consumption growth is usually the key driver of recoveries, and therefore, (d) what are the drivers of consumption growth in recoveries (if not credit growth, presumably income growth? but where is that coming from?)
The new global balance: financial de-globalization, savings drain, and the U.S. dollar. Christian Broda, Piero Ghezzi, Eduardo Levy-Yeyati, voxeu.
update: the authors of this post note that cross-border flows have dwindled; they then focus soley on the implications of the declining flows from foreigners into the U.S. (i.e. less foreign buying of U.S. assets means, in their view, a weaker dollar and higher interest rates); but they do not discuss the implications of the fact that American investors have also recently shown a home-bias, or of the change in composition of those American investors' portfolios, particularly in a period of increased savings (if foreigners are buying less U.S. bonds, isn't it because Americans are buying less foreign goods?)
*** The crisis and how to deal with it. Bill Bradley, Niall Ferguson, Paul Krugman, Nouriel Roubini, George Soros, Robin Wells et al, The New York Review of Books.
update: essential reading; read the Ferguson section, which is a great summary of what the consensus wisdom is right now (i.e. the combination of fiscal and monetary policy is terrible for bonds and terrible for the $); then read the Krugman rebuttal, which is a fantastic exposition of why I think domestic (U.S.) savings in excess of profitable investment opportunities implies a domestic savings glut, which should do now what Bernanke said the foreign savings glut did a few years ago (i.e. bond conundrum of low long-term yields even as the Fed was hiking); Roubini, Soros and Wells all follow up with great points too, mostly concurring with Krugman; mind you, its hard to disagree with Ferguson's last points; its a shame this debate ended prematurely
Global imbalanceds and future crises. Barry Eichengreen, via Mark Thoma's Economist's View.
China stuck in 'dollar trap'. FT.
similarly,
Asia will author its own destruction if it triggers a crisis over U.S. bonds. Ambrose Evans-Pritchard, Telegraph.
The dollar crisis. Sahm Adrangi, via Clusterstock.
Do be wary of green shoots. Randall Forsyth, Up and Down Wall Street, Barron's. see esp. pg. 2 with stock market parallels from Louise Yamada to 1938 and discussion of earnings as key to stock prices.
Electrical consumption sees first outage since WWII. Paul Kedrosky, Infectious Greed.
Here comes the OptionARM mortgage explosion. Joe Weisenthal, Clusterstock.
And a personal reminder from Doug Kass, via Kedrosky:
The perma-bear cult in markets.
The perma-bear cult, of which I have often been accused of being a member, is an especially strange clique that often sees the clandestine plunge protection teams saving the U.S. stock market at critical points. They have never met a government statistic they like but instead see the U.S. government as "massaging" and revising employment, inflation and many other economic statistics in order to paint a positive picture. They express contempt for second derivative economic improvement and never or rarely ever see prosperity. They view seeds of recovery as Superman saw Kryptonite and extrapolate economic/stock market weakness to the extreme.
And they never ever or rarely make money.
Can we inflate our way out of this mess? Jake, EconompicData.
The greatest swindle ever sold. Andy Kroll, The Nation. worth reading if just for the numbered bullet points.
Why Britain has to curb finance. Martin Wolf, FT.
two old ones:
Why the U.S. has really gone broke. Chalmers Johnson, via Jesse's Cafe Americain, and
The incontrovertible truth about debt, deleveraging, devaluation and recovery. Jesse.
As always, Willem Buiter calling it as he sees it:
Obushma-Biney in the home of the frightened. Willem Buiter, Maverecon.
*** Liquidity drowning the meaning of inflation? Leo Kolivakis, Pension Pulse, with plenty of excerpts from other sources. must read.
We cannot inflate our way out of this crisis. Wolfgang Munchau, FT.
Government Motors is born. Karl Denninger, The Market Ticker. reflections on what the government's handling of the priority of auto-makers' creditors may imply for govt debt.
Consumer confidence, or consumer hope? MarketWatch.
David Rosenberg: "600-840 on the S&P". Tyler Durden, ZeroHedge.
Has the U.S. recovery begun? Martin Feldstein, Project Syndicate.
conclusion:
The positive effect of the stimulus package is simply not large enough to offset the negative impact of dramatically lower household wealth, declines in residential construction, a dysfunctional banking system that does not increase credit creation, and the downward spiral of house prices. The Obama administration has developed policies to counter these negative effects, but, in my judgment, they are not adequate to turn the economy around and produce a sustained recovery. Having said that, these policies are still works in progress. If they are strengthened in the months ahead – to increase demand, fix the banking system, and stop the fall in house prices – we can hope to see a sustained recovery start in 2010. If not, we will just have to keep waiting and hoping.
A recovery without credit: possible, but... Stijn Claessens, M. Ayhan Kose, Marco E. Terrones, voxeu.
update: the authors look at past recessions in OECD countries that are associated with either a credit crunch, house price bust or equity price bust and conclude that a recession can end before the credit crunch; frankly, while i find this topic/issue interesting to think about, I find this kind of analysis to be a good example of crappy economics; in particular, what the authors fail to even note, much less study, is (a) what happens in recessions associated not with any one of the three other phenomenon, but with all three at once, (b) what happens when the recession is not isolated (in a single country or region) but is global, or (c) the level of debt at the time of recession, which could be crucial given their assessment that consumption growth is usually the key driver of recoveries, and therefore, (d) what are the drivers of consumption growth in recoveries (if not credit growth, presumably income growth? but where is that coming from?)
The new global balance: financial de-globalization, savings drain, and the U.S. dollar. Christian Broda, Piero Ghezzi, Eduardo Levy-Yeyati, voxeu.
update: the authors of this post note that cross-border flows have dwindled; they then focus soley on the implications of the declining flows from foreigners into the U.S. (i.e. less foreign buying of U.S. assets means, in their view, a weaker dollar and higher interest rates); but they do not discuss the implications of the fact that American investors have also recently shown a home-bias, or of the change in composition of those American investors' portfolios, particularly in a period of increased savings (if foreigners are buying less U.S. bonds, isn't it because Americans are buying less foreign goods?)
*** The crisis and how to deal with it. Bill Bradley, Niall Ferguson, Paul Krugman, Nouriel Roubini, George Soros, Robin Wells et al, The New York Review of Books.
update: essential reading; read the Ferguson section, which is a great summary of what the consensus wisdom is right now (i.e. the combination of fiscal and monetary policy is terrible for bonds and terrible for the $); then read the Krugman rebuttal, which is a fantastic exposition of why I think domestic (U.S.) savings in excess of profitable investment opportunities implies a domestic savings glut, which should do now what Bernanke said the foreign savings glut did a few years ago (i.e. bond conundrum of low long-term yields even as the Fed was hiking); Roubini, Soros and Wells all follow up with great points too, mostly concurring with Krugman; mind you, its hard to disagree with Ferguson's last points; its a shame this debate ended prematurely
Global imbalanceds and future crises. Barry Eichengreen, via Mark Thoma's Economist's View.
China stuck in 'dollar trap'. FT.
similarly,
Asia will author its own destruction if it triggers a crisis over U.S. bonds. Ambrose Evans-Pritchard, Telegraph.
The dollar crisis. Sahm Adrangi, via Clusterstock.
Do be wary of green shoots. Randall Forsyth, Up and Down Wall Street, Barron's. see esp. pg. 2 with stock market parallels from Louise Yamada to 1938 and discussion of earnings as key to stock prices.
Electrical consumption sees first outage since WWII. Paul Kedrosky, Infectious Greed.
Here comes the OptionARM mortgage explosion. Joe Weisenthal, Clusterstock.
And a personal reminder from Doug Kass, via Kedrosky:
The perma-bear cult in markets.
The perma-bear cult, of which I have often been accused of being a member, is an especially strange clique that often sees the clandestine plunge protection teams saving the U.S. stock market at critical points. They have never met a government statistic they like but instead see the U.S. government as "massaging" and revising employment, inflation and many other economic statistics in order to paint a positive picture. They express contempt for second derivative economic improvement and never or rarely ever see prosperity. They view seeds of recovery as Superman saw Kryptonite and extrapolate economic/stock market weakness to the extreme.
And they never ever or rarely make money.
Can we inflate our way out of this mess? Jake, EconompicData.
The greatest swindle ever sold. Andy Kroll, The Nation. worth reading if just for the numbered bullet points.
Why Britain has to curb finance. Martin Wolf, FT.
two old ones:
Why the U.S. has really gone broke. Chalmers Johnson, via Jesse's Cafe Americain, and
The incontrovertible truth about debt, deleveraging, devaluation and recovery. Jesse.
As always, Willem Buiter calling it as he sees it:
Obushma-Biney in the home of the frightened. Willem Buiter, Maverecon.
Saturday, May 23, 2009
Reality vs. Perception
subtitle: have i f'd up?
or, alternatively: my convictions wavering?
Back in December, when the US 10 yr flirted with 2%, I figured that I'd been right to predict/worry that the housing depression, the blowing up of the debt bubble, the stock market collapse, the dismal economy, and the consequent imminent risk of deflation implied a period of structural lower government bond yields, a la Japan.
How fleeting that feeling was!
With the exception of a brief rally in late March after Ben announced implementation of Q.E., rates have been steadily trending higher almost all YTD, with the 10-yr now back to 3.45.
What's changed? Not the economic reality. The economy has contracted at a fast rate over the last two quarters (having fallen faster to a lower level now than anyone in mid-December must have been thinking likely), and though its contracting at a slower rate now (+ve 2nd derivative), the contraction is not yet over (still -ve 1st derivative).
The housing market has shown blips, but its done that off-and-on for two years. So the housing recession is also not yet over, for reasons I've cited before: home prices still too high relative to incomes or rents; still too much excess supply and shadow inventory; credit is constrained, particularly at lower end, which prevents the whole process of sellers at the lower end moving up to be buyers at the higher end. The debt bubble has burst, and a new credit cycle has not been restarted; it will take a long time yet to digest the excessive (private) debt already in the system, an unhealthy portion of which is bad. Particularly given that unemployment keeps rising and incomes are stagnating (at best). Similarly, the consumer retrenchment, as hard as it is psychologically for Americans to give up their spendthrift ways, also won't be over with just a few months of paring back. In a deleveraging world, and one in which repaying debt is prevalent because asset prices are no longer rising, then spending will be constrained to something less than incomes, which themselves are contracting. Corporate profits have tanked, margins are constricted, cost cutting is the order of the day, capacity utilization is awfully low, etc. There don't seem to be many areas in which there is pricing power.
So, for all those reasons, the deflationary forces are as pertinent today as they were in December, if not more so.
But what HAS changed is the market's perception of government's approach to dealing with all this. As Karl Denninger says in U.S. credit rating under fire:
Inflation fears in this regard are somewhat misplaced, because there is a black hole of defaulting credit into which one is attempting to issue, but it is perceptions that counts in a fiat currency world, and the perception in the market is that the US Government has lost control of its deficit and budget process, and The Fed has lost control of the money supply.
Perhaps the bond vigilantes really ARE back!
Denninger believes foreign central banks are selling into Ben's bid, and, if that's so, the game is up --- there will be a bond market implosion and an economic collapse. (Denninger's been warning of this for over a year, of course, which means he was warning of it with yields north of 4%, well over where they are now. I don't believe he foresaw them dropping as low as they did at the end of last year, so the sell-off we've experienced recently still doesn't get us back to levels at which he was saying bonds were doomed. That said, maybe his concerns back then took some time to become widely perceived, but, now that they are, this sell-off, which is already nearing 150bps, could go a long ways yet if Denninger is right. And, needless to say, its views of his type that test my convictions.)
My impression has always been that Denninger's concerns are totally valid, but the question is one of timing. I saw David Walker's Fiscal Wake-Up Tour material while he was still Comptroller General at the GAO (before leaving to work on the same crusade at the Peterson Institute), so I know Denninger is right: the U.S. simply cannot afford to pay off its debts, not while also maintaing the commitments it has made through all its non-funded liabilities, particularly healthcare. At least, it can't do so with dollars that are worth something! The burden is just too big: as Walker's GAO material pointed out, it added up to $170,000 PER PERSON, or $440,000 per household --- and that was as of the end of 2006!! As per the Peterson Foundation, the burden is now $184,000 per person and growing.
But, in the meantime, deleveraging and debt contraction and deflation and the historically very low proportion that bond holdings represent of the U.S. household sector's balance sheets and the relative near-term safety of government debt relative to riskier assets which have taken a drubbing, all meant that there was plenty of room for incremental new internal domestic bond demand to take up the incremental new supply (as Rosenberg argued repeatedly). And even low nominal yields look okay in a disinflationary or deflationary period --- this is one of those rare times that real yields are actually higher than nominal yields.
Meanwhile, though foreign central banks certainly realize the risk to their appreciable U.S. holdings, they're stuck between a rock and a hard place. They may not want to throw good money after bad, but if they stop buying U.S. debt now, not only do they guarantee a loss on their existing positions, but their currencies, which they've been holding down relative to the US$ with those past purchases, would go the other way, killing their own export-dependent economies. And, to the extent that they have trade surpluses with the U.S., they need to do something with the dollars they receive. Would they rather exchange those greenbacks for Euros? Pounds? Yen? Swiss Francs? Lats? Lira? Roubles?
Besides, I'm really not sure Denninger is correct that foreign C.B.s are indeed cutting back on their purchases. Brad Setser is the expert in this field, and he says that central banks still (heart) dollar reserves. Now, it is true that the U.S. trade deficit has declined, in part because oil prices have fallen, and in part because personal consumption has fallen, so imports have fallen faster than exports. And to the extent that the trade deficit is smaller, that implies a smaller net outflow from the U.S. of dollars to the world (to pay for imports relative to received for exports). So less currency recycling is necessary just as the government is ramping up issuance.
But, according to Setser, central banks have actually increased their Treasury holdings at the Fed by almost twice as much as required to finance the trade deficit. However, they are indeed shortening the maturities of the U.S. debt they purchase. So maybe they don't (heart) long bonds. But Setser believes that as the yield curve has steepened significantly, we'll soon get to a point where those foreign buyers will once again look at the paltry yields they're getting on their bills and notes and opt again for the higher yields on bonds.
All told, my convictions have been sorely tested, but, perhaps naively, I don't think I've f'd up too badly. Just like last year when the markets were all gung-ho about commodity-driven inflation, the markets this year are now gung-ho about money-printing-driven inflation. And, just like last year when government bonds rallied in the second half, I remain convinced, like the Van Hoisingtons and Gary Shillings of the world, that we'll have another significant rally coming.
Where my conviction has been most sorely tested, and maybe even lost, (which isn't much help for tactical trading), is how high yields might get in the meantime. But, as I suggested in my May 4 notes about 1998 Japan (In Japan in 1998, long-bond yields declined fairly steadily from 2.70 in January to 1.16 in October, then spiked back to 2.97 by year-end and 3.53 in February. They then fell back below 2 by May.) I think these so-called "green-shoots" type periods will hurt bonds, but, ultimatley, all the bond-friendly factors will prevail, albeit with remarkable volatility in the interim.
or, alternatively: my convictions wavering?
Back in December, when the US 10 yr flirted with 2%, I figured that I'd been right to predict/worry that the housing depression, the blowing up of the debt bubble, the stock market collapse, the dismal economy, and the consequent imminent risk of deflation implied a period of structural lower government bond yields, a la Japan.
How fleeting that feeling was!
With the exception of a brief rally in late March after Ben announced implementation of Q.E., rates have been steadily trending higher almost all YTD, with the 10-yr now back to 3.45.
What's changed? Not the economic reality. The economy has contracted at a fast rate over the last two quarters (having fallen faster to a lower level now than anyone in mid-December must have been thinking likely), and though its contracting at a slower rate now (+ve 2nd derivative), the contraction is not yet over (still -ve 1st derivative).
The housing market has shown blips, but its done that off-and-on for two years. So the housing recession is also not yet over, for reasons I've cited before: home prices still too high relative to incomes or rents; still too much excess supply and shadow inventory; credit is constrained, particularly at lower end, which prevents the whole process of sellers at the lower end moving up to be buyers at the higher end. The debt bubble has burst, and a new credit cycle has not been restarted; it will take a long time yet to digest the excessive (private) debt already in the system, an unhealthy portion of which is bad. Particularly given that unemployment keeps rising and incomes are stagnating (at best). Similarly, the consumer retrenchment, as hard as it is psychologically for Americans to give up their spendthrift ways, also won't be over with just a few months of paring back. In a deleveraging world, and one in which repaying debt is prevalent because asset prices are no longer rising, then spending will be constrained to something less than incomes, which themselves are contracting. Corporate profits have tanked, margins are constricted, cost cutting is the order of the day, capacity utilization is awfully low, etc. There don't seem to be many areas in which there is pricing power.
So, for all those reasons, the deflationary forces are as pertinent today as they were in December, if not more so.
But what HAS changed is the market's perception of government's approach to dealing with all this. As Karl Denninger says in U.S. credit rating under fire:
Inflation fears in this regard are somewhat misplaced, because there is a black hole of defaulting credit into which one is attempting to issue, but it is perceptions that counts in a fiat currency world, and the perception in the market is that the US Government has lost control of its deficit and budget process, and The Fed has lost control of the money supply.
Perhaps the bond vigilantes really ARE back!
Denninger believes foreign central banks are selling into Ben's bid, and, if that's so, the game is up --- there will be a bond market implosion and an economic collapse. (Denninger's been warning of this for over a year, of course, which means he was warning of it with yields north of 4%, well over where they are now. I don't believe he foresaw them dropping as low as they did at the end of last year, so the sell-off we've experienced recently still doesn't get us back to levels at which he was saying bonds were doomed. That said, maybe his concerns back then took some time to become widely perceived, but, now that they are, this sell-off, which is already nearing 150bps, could go a long ways yet if Denninger is right. And, needless to say, its views of his type that test my convictions.)
My impression has always been that Denninger's concerns are totally valid, but the question is one of timing. I saw David Walker's Fiscal Wake-Up Tour material while he was still Comptroller General at the GAO (before leaving to work on the same crusade at the Peterson Institute), so I know Denninger is right: the U.S. simply cannot afford to pay off its debts, not while also maintaing the commitments it has made through all its non-funded liabilities, particularly healthcare. At least, it can't do so with dollars that are worth something! The burden is just too big: as Walker's GAO material pointed out, it added up to $170,000 PER PERSON, or $440,000 per household --- and that was as of the end of 2006!! As per the Peterson Foundation, the burden is now $184,000 per person and growing.
But, in the meantime, deleveraging and debt contraction and deflation and the historically very low proportion that bond holdings represent of the U.S. household sector's balance sheets and the relative near-term safety of government debt relative to riskier assets which have taken a drubbing, all meant that there was plenty of room for incremental new internal domestic bond demand to take up the incremental new supply (as Rosenberg argued repeatedly). And even low nominal yields look okay in a disinflationary or deflationary period --- this is one of those rare times that real yields are actually higher than nominal yields.
Meanwhile, though foreign central banks certainly realize the risk to their appreciable U.S. holdings, they're stuck between a rock and a hard place. They may not want to throw good money after bad, but if they stop buying U.S. debt now, not only do they guarantee a loss on their existing positions, but their currencies, which they've been holding down relative to the US$ with those past purchases, would go the other way, killing their own export-dependent economies. And, to the extent that they have trade surpluses with the U.S., they need to do something with the dollars they receive. Would they rather exchange those greenbacks for Euros? Pounds? Yen? Swiss Francs? Lats? Lira? Roubles?
Besides, I'm really not sure Denninger is correct that foreign C.B.s are indeed cutting back on their purchases. Brad Setser is the expert in this field, and he says that central banks still (heart) dollar reserves. Now, it is true that the U.S. trade deficit has declined, in part because oil prices have fallen, and in part because personal consumption has fallen, so imports have fallen faster than exports. And to the extent that the trade deficit is smaller, that implies a smaller net outflow from the U.S. of dollars to the world (to pay for imports relative to received for exports). So less currency recycling is necessary just as the government is ramping up issuance.
But, according to Setser, central banks have actually increased their Treasury holdings at the Fed by almost twice as much as required to finance the trade deficit. However, they are indeed shortening the maturities of the U.S. debt they purchase. So maybe they don't (heart) long bonds. But Setser believes that as the yield curve has steepened significantly, we'll soon get to a point where those foreign buyers will once again look at the paltry yields they're getting on their bills and notes and opt again for the higher yields on bonds.
All told, my convictions have been sorely tested, but, perhaps naively, I don't think I've f'd up too badly. Just like last year when the markets were all gung-ho about commodity-driven inflation, the markets this year are now gung-ho about money-printing-driven inflation. And, just like last year when government bonds rallied in the second half, I remain convinced, like the Van Hoisingtons and Gary Shillings of the world, that we'll have another significant rally coming.
Where my conviction has been most sorely tested, and maybe even lost, (which isn't much help for tactical trading), is how high yields might get in the meantime. But, as I suggested in my May 4 notes about 1998 Japan (In Japan in 1998, long-bond yields declined fairly steadily from 2.70 in January to 1.16 in October, then spiked back to 2.97 by year-end and 3.53 in February. They then fell back below 2 by May.) I think these so-called "green-shoots" type periods will hurt bonds, but, ultimatley, all the bond-friendly factors will prevail, albeit with remarkable volatility in the interim.
Thursday, May 21, 2009
Is it always a lagging indicator?
There are some themes or ideas that are just accepted as common wisdom, and, as such, ordained as truisms.
For a time, one of those ideas was that the U.S. consumer was resilient; for a long-time this remained true ---- until it wasn't. Another such theme was that of global decoupling; for a while, it too looked like it might turn out true --- until it didn't. A third was that subprime would be contained --- which, likewise, wasn't based on facts or evidence or even well thought-out analysis, but was just an optimistic assumption, or, better yet, presumption, that ultimately got disproved.
The problem with ideas such as these is that the reason for the platitude is hardly ever examined; its truism-ity is usually just assumed on a prospective basis, often because it has been generally true retrospectively.
I worry that the notion that labour is a lagging indicator is just such a notion.
Undoubtedly, in most recessions, labour has been a lagging indicator. But most recessions that we are familiar with have been inventory-cycle recessions, or have been recessions caused by the Fed hiking rates until something breaks, after which time they drop rates again and re-start the economic cycle, principally by way of the credit cycle.
In an inventory-led recession, such as the dot-com bust, companies project the good times too far out into the future, they build to over-capacity, find out they have too much inventory, cut back on hiring, do some firing, work down their inventories, and its only after a while of those inventories being worked off, whether or not sales have picked up, that they need to resume the labour cycle, once their inventories are lean again. Therefore, labour indicators lag in such a cycle.
In other Fed-hiking-induced recessions, the Fed fears the inflationary effects of an overheating economy, so it hikes til the economy breaks/brakes; then once it has decided that it has slowed the economy enough that inflation will remain contained, it reduces interest rates, which spurs lending, as both consumers can incur new debt more cheaply to finance their spending (mostly through housing) and businesses can likewise finance more projects because their cost of financing has fallen, which makes more projects profitable. As such, the economy gets going again, and as consumers spend and as businesses ramp up, more labour is required, and hiring picks up, but in lagged fashion.
These are the typical types of recessions we are familiar with; and these are the types of economic cycles from which we evolved the common wisdom that labour is a lagging indicator.
But is that equally true today? Needless to say, I have my (serious) doubts.
Back on April 9 I published a post called U.S. Employment Data, at the conclusion of which I noted:
"Labour data is considered a lagging indicator. While that surely remains true (i.e. the economy will show other signs of rebounding before labour does), labour trends impart their own impact on the economy, particularly in a recession that is being consumer-led, unlike some past inventory-cycle recessions. In this case, the consumer retrenchment can't help but be re-inforced by the employment trends, as overly-indebted consumers are now also increasingly income-constrained consumers."
Normally, when the Fed tries to rescue the economy by cutting interest rates, that works its magic by restarting the credit cycle --- borrowing escalates, which finances economic activity, which spurs labour creation. Today, the Fed has dropped rates to as low as they can go, but its magic has lost its magic. Banks are not expanding the credit on offer. And even if they were inclined to, consumers are in no shape (or mood) to incrementally add to their monstrous debt burdens.
Furthermore, the primary channel through which Fed-engineered interest rate changes has historically had its impact is through housing: low Fed rates tend to lead to lower mortgage rates tends to lead to more housing activity, including all the various multiplier effects therefrom. But in this cycle, because of the still large overhang of excess homes, that's simply not happening. Sure, homeowners will refi as much as they can to take advantage of lower interest payments on outstanding mortgage burdens, and this will help ease their pain and suffering, and, at the margin, will mean they have more money in their pockets to spend on gas and groceries, and it will also allow their debt repayments to work more on reducing the principal rather than just paying mostly interest, but it does NOT mean they will take on more debt.
Households are deleveraging. They have taken a huge hit to their wealth, there is no more MEW available, they are closer to retirement than they were a decade ago, during which time they've had very little savings (relying instead on asset price appreciation that has quickly since dissolved), and, even for those who had pension plans, those too have taken a serious hit, so they now realize they need to save. They need to repay their outstanding debts, and also to re-build their nest eggs (can't just retire off the proceeds of a future house sale), which means that consumption must be constrained to something less than their incomes. Which, in the meantime, is falling (not just from lost jobs, but from lost hours for those still working, and from neglible wage gains).
Similarly, businesses haven't much motivation to leverage off of low interest rates to increase their activity. They have huge levels of unutilized capacity, so, as low as (government-backed) interest rates are, they have little incentive to take that money to invest in new productive capacity or in the creation of new widgets. And, not all businesses have access to government-guaranteed debt, so funding costs for the broader business community, due to still-wide spreads, are not that incentivizing in any case.
Therefore, if the Fed can't re-start the credit cycle, then it can't restart the economic business cycle, and thus it can't do much to promote job growth.
Banks don't want to expand lending (they have enough NPLs and bad debts to worry about already, and why extend more credit into an already debt-heavy economy that is in recession and to debt-burdened consumers who have poor job prospects and declining collateral values). Consumers don't want to take on more lending (for all the same reasons the banks don't want to extend it --- both groups are properly motivated to see debt levels in aggregate fall). And businesses might be in a position to borrow money, but the question for them is what to do with it (Microsoft, for instance, did a very opportunistic (first ever, I believe?) debt issue to lock in some nice borrowing rates (just 100 back of Treasuries), but it was already sitting on a ton of cash, and its not as if issuing a bunch of bonds has any implication for its order book.)
So, without labour growth, where will expanding economic activity come from? For now, there is some that is coming from the government purse, and that increase in federal expenditures (above and beyond the decrease in state and local outlays) will likely be sufficient to impact growth in the near-term, but does little to address the structural problems in the economy (i.e. excessive debt) that do not bode well for the mid- to long-term.
At the end of the day, what promotes economic growth is spending growth, and what promotes spending growth is income growth, and what promotes income growth is job growth. And we ain't got none of that right now.
As long as deleveraging persists (and it will for quite some time given that total economy-wide debt loads have continued to increase relative to the size of the economy or personal disposable income, which have fallen faster than debt has been paid off, and given that the mirage that it was sustainable on the back of housing values has been discredited, and given that housing prices still remain stretched relative to historical norms), it is my belief that job growth will be a leading, not lagging, indicator of demand, and, therefore, of economic activity.
And, most unfortunately, we are stuck in a vicious circle. Businesses' profit margins have been crushed, so pressure remains on them to cut costs (i.e. cut labour). As labour conditions continue to deteriorate, aggregate demand will continue to be stifled. And so it goes and so it goes.
At some point, conditions will have reached a point that sustainable growth will become inevitable. But a decade-long debt-drinking binge will not be cured with a 10-month hangover --- not until all that bad booze has been purged from the system and the drunks are over the memory of how bad that hangover felt.
For a time, one of those ideas was that the U.S. consumer was resilient; for a long-time this remained true ---- until it wasn't. Another such theme was that of global decoupling; for a while, it too looked like it might turn out true --- until it didn't. A third was that subprime would be contained --- which, likewise, wasn't based on facts or evidence or even well thought-out analysis, but was just an optimistic assumption, or, better yet, presumption, that ultimately got disproved.
The problem with ideas such as these is that the reason for the platitude is hardly ever examined; its truism-ity is usually just assumed on a prospective basis, often because it has been generally true retrospectively.
I worry that the notion that labour is a lagging indicator is just such a notion.
Undoubtedly, in most recessions, labour has been a lagging indicator. But most recessions that we are familiar with have been inventory-cycle recessions, or have been recessions caused by the Fed hiking rates until something breaks, after which time they drop rates again and re-start the economic cycle, principally by way of the credit cycle.
In an inventory-led recession, such as the dot-com bust, companies project the good times too far out into the future, they build to over-capacity, find out they have too much inventory, cut back on hiring, do some firing, work down their inventories, and its only after a while of those inventories being worked off, whether or not sales have picked up, that they need to resume the labour cycle, once their inventories are lean again. Therefore, labour indicators lag in such a cycle.
In other Fed-hiking-induced recessions, the Fed fears the inflationary effects of an overheating economy, so it hikes til the economy breaks/brakes; then once it has decided that it has slowed the economy enough that inflation will remain contained, it reduces interest rates, which spurs lending, as both consumers can incur new debt more cheaply to finance their spending (mostly through housing) and businesses can likewise finance more projects because their cost of financing has fallen, which makes more projects profitable. As such, the economy gets going again, and as consumers spend and as businesses ramp up, more labour is required, and hiring picks up, but in lagged fashion.
These are the typical types of recessions we are familiar with; and these are the types of economic cycles from which we evolved the common wisdom that labour is a lagging indicator.
But is that equally true today? Needless to say, I have my (serious) doubts.
Back on April 9 I published a post called U.S. Employment Data, at the conclusion of which I noted:
"Labour data is considered a lagging indicator. While that surely remains true (i.e. the economy will show other signs of rebounding before labour does), labour trends impart their own impact on the economy, particularly in a recession that is being consumer-led, unlike some past inventory-cycle recessions. In this case, the consumer retrenchment can't help but be re-inforced by the employment trends, as overly-indebted consumers are now also increasingly income-constrained consumers."
Normally, when the Fed tries to rescue the economy by cutting interest rates, that works its magic by restarting the credit cycle --- borrowing escalates, which finances economic activity, which spurs labour creation. Today, the Fed has dropped rates to as low as they can go, but its magic has lost its magic. Banks are not expanding the credit on offer. And even if they were inclined to, consumers are in no shape (or mood) to incrementally add to their monstrous debt burdens.
Furthermore, the primary channel through which Fed-engineered interest rate changes has historically had its impact is through housing: low Fed rates tend to lead to lower mortgage rates tends to lead to more housing activity, including all the various multiplier effects therefrom. But in this cycle, because of the still large overhang of excess homes, that's simply not happening. Sure, homeowners will refi as much as they can to take advantage of lower interest payments on outstanding mortgage burdens, and this will help ease their pain and suffering, and, at the margin, will mean they have more money in their pockets to spend on gas and groceries, and it will also allow their debt repayments to work more on reducing the principal rather than just paying mostly interest, but it does NOT mean they will take on more debt.
Households are deleveraging. They have taken a huge hit to their wealth, there is no more MEW available, they are closer to retirement than they were a decade ago, during which time they've had very little savings (relying instead on asset price appreciation that has quickly since dissolved), and, even for those who had pension plans, those too have taken a serious hit, so they now realize they need to save. They need to repay their outstanding debts, and also to re-build their nest eggs (can't just retire off the proceeds of a future house sale), which means that consumption must be constrained to something less than their incomes. Which, in the meantime, is falling (not just from lost jobs, but from lost hours for those still working, and from neglible wage gains).
Similarly, businesses haven't much motivation to leverage off of low interest rates to increase their activity. They have huge levels of unutilized capacity, so, as low as (government-backed) interest rates are, they have little incentive to take that money to invest in new productive capacity or in the creation of new widgets. And, not all businesses have access to government-guaranteed debt, so funding costs for the broader business community, due to still-wide spreads, are not that incentivizing in any case.
Therefore, if the Fed can't re-start the credit cycle, then it can't restart the economic business cycle, and thus it can't do much to promote job growth.
Banks don't want to expand lending (they have enough NPLs and bad debts to worry about already, and why extend more credit into an already debt-heavy economy that is in recession and to debt-burdened consumers who have poor job prospects and declining collateral values). Consumers don't want to take on more lending (for all the same reasons the banks don't want to extend it --- both groups are properly motivated to see debt levels in aggregate fall). And businesses might be in a position to borrow money, but the question for them is what to do with it (Microsoft, for instance, did a very opportunistic (first ever, I believe?) debt issue to lock in some nice borrowing rates (just 100 back of Treasuries), but it was already sitting on a ton of cash, and its not as if issuing a bunch of bonds has any implication for its order book.)
So, without labour growth, where will expanding economic activity come from? For now, there is some that is coming from the government purse, and that increase in federal expenditures (above and beyond the decrease in state and local outlays) will likely be sufficient to impact growth in the near-term, but does little to address the structural problems in the economy (i.e. excessive debt) that do not bode well for the mid- to long-term.
At the end of the day, what promotes economic growth is spending growth, and what promotes spending growth is income growth, and what promotes income growth is job growth. And we ain't got none of that right now.
As long as deleveraging persists (and it will for quite some time given that total economy-wide debt loads have continued to increase relative to the size of the economy or personal disposable income, which have fallen faster than debt has been paid off, and given that the mirage that it was sustainable on the back of housing values has been discredited, and given that housing prices still remain stretched relative to historical norms), it is my belief that job growth will be a leading, not lagging, indicator of demand, and, therefore, of economic activity.
And, most unfortunately, we are stuck in a vicious circle. Businesses' profit margins have been crushed, so pressure remains on them to cut costs (i.e. cut labour). As labour conditions continue to deteriorate, aggregate demand will continue to be stifled. And so it goes and so it goes.
At some point, conditions will have reached a point that sustainable growth will become inevitable. But a decade-long debt-drinking binge will not be cured with a 10-month hangover --- not until all that bad booze has been purged from the system and the drunks are over the memory of how bad that hangover felt.
Tuesday, May 19, 2009
Worthwhile Reading - May 9 - 21
Kabuki on the Potomac: Reforming CDS and OTC derivatives. Chris Whalen, The Institutional Risk Analyst, via Barry Ritholthz's The Big Picture.
Normalizing earnings during profit freefalls. Barry Ritholtz.
Novelty chart of the day. Zero Hedge, with chart from NDR.
Perfect revelation. Cassandra Does Tokyo (on origins, and bastardization, of QE).
Credit crisis watch: thawing -- noteworthy progress. Prieur du Plessis, via The Big Picture.
HOWEVER...
The world in recession. Carnegie Endowment. includes presentations from Olivier Blanchard, Director of the Research Department of the IMF, among others.
U.S. banking crisis may last until 2013: S&P. Reuters.
Secular Outlook: A new normal. Mohamed El Erian, PIMCO.
The "new normal" for growth. Kenneth Rogoff, Project Syndicate.
Damage assessment: how much will the financial crisis hurt America's economic potential. The Economist.
*** The end-game draws nigh: the future evolution of the debt-to-GDP ratio. Dr. Woody Brock, of Strategic Economic Decisions, via John Mauldin's Outside the Box.
The exuberance glut, or the dollar-euro short squeeze race. Tyler Durden, Zero Hedge.
Deep thoughts from Bob Janjuah. Zero Hedge.
*** Banks pass stress test; regulators fail ethics test. John Hussman.
read it all, but here's one excerpt on the markets:
"Even if we have observed the ultimate lows of this downturn (which I would not take as given), it does not follow that the decline we've observed over the past 18 months will be progressively recovered without a great deal of intervening difficulty. The S&P 500 has retraced just over 25% of its bear market loss. The 904 level on the S&P 500 was a 25% retracement, and 977 would be a 1/3 retracement, which is not unreasonable. Aside from such retracements, the idea of a “V-shaped” recovery in the market is strongly odds with “post-crash” market behavior, which generally features a long and drawn-out flat period for years afterward. Given the enormous overhang of Alt-A and option-ARM resets scheduled to begin later this year, extending into 2012, such a profile would not be surprising in the present case."
and another on the stress tests:
"Now, just think of this for a minute. Even if you assume that the “risk-weighted assets” of the banks are about two-thirds of their total assets (as the stress-test does), we're still looking at $7.8 trillion in total assets at risk in these banks, and despite being on the edge of insolvency only weeks ago, we are asked to believe that they will need less than 1% of this amount – $74.6 billion – of additional capital even in a worst case scenario."
The destructive implications of the bailout -- understanding equilibrium. Hussman again.
excerpt:
"One of the features that has enabled the bureaucratic abuse of the public during the past year has been the frantic, if temporary, flight-to-safety by investors. The Treasury has issued an enormous volume of debt into the frightened hands of investors seeking default-free securities. This has allowed the Treasury to finance a massive and largely needless transfer of wealth to bank bondholders so easily over the short-term that the longer-term cost has been almost completely obscured. But by transferring wealth from those who did not finance reckless loans to those who did – providing monetary compensation without economic production – the bureaucrats at the Treasury and Federal Reserve have crowded out more than a trillion dollars of gross investment that would have otherwise have been made by responsible people in the coming years, shifted assets to the control of those who have proven themselves to be irresponsible destroyers of capital, and have planted the seeds of inflation that will cut short any emerging recovery."
a bunch on banks:
Inside Citi's stress test: more like an F than a B+. Time.
and
How the bailouts screw smaller banks. Barry Ritholtz.
and
I would not own banks stocks: Meredith Whitney. CNBC.
and
The race: future earnings vs. writedowns. CR, with reference to Roubini and Hatzius.
and
Mark Patterson: "It's a sham; the banks are insolvent." Zero Hedge.
and
Breathing easier after bank stress tests? You shouldn't. McClatchy.
and
Red pill or blue pill? Jesse's Cafe Americain.
and a bunch on housing and mortgages:
Housing bubbles around the world: looks pretty bad. Rebecca Wilder, News N Economics.
and
On "rock bottom" housing prices. Zero Hedge.
and
A portrait of the ax, not falling. Rolfe Winkler, Option Armageddon.
and
April foreclosure and servicer tracker report. Mark Hanson, Mr. Mortgage.
excerpt:
"Bottom Line — after seeing these latest figures I am more convinced than ever that the next step is wide-spread principal balance reductions that will reduce the massive negative equity burden in America and be a first-step to solving the mortgage and housing crisis once and for all."
and
Loan reset threat looms until 2012. Mathew Padilla, Mortgage Insider, with charts from Credit Suisse.
and
Loan reset / recast schedule. Calculated Risk.
and
Zillow: higher percentage of homeowners waiting for a market turnaround. Calculated Risk.
and
Foreclosure activity remains at record levels in April. RealtyTrac.
excerpt:
"This suggests that many lenders and servicers are beginning foreclosure proceedings on delinquent loans that had been delayed by legislative and industry moratoria. It's likely that we'll see a corresponding spike in REOs as these loans move through the foreclosure process over the next few months."
and
Freddie reports $9.9 billion quarterly loss. MarketWatch.
excerpt:
"This delinquency data suggests that continuing home price declines and growing unemployment are significantly affecting behavior by a broader segment of mortgage borrowers. Additionally, as the slump in the U.S. housing market has persisted for more than a year, increasing numbers of borrowers that began with significant equity are now “underwater,” or owing more on their mortgage loans than their homes are currently worth. Our loan loss severities, or the average amount of recognized losses per loan, also continued to increase"
so, house prices are still too high, shadow inventory is building, more foreclosures are coming, and plenty more mortgage resets will be coming down the pike, more homeowners are underwater and it sounds like from Freddie that walking away is becoming more common (even in prime, not just subprime), all at time when mortgage rates are lower but lending standards are MUCH tighter.
Options for Fannie, Freddie may include "wind-down" [:OMB]. Bloomberg. (after hundreds of billions sunk)
meanwhile...
Commercial property prices. Mark Thoma, Economist's View, with info from MIT.
MEW, consumption, and personal savings rate. Calculated Risk again.
Update on inventory correction. CR. (yes, there was a big inventory correction in recent quarters, but inventory decumulation not keeping pace with decline in sales, so inventory-to-sales ratios remain higher than they've been since 01-02 recession -- and with retail sales still declining in April, that doesn't bode well for the inventory correction being done)
The anorexia of earnings and the government's junk diet. Tyler Durden, Zero Hedge.
Krugman fears lost decade for U.S. due to half-steps. Reuters.
Turning which corner? and Not so green Wednesday. Tim Duy's FedWatch.
Financial policy: looking forward. Susan Woodward and Robert Hall, Financial Crisis and Recession.
The worst is yet to come. Jesse's Cafe Americain, channeling Howard Davidowitz.
[update: Mish gives his take on this here]
The collapse of the neoliberal model: Where Russia went wrong. Michael Hudson, counterpunch.
excerpt:
"The problem is how to restructure the financial system to make it serve the objectives of industrial growth rather than merely facilitating capital flight. Throughout the world financial interests have taken control of government and used neoliberal policies to promote their own gain-seeking – financial gains without industrialization or agricultural self-sufficiency. Betting against one’s own currency is more remunerative than making the effort to invest in capital equipment and develop markets for new output. So unemployment and domestic budget deficits are soaring. The neoliberal failure to distinguish between productive and merely extractive or speculative forms of gain seeking has created a travesty of the kind of wealth creation that Adam Smith described in The Wealth of Nations. The financialization of economies has been decoupled from tangible capital investment to expand employment and productive powers."
Apocalypse when? Investors' Business Daily. (on social security and medicare)
The 81% tax increase. Bruce Bartlett, Forbes.
Fed: delinquency rates surged in Q1 2009. Calculated Risk.
and
Credit card defaults reach record highs in April. CNBC.
Asia needs to dump its growth model. Michael Pettis, FT.
China cuts lending amid asset bubble fears. FT.
Chinese power generation. Jake, Econompic Data.
China and the liquidity trap. Paul Krugman.
Not putting your money where your mouth is. Brad Setser, Follow the Money.
The wonderful world of negative nominal interest rates, again. Willem Buiter, Maverecon.
Inflection points and turning points - since you asked. Buiter again.
Credit growth in the aftermath of a crisis. Michael Pomerleano, FT.
(so, with no income growth, and no credit growth, where is PCE spending growth supposed to come from?)
Consumer credit contracts. Jake, EconompicData.
for more on that point, we have:
U.S. household deleveraging and future consumption growth. FRBSF Economic Letter.
excerpt:
"In the long-run, consumption cannot grow faster than income because there is an upper limit to how much debt households can service, based on their incomes. For many U.S. households, current debt levels appear too high, as evidenced by the sharp rise in delinquencies and foreclosures in recent years. To achieve a sustainable level of debt relative to income, households may need to undergo a prolonged period of deleveraging, whereby debt is reduced and saving is increased. This Economic Letter discusses how a deleveraging of the U.S. household sector might affect the growth rate of consumption going forward.....
... More than 20 years ago, economist Hyman Minsky (1986) proposed a "financial instability hypothesis." He argued that prosperous times can often induce borrowers to accumulate debt beyond their ability to repay out of current income, thus leading to financial crises and severe economic contractions....
... could result in a substantial and prolonged slowdown in consumer spending"
[update: Mish has his own commentary here on this FRBSF report]
a bunch from Hellasious:
How steep is my valley. (does the shape of the yield curve mean now what it would normally mean?)
and
It's a copycat - deadcat bounce. (from risk revulsion to risk appetite.... on what?)
and, to answer that question:
Bailouts, inventories and jobs.
and why things are likely getting ahead of themselves:
The great reset results in traps. and The Lazarus market. and The real economy in pictures. and
*** Low wages + high consumption = massive debt. and GDP on debt steroids.
all from Sudden Debt.
One thought could change your life. Michael Matovcik, via Zero Hedge.
lotsa little quotes/ideas, my favourite of which is:
“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” Ludwig Von Mises
FRBSF Economic Outlook. Mark Thoma, Economist's View.
Economists stuck in 1930s need a decade update. Caroline Baum, Bloomberg. (partly about leading indicators, partly about Alan Blinder's opinion not to take the foot off the gas too soon, partly C.B.'s opinion that following A.B.'s advice to avoid the 1930s might lead to reprise of 1970s)
Involuntary part-time workers and the deficiencies of the unemployment rate. Federal Reserve Bank of Cleveland.
Government payroll warping overall data? Jake, Econompic Data. (published figure: -539, take off downward revisions to past months of -66 and one-time census hiring -66, and you get -671 (and that's ignoring the huge assumed positive contribution (241k) of the Birth/Death adjustment)
Bad collateral. Jim Kunstler.
excerpt:
"... All this is to say why it is so dispiriting to see Mr. Obama's White House mount a campaign to sustain the unsustainable in the economic realm. Everything they've done for four months involving money management and enterprise policy -- from backstopping hopeless banks, to gaming the bankruptcies of the big car companies, to the bungled efforts to prop up artificially-high house prices -- amounts to a gigantic exercise in futility. Worse, it gives off odors of dishonesty or stupidity, since the ominous tendings of our system are so starkly self-evident. Not least of the problems entailed in all this are the scary political consequences. ... The Obama White House has very quickly painted itself into a corner on these things. The so-called bank "stress test" couldn't have backfired more completely. Rather than bolster confidence in our money system and the people who run it, it only made the system appear more obviously corrupt. It made the Treasury Department (and the White House by extension) look idiotic for concocting it. Worse, the game of allowing the banks to audit themselves, and cook their books under newly jiggered accounting rules, only made them look less sound and trustworthy, and their executives more venal and mendacious. The stress test scam also virtually guaranteed that the banks will not get another dime out of congress -- even while it is common knowledge that they will desperately need quadrillions more dimes in the months ahead. Who knows what the point of this ludicrous exercise was?"
Another 'I told you so': pensions. Karl Denninger. (the PBGC's deficit has tripled in the last six months to $33.5B, and that's before it has to account for Chrysler or GM)
Let's assume we have a can opener. Steve Keen's Debtwatch. (applies to Australia's budget forecasts, but same line of thinking applies to Obama's and even the BoC's rosy forward-looking return to trend-growth forecasts.)
first, in praise of gold:
Financial Psalm 16. Cassandra.
Monetizing the debt: explanation for non-economists and laymen. The Prudent Investor.
a little bball debate:
Kobe vs. LeBron. excerpts from TrueHoop debate.
and some cool art:
WOW! 3D pavement art. must see. Edgar Mueller.
Normalizing earnings during profit freefalls. Barry Ritholtz.
Novelty chart of the day. Zero Hedge, with chart from NDR.
Perfect revelation. Cassandra Does Tokyo (on origins, and bastardization, of QE).
Chasing the shadow of money. Tyler Durden, via nakedcapitalism.
Why I'm freaking out. Gonzalo Lira, via nakedcapitalism.
The simplest explanation. Distressed Lookout, via Zero Hedge.
*** The last hurrah and seven lean years. Jeremy Grantham, GMO Quarterly Letter, via Option Amageddon
excerpt: "Probably the single biggest drag on the economy over the next several years will be the massive write-down in perceived wealth that I described briefly last quarter. In the U.S., the total market value of housing, commercial real estate, and stocks was about $50 trillion at the peak and fell below $30 trillion at the low. This loss of $20-$23 trillion of perceived wealth in the U.S. alone (although it is not a drop in real wealth, which is comprised of a stock of educated workers and modern plants, etc.) is still enough to deliver a life-changing shock for hundreds of millions of people. No longer as rich as we thought – under-saved, under-pensioned, and realizing it – we will enter a less indulgent world, if a more realistic one, in which life is to be lived more frugally. Collectively, we will save more, spend less, and waste less. It may not even be a less pleasant world when we get used to it, but for several years it will cause a lot of readjustment problems."
Enjoy the rally while it lasts -- but expect to take a sucker punch. Ambrose-Evans Pritchard, Telegraph. (quoting James Montier and Albert Edwards from SocGen and Teun Draaisma from Morgan Stanley)
Was it a sucker's rally? Andy Kessler, WSJ.
Liquidity crisis? Check. James Kwak, The Baseline Scenario.
with stocks having rallied as much as they have since March 9, its good to note that its not been just an equity-mope phenomenon, as credit indications have improved also; green shoots theories helping all risk assets:Credit crisis watch: thawing -- noteworthy progress. Prieur du Plessis, via The Big Picture.
HOWEVER...
The world in recession. Carnegie Endowment. includes presentations from Olivier Blanchard, Director of the Research Department of the IMF, among others.
U.S. banking crisis may last until 2013: S&P. Reuters.
Secular Outlook: A new normal. Mohamed El Erian, PIMCO.
The "new normal" for growth. Kenneth Rogoff, Project Syndicate.
Damage assessment: how much will the financial crisis hurt America's economic potential. The Economist.
It's that "vision" thing: why the bailouts aren't working, and why a new financial system is needed. Jan Kregel, Levy Institute.
*** The $33,000,000,000,000 question. Niels Jensen, via John Mauldin's Outside the Box.
Faith-based economics. John Mauldin, Thoughts from the Frontline.*** The end-game draws nigh: the future evolution of the debt-to-GDP ratio. Dr. Woody Brock, of Strategic Economic Decisions, via John Mauldin's Outside the Box.
The exuberance glut, or the dollar-euro short squeeze race. Tyler Durden, Zero Hedge.
Deep thoughts from Bob Janjuah. Zero Hedge.
*** Banks pass stress test; regulators fail ethics test. John Hussman.
read it all, but here's one excerpt on the markets:
"Even if we have observed the ultimate lows of this downturn (which I would not take as given), it does not follow that the decline we've observed over the past 18 months will be progressively recovered without a great deal of intervening difficulty. The S&P 500 has retraced just over 25% of its bear market loss. The 904 level on the S&P 500 was a 25% retracement, and 977 would be a 1/3 retracement, which is not unreasonable. Aside from such retracements, the idea of a “V-shaped” recovery in the market is strongly odds with “post-crash” market behavior, which generally features a long and drawn-out flat period for years afterward. Given the enormous overhang of Alt-A and option-ARM resets scheduled to begin later this year, extending into 2012, such a profile would not be surprising in the present case."
and another on the stress tests:
"Now, just think of this for a minute. Even if you assume that the “risk-weighted assets” of the banks are about two-thirds of their total assets (as the stress-test does), we're still looking at $7.8 trillion in total assets at risk in these banks, and despite being on the edge of insolvency only weeks ago, we are asked to believe that they will need less than 1% of this amount – $74.6 billion – of additional capital even in a worst case scenario."
The destructive implications of the bailout -- understanding equilibrium. Hussman again.
excerpt:
"One of the features that has enabled the bureaucratic abuse of the public during the past year has been the frantic, if temporary, flight-to-safety by investors. The Treasury has issued an enormous volume of debt into the frightened hands of investors seeking default-free securities. This has allowed the Treasury to finance a massive and largely needless transfer of wealth to bank bondholders so easily over the short-term that the longer-term cost has been almost completely obscured. But by transferring wealth from those who did not finance reckless loans to those who did – providing monetary compensation without economic production – the bureaucrats at the Treasury and Federal Reserve have crowded out more than a trillion dollars of gross investment that would have otherwise have been made by responsible people in the coming years, shifted assets to the control of those who have proven themselves to be irresponsible destroyers of capital, and have planted the seeds of inflation that will cut short any emerging recovery."
a bunch on banks:
Inside Citi's stress test: more like an F than a B+. Time.
and
How the bailouts screw smaller banks. Barry Ritholtz.
and
I would not own banks stocks: Meredith Whitney. CNBC.
and
The race: future earnings vs. writedowns. CR, with reference to Roubini and Hatzius.
and
Mark Patterson: "It's a sham; the banks are insolvent." Zero Hedge.
and
Breathing easier after bank stress tests? You shouldn't. McClatchy.
and
Red pill or blue pill? Jesse's Cafe Americain.
and a bunch on housing and mortgages:
Housing bubbles around the world: looks pretty bad. Rebecca Wilder, News N Economics.
and
On "rock bottom" housing prices. Zero Hedge.
and
A portrait of the ax, not falling. Rolfe Winkler, Option Armageddon.
and
April foreclosure and servicer tracker report. Mark Hanson, Mr. Mortgage.
excerpt:
"Bottom Line — after seeing these latest figures I am more convinced than ever that the next step is wide-spread principal balance reductions that will reduce the massive negative equity burden in America and be a first-step to solving the mortgage and housing crisis once and for all."
and
Loan reset threat looms until 2012. Mathew Padilla, Mortgage Insider, with charts from Credit Suisse.
and
Loan reset / recast schedule. Calculated Risk.
and
Zillow: higher percentage of homeowners waiting for a market turnaround. Calculated Risk.
and
Foreclosure activity remains at record levels in April. RealtyTrac.
excerpt:
"This suggests that many lenders and servicers are beginning foreclosure proceedings on delinquent loans that had been delayed by legislative and industry moratoria. It's likely that we'll see a corresponding spike in REOs as these loans move through the foreclosure process over the next few months."
and
Freddie reports $9.9 billion quarterly loss. MarketWatch.
excerpt:
"This delinquency data suggests that continuing home price declines and growing unemployment are significantly affecting behavior by a broader segment of mortgage borrowers. Additionally, as the slump in the U.S. housing market has persisted for more than a year, increasing numbers of borrowers that began with significant equity are now “underwater,” or owing more on their mortgage loans than their homes are currently worth. Our loan loss severities, or the average amount of recognized losses per loan, also continued to increase"
so, house prices are still too high, shadow inventory is building, more foreclosures are coming, and plenty more mortgage resets will be coming down the pike, more homeowners are underwater and it sounds like from Freddie that walking away is becoming more common (even in prime, not just subprime), all at time when mortgage rates are lower but lending standards are MUCH tighter.
Options for Fannie, Freddie may include "wind-down" [:OMB]. Bloomberg. (after hundreds of billions sunk)
meanwhile...
Commercial property prices. Mark Thoma, Economist's View, with info from MIT.
MEW, consumption, and personal savings rate. Calculated Risk again.
Update on inventory correction. CR. (yes, there was a big inventory correction in recent quarters, but inventory decumulation not keeping pace with decline in sales, so inventory-to-sales ratios remain higher than they've been since 01-02 recession -- and with retail sales still declining in April, that doesn't bode well for the inventory correction being done)
The anorexia of earnings and the government's junk diet. Tyler Durden, Zero Hedge.
Krugman fears lost decade for U.S. due to half-steps. Reuters.
Turning which corner? and Not so green Wednesday. Tim Duy's FedWatch.
Financial policy: looking forward. Susan Woodward and Robert Hall, Financial Crisis and Recession.
The worst is yet to come. Jesse's Cafe Americain, channeling Howard Davidowitz.
[update: Mish gives his take on this here]
The collapse of the neoliberal model: Where Russia went wrong. Michael Hudson, counterpunch.
excerpt:
"The problem is how to restructure the financial system to make it serve the objectives of industrial growth rather than merely facilitating capital flight. Throughout the world financial interests have taken control of government and used neoliberal policies to promote their own gain-seeking – financial gains without industrialization or agricultural self-sufficiency. Betting against one’s own currency is more remunerative than making the effort to invest in capital equipment and develop markets for new output. So unemployment and domestic budget deficits are soaring. The neoliberal failure to distinguish between productive and merely extractive or speculative forms of gain seeking has created a travesty of the kind of wealth creation that Adam Smith described in The Wealth of Nations. The financialization of economies has been decoupled from tangible capital investment to expand employment and productive powers."
Apocalypse when? Investors' Business Daily. (on social security and medicare)
Unintended consequences....again! Karl Denninger, The Market Ticker.
re: Obama's treatment of GM and Chrysler debt-holders:
"Without capital formation and private investment, our capital markets and ultimately our business environment will wither and die. This is not conjecture, it is mathematical certainty.
The Rule of Law is what has separated us from a banana republic for over 200 years. That has now been relegated to the dustbin of history"
The 81% tax increase. Bruce Bartlett, Forbes.
Fed: delinquency rates surged in Q1 2009. Calculated Risk.
and
Credit card defaults reach record highs in April. CNBC.
Asia needs to dump its growth model. Michael Pettis, FT.
China cuts lending amid asset bubble fears. FT.
Chinese power generation. Jake, Econompic Data.
China and the liquidity trap. Paul Krugman.
Not putting your money where your mouth is. Brad Setser, Follow the Money.
The wonderful world of negative nominal interest rates, again. Willem Buiter, Maverecon.
Inflection points and turning points - since you asked. Buiter again.
Credit growth in the aftermath of a crisis. Michael Pomerleano, FT.
(so, with no income growth, and no credit growth, where is PCE spending growth supposed to come from?)
Consumer credit contracts. Jake, EconompicData.
for more on that point, we have:
U.S. household deleveraging and future consumption growth. FRBSF Economic Letter.
excerpt:
"In the long-run, consumption cannot grow faster than income because there is an upper limit to how much debt households can service, based on their incomes. For many U.S. households, current debt levels appear too high, as evidenced by the sharp rise in delinquencies and foreclosures in recent years. To achieve a sustainable level of debt relative to income, households may need to undergo a prolonged period of deleveraging, whereby debt is reduced and saving is increased. This Economic Letter discusses how a deleveraging of the U.S. household sector might affect the growth rate of consumption going forward.....
... More than 20 years ago, economist Hyman Minsky (1986) proposed a "financial instability hypothesis." He argued that prosperous times can often induce borrowers to accumulate debt beyond their ability to repay out of current income, thus leading to financial crises and severe economic contractions....
... could result in a substantial and prolonged slowdown in consumer spending"
[update: Mish has his own commentary here on this FRBSF report]
a bunch from Hellasious:
How steep is my valley. (does the shape of the yield curve mean now what it would normally mean?)
and
It's a copycat - deadcat bounce. (from risk revulsion to risk appetite.... on what?)
and, to answer that question:
Bailouts, inventories and jobs.
and why things are likely getting ahead of themselves:
The great reset results in traps. and The Lazarus market. and The real economy in pictures. and
*** Low wages + high consumption = massive debt. and GDP on debt steroids.
all from Sudden Debt.
One thought could change your life. Michael Matovcik, via Zero Hedge.
lotsa little quotes/ideas, my favourite of which is:
“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” Ludwig Von Mises
FRBSF Economic Outlook. Mark Thoma, Economist's View.
Economists stuck in 1930s need a decade update. Caroline Baum, Bloomberg. (partly about leading indicators, partly about Alan Blinder's opinion not to take the foot off the gas too soon, partly C.B.'s opinion that following A.B.'s advice to avoid the 1930s might lead to reprise of 1970s)
Involuntary part-time workers and the deficiencies of the unemployment rate. Federal Reserve Bank of Cleveland.
Government payroll warping overall data? Jake, Econompic Data. (published figure: -539, take off downward revisions to past months of -66 and one-time census hiring -66, and you get -671 (and that's ignoring the huge assumed positive contribution (241k) of the Birth/Death adjustment)
Bad collateral. Jim Kunstler.
excerpt:
"... All this is to say why it is so dispiriting to see Mr. Obama's White House mount a campaign to sustain the unsustainable in the economic realm. Everything they've done for four months involving money management and enterprise policy -- from backstopping hopeless banks, to gaming the bankruptcies of the big car companies, to the bungled efforts to prop up artificially-high house prices -- amounts to a gigantic exercise in futility. Worse, it gives off odors of dishonesty or stupidity, since the ominous tendings of our system are so starkly self-evident. Not least of the problems entailed in all this are the scary political consequences. ... The Obama White House has very quickly painted itself into a corner on these things. The so-called bank "stress test" couldn't have backfired more completely. Rather than bolster confidence in our money system and the people who run it, it only made the system appear more obviously corrupt. It made the Treasury Department (and the White House by extension) look idiotic for concocting it. Worse, the game of allowing the banks to audit themselves, and cook their books under newly jiggered accounting rules, only made them look less sound and trustworthy, and their executives more venal and mendacious. The stress test scam also virtually guaranteed that the banks will not get another dime out of congress -- even while it is common knowledge that they will desperately need quadrillions more dimes in the months ahead. Who knows what the point of this ludicrous exercise was?"
Another 'I told you so': pensions. Karl Denninger. (the PBGC's deficit has tripled in the last six months to $33.5B, and that's before it has to account for Chrysler or GM)
Let's assume we have a can opener. Steve Keen's Debtwatch. (applies to Australia's budget forecasts, but same line of thinking applies to Obama's and even the BoC's rosy forward-looking return to trend-growth forecasts.)
Wholesale prices post largest 12-month decline since 1950 [finished goods PPI down 3.7% YoY, but intermediate goods down 10.5% and crude goods down 40%!]
and Non-existent "pre-recovery" in manufacturing suggests U.S. Treasuries a buy. both by Michael Shedlock.The dynamically-hedged economy II. Doug Noland, Prudent Bear (skip to the last section); excerpt:
"The more bearish analysts argue that current economic underpinnings do not support surging stock and debt prices. Of course they don’t, but that’s not really the key issue. Rather, the question is whether the return of liquidity and securities market inflation will stoke sufficient confidence (from both spenders and lenders) to spur sustainable economic recovery. Here I must lean heavily on my analytical framework. In the short-run, I have to presume that major financial sector and market developments will work to stimulate the real economy (as they have repeatedly in the past). At the same time, it’s my view that the economy today is unusually susceptible to an artificial and fleeting recovery. The unwind of bearish hedges will at some point have run its course, concluding a period of major artificial liquidity generation. Moreover, I question the sustainability of the Government Finance Bubble (fiscal and monetary) overall. The markets are setting themselves up for disappointment."
The economic crisis and its implications for the science of economics. The Perimeter Institute Recorded Seminar Archive. (includes Roubini, Taleb, Andrew Lo, Bill Janeway)
'I think people are still in denial'. Brian Milner interviews David Rosenberg, G&M.
and, great news, at least for a limited time:
Sign up for economic reports featuring David Rosenberg. Gluskin Sheff.
and, a few on the light-hearted side:first, in praise of gold:
Financial Psalm 16. Cassandra.
Monetizing the debt: explanation for non-economists and laymen. The Prudent Investor.
a little bball debate:
Kobe vs. LeBron. excerpts from TrueHoop debate.
and some cool art:
WOW! 3D pavement art. must see. Edgar Mueller.
Friday, May 8, 2009
Worthwhile Reading - May 8
Greenish shoots in East Asia. Brad Setser, Follow the Money.
Stressing the positive. Paul Krugman, NYT.
The spring of the zombies. Joseph Stiglitz, Project Syndicate.
excerpt:
The bottom may be near - perhaps by the end of the year. But that does not mean that the global economy is set for a robust recovery any time soon.... This downturn is complex: an economic crisis combined with a financial crisis. Before its onset, America's debt-ridden consumers were the engine of global growth. That model has broken down, and will not be replaced soon. For, even if America's banks were healthy, household wealth has been devastated, and Americans were borrowing and consuming on the assumption that house prices would rise forever.
Fannie Mae asks for another $19 billion. Calculated Risk.
Export versus domestic demand - the argument rages. Michael Pettis, China Financial Markets.
excerpt:
Increasingly I am hearing people here say that, although few expect a “collapse”, whatever that means, China is facing its own “lost decade” of sub-par economic growth and a very difficult transition. As regular readers know, I am very inclined to agree.... the surge in lending actually makes China’s transition more difficult in the medium term because it will act to constrain future consumption in China.
Power generation declines; China's recovery is lagging. China Stakes.
China consumer spending vs savings. Barry Ritholtz, The Big Picture.
From recession to recovery: a long and hard road. Prakash Kannan, Alasdair Scott and Marco Terrones, voxeu.
What keeps me awake at night: economy edition. Roger Ehrenberg, Information Arbitrage.
Global crisis 'vastly worse' than 1930s, Taleb says. Bloomberg.
Are U.S. investors pathologically optimistic? Frank Veneroso, via Paul Kedrosky's Infectious Greed.
Stressing the positive. Paul Krugman, NYT.
The spring of the zombies. Joseph Stiglitz, Project Syndicate.
excerpt:
The bottom may be near - perhaps by the end of the year. But that does not mean that the global economy is set for a robust recovery any time soon.... This downturn is complex: an economic crisis combined with a financial crisis. Before its onset, America's debt-ridden consumers were the engine of global growth. That model has broken down, and will not be replaced soon. For, even if America's banks were healthy, household wealth has been devastated, and Americans were borrowing and consuming on the assumption that house prices would rise forever.
Fannie Mae asks for another $19 billion. Calculated Risk.
Export versus domestic demand - the argument rages. Michael Pettis, China Financial Markets.
excerpt:
Increasingly I am hearing people here say that, although few expect a “collapse”, whatever that means, China is facing its own “lost decade” of sub-par economic growth and a very difficult transition. As regular readers know, I am very inclined to agree.... the surge in lending actually makes China’s transition more difficult in the medium term because it will act to constrain future consumption in China.
Power generation declines; China's recovery is lagging. China Stakes.
China consumer spending vs savings. Barry Ritholtz, The Big Picture.
From recession to recovery: a long and hard road. Prakash Kannan, Alasdair Scott and Marco Terrones, voxeu.
What keeps me awake at night: economy edition. Roger Ehrenberg, Information Arbitrage.
Global crisis 'vastly worse' than 1930s, Taleb says. Bloomberg.
Are U.S. investors pathologically optimistic? Frank Veneroso, via Paul Kedrosky's Infectious Greed.
Wednesday, May 6, 2009
Worthwhile Reading - May 6
Inflation: not this ship, sister. Accrued Interest.
Fact checking Bernanke on real estate. Calculated Risk.
Wages contract in US, UK, Japan. Michael Shedlock.
Staying the course... toward 1990s Japan? Mark Thoma, The Hearing, WaPo.
Of fingers and dikes. Contrary Investor.
The federal budget, rescaled. Terence Tao.
Comfortable with uncertainty. John Hussman.
an excerpt of Hussman's comments on uncertainty:
In his book On Being Certain, neurologist Robert A. Burton quotes F. Scott Fitzgerald – “The test of a first rate intelligence is the ability to hold two opposed ideas in the mind at the same time and still retain the ability to function.” Buddhist teacher Pema Chodron calls it “being comfortable with uncertainty” – being willing to take every aspect of reality as the starting point, without wasting energy wishing things were different, without denying reality as it is (even if your next step is to work toward changing things), and without needing to know what will happen in the future. “The truth you believe and cling to makes you unavailable to hear anything new. The best thing we can do for ourselves is to be open to an unknown future.”
Burton offers the same advice. Tolerating the unpleasantness of uncertainty, he writes, “is the only practical alternative to cognitive dissonance, where one set of values overrides otherwise convincing contrary evidence. Each position has its own risks and rewards; both need to be considered and balanced within the overarching mandate: Above all, do no harm. Science has given us the language and tools of probabilities. We have methods for analyzing and ranking opinion according to their likelihood of correctness. That is enough. We do not need and cannot afford the catastrophes born out of a belief in certainty.”
Make it seven! Jim Balsillie.
Fact checking Bernanke on real estate. Calculated Risk.
Wages contract in US, UK, Japan. Michael Shedlock.
Staying the course... toward 1990s Japan? Mark Thoma, The Hearing, WaPo.
Of fingers and dikes. Contrary Investor.
The federal budget, rescaled. Terence Tao.
Comfortable with uncertainty. John Hussman.
an excerpt of Hussman's comments on uncertainty:
In his book On Being Certain, neurologist Robert A. Burton quotes F. Scott Fitzgerald – “The test of a first rate intelligence is the ability to hold two opposed ideas in the mind at the same time and still retain the ability to function.” Buddhist teacher Pema Chodron calls it “being comfortable with uncertainty” – being willing to take every aspect of reality as the starting point, without wasting energy wishing things were different, without denying reality as it is (even if your next step is to work toward changing things), and without needing to know what will happen in the future. “The truth you believe and cling to makes you unavailable to hear anything new. The best thing we can do for ourselves is to be open to an unknown future.”
Burton offers the same advice. Tolerating the unpleasantness of uncertainty, he writes, “is the only practical alternative to cognitive dissonance, where one set of values overrides otherwise convincing contrary evidence. Each position has its own risks and rewards; both need to be considered and balanced within the overarching mandate: Above all, do no harm. Science has given us the language and tools of probabilities. We have methods for analyzing and ranking opinion according to their likelihood of correctness. That is enough. We do not need and cannot afford the catastrophes born out of a belief in certainty.”
Make it seven! Jim Balsillie.
Tuesday, May 5, 2009
Worthwhile Reading - May 5
If China loses faith the dollar will collapse. Andy Xie, FT.
The economic outlook. Ben Bernanke, Fed. its all about 2nd derivatives --- tentative signs of moderating declines:
"Even after a recovery gets under way, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while, implying that the current slack in resource utilization will increase further.... a sustained recovery in economic activity depends critically on restoring stability to the financial system."
Lessons of the global financial crisis: 1. The end of Ponzi prosperity. Satyajit Das, eurointelligence.
Nation ready to be lied to about economy again. The Onion.
The economic outlook. Ben Bernanke, Fed. its all about 2nd derivatives --- tentative signs of moderating declines:
"Even after a recovery gets under way, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while, implying that the current slack in resource utilization will increase further.... a sustained recovery in economic activity depends critically on restoring stability to the financial system."
Lessons of the global financial crisis: 1. The end of Ponzi prosperity. Satyajit Das, eurointelligence.
Nation ready to be lied to about economy again. The Onion.
Data - May 1 to May 5
CANADA
average weekly earnings were reported last week as having risen just 1.8% YoY through February, down from 2.4%, continuing a steady slide since 2007Q1;
meanwhile, the average workweek of hourly paid employees remains low, at just 30.2
U.S.
UofM confidence up to 65 from 62 ("what do those students know, anyways?")
factory orders down 0.9% in March, more than expected, and February's rise was revised down to +0.7% from 1.8%
ISM manufacturing contracting but not as fast, up to 40.1 in April vs 36.3 in March
ISM prices paid component didn't rise as much as anticipated, still quite low at 32
total vehicle sales down to 9.3M for April
pending home sales were up 3.2% in March, better than the flat reading that was anticipated
construction spending, expected to have fallen a bit further after February's decline of 1%, was up 0.3% in March
ISM non-manufacturing, which was expected to rise to 42.2 from 40.8, did a bit better, climbing to 43.7, due largely to the new orders component rebounding to 47 from 39
INTERNATIONAL
Japan:
jobless rate rose more than expected, to 4.8% from 4.4%
household spending declined less than expected, down just 0.4% YoY
CPI fell 0.3% YoY through February, down from -0.1%
vehicle sales down 28.6% YoY
Europe:
U.K., Italian, French, German and Eurozone manufacturing PMIs all contracting at a slower pace, up to 42.9, 37.2, 40.1, 35.4 and 36.8, respectively (the last three were basically flat month-over-month)
German retail sales down 1% in March and therefore down 1.5% YoY
U.K. construction PMI rose to 38
Eurozone PPI down .7% MoM and 3.1% YoY
Spanish building permits were up in February, but remain down 60% YoY
Greek retail sales are down 13% YoY, and in Ireland, real retail sales (volumes) are down 21%
China:
the CLSA Manufacturing PMI has joined the government's official PMI measure above 50; the latter, which is weighted more heavily toward large state-owned enterprises, has been there for two months (53.5), but the CLSA measure's rise to 50.1 in April is the first expansion (however modest) in nine months, up from 44.8
Aussie:
the RBA left rates unchanged at 3%
Other:
LIBOR fell under 1%!
but U.S. commercial paper outstanding keeps falling, now as low as its been since 2004, driven largely by asset-backed CP, but even the non-ABCP CP is down to levels it was at in 2005
Baltic Dry has been fairly steady for last couple of weeks, but the Journal of Commerce industrial (smoothed) price commodity index has been steadily rising since December (though it has only gotten back to October levels and remains well below last spring's levels)
VIX is under 35
average weekly earnings were reported last week as having risen just 1.8% YoY through February, down from 2.4%, continuing a steady slide since 2007Q1;
meanwhile, the average workweek of hourly paid employees remains low, at just 30.2
U.S.
UofM confidence up to 65 from 62 ("what do those students know, anyways?")
factory orders down 0.9% in March, more than expected, and February's rise was revised down to +0.7% from 1.8%
ISM manufacturing contracting but not as fast, up to 40.1 in April vs 36.3 in March
ISM prices paid component didn't rise as much as anticipated, still quite low at 32
total vehicle sales down to 9.3M for April
pending home sales were up 3.2% in March, better than the flat reading that was anticipated
construction spending, expected to have fallen a bit further after February's decline of 1%, was up 0.3% in March
ISM non-manufacturing, which was expected to rise to 42.2 from 40.8, did a bit better, climbing to 43.7, due largely to the new orders component rebounding to 47 from 39
INTERNATIONAL
Japan:
jobless rate rose more than expected, to 4.8% from 4.4%
household spending declined less than expected, down just 0.4% YoY
CPI fell 0.3% YoY through February, down from -0.1%
vehicle sales down 28.6% YoY
Europe:
U.K., Italian, French, German and Eurozone manufacturing PMIs all contracting at a slower pace, up to 42.9, 37.2, 40.1, 35.4 and 36.8, respectively (the last three were basically flat month-over-month)
German retail sales down 1% in March and therefore down 1.5% YoY
U.K. construction PMI rose to 38
Eurozone PPI down .7% MoM and 3.1% YoY
Spanish building permits were up in February, but remain down 60% YoY
Greek retail sales are down 13% YoY, and in Ireland, real retail sales (volumes) are down 21%
China:
the CLSA Manufacturing PMI has joined the government's official PMI measure above 50; the latter, which is weighted more heavily toward large state-owned enterprises, has been there for two months (53.5), but the CLSA measure's rise to 50.1 in April is the first expansion (however modest) in nine months, up from 44.8
Aussie:
the RBA left rates unchanged at 3%
Other:
LIBOR fell under 1%!
but U.S. commercial paper outstanding keeps falling, now as low as its been since 2004, driven largely by asset-backed CP, but even the non-ABCP CP is down to levels it was at in 2005
Baltic Dry has been fairly steady for last couple of weeks, but the Journal of Commerce industrial (smoothed) price commodity index has been steadily rising since December (though it has only gotten back to October levels and remains well below last spring's levels)
VIX is under 35
Monday, May 4, 2009
Worthwhile Reading - May 4
Falling wage syndrome. Paul Krugman, NYT.
Senior Loan Officer Opinion Survey on Bank Lending Practices. Fed. more tightening of credit policies from banks, though not at the same pace, while demand for loans is down, with the exception of prime mortgages
How will Chrysler bankruptcy affect insolvent banks? Barry Ritholtz, The Big Picture.
Financial Gitmo. Cassandra Does Tokyo.
Reflections on the chronology of the financial crisis. Roger Kubarych, voxeu.
a two-fer:
The crisis, part two; and The culprit, revealed. Sudden Debt.
Monsters, Inc. James Surowiecki, The Financial Page, The New Yorker.
EU says Eurozone jobless to hit postwar record. Yahoo! Finance.
excerpt:
[EU Economy Commissioner Joaquin] Almunia did say quarterly growth is unlikely to emerge until 2010, and that even then both the EU and the euro-zone will likely shrink 0.1 percent over the whole year -- provided the banking sector recovers and world trade turns around.
Wow - predicting two years of contraction even if world trade and the banking sector recover!
You realithe, of courth, thith meanth war. The Epicurean Dealmaker.
Senior Loan Officer Opinion Survey on Bank Lending Practices. Fed. more tightening of credit policies from banks, though not at the same pace, while demand for loans is down, with the exception of prime mortgages
How will Chrysler bankruptcy affect insolvent banks? Barry Ritholtz, The Big Picture.
Financial Gitmo. Cassandra Does Tokyo.
Reflections on the chronology of the financial crisis. Roger Kubarych, voxeu.
a two-fer:
The crisis, part two; and The culprit, revealed. Sudden Debt.
Monsters, Inc. James Surowiecki, The Financial Page, The New Yorker.
EU says Eurozone jobless to hit postwar record. Yahoo! Finance.
excerpt:
[EU Economy Commissioner Joaquin] Almunia did say quarterly growth is unlikely to emerge until 2010, and that even then both the EU and the euro-zone will likely shrink 0.1 percent over the whole year -- provided the banking sector recovers and world trade turns around.
Wow - predicting two years of contraction even if world trade and the banking sector recover!
You realithe, of courth, thith meanth war. The Epicurean Dealmaker.
Sunday, May 3, 2009
3 better than just worthwhile...
From Alan Abelson's latest column in Barron's, Shotgun Wedding, we get "Stephanie Pomboy's acerbic take on corporate profits, the stock market and the economy":
THE INCOMPARABLE STEPHANIE POMBOY, no stranger to this space, week in week out spices her intriguing insights with sprightly irreverence. But she was really in top form in the latest edition of her worthy MacroMavens commentary. So we thought we might pass along some of her bon thoughts and bon mots that enlightened and tickled us.
Under the elegant title "Burping Out Loud," Stephanie stands the conventional wisdom on its head on corporate profits and the stock market. We should warn you that recovery isn't currently a prominent part of her lexicon.
For openers, she doesn't buy the growing conviction that what we've been witnessing is more than a bear-market rally.
And her Exhibit A is the amount of financial pain being priced into the credit markets. She readily grants that spreads have narrowed, but notes that they remain "far, far wider than they were at the 2003 cycle lows."
The complacent reaction among the investment cognoscenti is that the credit markets are wildly oversold. More likely, she sniffs, it has something to do with the fact that "an overwhelming portion of some $8 trillion in mortgage debt (or 80% of the total) is teetering on the edge of, or in some state of, negative equity."
As to the Fed's claim that the equity of homeowners as a group stands at 43%, she points out that what the Fed neglects to tell you is that roughly a third of them have their houses free and clear. Lo and behold, some basic arithmetic reveals that 67% of homeowners with mortgages have equity of less than 15%. That, Stephanie comments drily, suggests the "destruction priced into the credit markets hardly seems out of whack with potential reality."
And while, thanks to "the transfer of toxic assets to taxpayers" and the magic of accounting legerdemain, the scarred financials to some significant extent may be spared further pain, the same, alas, can't be said for the nonfinancial sector. Little recognized, she insists, is how much the extraordinary gains in domestic nonfinancial profits from the low in 2001 to the peak in 2006 -- a stunning rise of 388% -- owed to the housing bubble.
"Who in his right mind," she asks, "would believe that explosion in profits during the housing-bubble stretch a mere coincidence and, therefore, in no way subject to the same inexorable decline?" Since we delight in answering rhetorical questions, we'd reckon not more than 95% of the folks who contend we're in a new bull market.
Absent the powerful stimulus provided by the unprecedented boom in housing, she sees a huge hit still in the offing for nonfinancial corporate profits. A worst-case analysis is that such profits would sink to 2003 levels, a further decline of $450 billion, or 54%. Under a less exacting (and frightening) estimate, using their relationship to GDP, they would return to their pre-bubble percentage of 3.5%, which translates into a drop from here of $340 billion, or 41%.
At the end of the day, earnings, to state the obvious, are what makes the stock market go up -- and down. The prospect that they are in for a fresh drubbing is all the more ominous because it's unexpected. As Stephanie reflects, "bear-market rallies come and go, but what makes this one so noteworthy is just how far removed perception is from reality."
THE INCOMPARABLE STEPHANIE POMBOY, no stranger to this space, week in week out spices her intriguing insights with sprightly irreverence. But she was really in top form in the latest edition of her worthy MacroMavens commentary. So we thought we might pass along some of her bon thoughts and bon mots that enlightened and tickled us.
Under the elegant title "Burping Out Loud," Stephanie stands the conventional wisdom on its head on corporate profits and the stock market. We should warn you that recovery isn't currently a prominent part of her lexicon.
For openers, she doesn't buy the growing conviction that what we've been witnessing is more than a bear-market rally.
And her Exhibit A is the amount of financial pain being priced into the credit markets. She readily grants that spreads have narrowed, but notes that they remain "far, far wider than they were at the 2003 cycle lows."
The complacent reaction among the investment cognoscenti is that the credit markets are wildly oversold. More likely, she sniffs, it has something to do with the fact that "an overwhelming portion of some $8 trillion in mortgage debt (or 80% of the total) is teetering on the edge of, or in some state of, negative equity."
As to the Fed's claim that the equity of homeowners as a group stands at 43%, she points out that what the Fed neglects to tell you is that roughly a third of them have their houses free and clear. Lo and behold, some basic arithmetic reveals that 67% of homeowners with mortgages have equity of less than 15%. That, Stephanie comments drily, suggests the "destruction priced into the credit markets hardly seems out of whack with potential reality."
And while, thanks to "the transfer of toxic assets to taxpayers" and the magic of accounting legerdemain, the scarred financials to some significant extent may be spared further pain, the same, alas, can't be said for the nonfinancial sector. Little recognized, she insists, is how much the extraordinary gains in domestic nonfinancial profits from the low in 2001 to the peak in 2006 -- a stunning rise of 388% -- owed to the housing bubble.
"Who in his right mind," she asks, "would believe that explosion in profits during the housing-bubble stretch a mere coincidence and, therefore, in no way subject to the same inexorable decline?" Since we delight in answering rhetorical questions, we'd reckon not more than 95% of the folks who contend we're in a new bull market.
Absent the powerful stimulus provided by the unprecedented boom in housing, she sees a huge hit still in the offing for nonfinancial corporate profits. A worst-case analysis is that such profits would sink to 2003 levels, a further decline of $450 billion, or 54%. Under a less exacting (and frightening) estimate, using their relationship to GDP, they would return to their pre-bubble percentage of 3.5%, which translates into a drop from here of $340 billion, or 41%.
At the end of the day, earnings, to state the obvious, are what makes the stock market go up -- and down. The prospect that they are in for a fresh drubbing is all the more ominous because it's unexpected. As Stephanie reflects, "bear-market rallies come and go, but what makes this one so noteworthy is just how far removed perception is from reality."
Second, from Jim Welsh of Welsh Money Management, courtesy of Barry Ritholtz's blog, The Big Picture:
Investment letter – April 23, 2009
ECONOMY
Perspective – A way of regarding facts and judging their relative importance.
There are a number of data series that evaluate economic conditions using a diffusion index. A diffusion index will have a value above 50, when a plurality of respondents are positive, and below 50 when a majority are negative. If a diffusion index increases from 35 to 38, it represents a gain of 8.6%, while a rise to 46 from 45 is only a gain of 2.2%. It is natural to think of the larger percentage gain to be more noteworthy. However, the smaller gain is actually more significant, since it will only require a small further improvement, before actual economic growth is achieved. In recent weeks, many economists and market strategists have heralded the end of the recession and the arrival of spring, after spotting a few ‘green shoots’ of improvement. In most cases, the ‘green shoot’ was a modest up tick, from a multi-decade low! For instance, the Conference Board’s Consumer Confidence Index edged up to 26.0 in March, from 25.3 in February, the lowest reading since records began in 1967.
In February, new home sales were up 4.7% to 337,000, and after that robust increase, were only down 75.7% from their July 2005 peak. In the last three years, housing starts have plunged from 1,823,000 to 358,000, or 80.4%. At the February sales rate, it will take 12.2 months to clear the inventory of new homes for sale, versus 5 months in a healthy market. In the past year, the median price of a new home has fallen from $251,000 to $200,900, a drop of 20%. After retail sales collapsed in the fourth quarter, the inventory-to-sales ratio soared from 1.25 to 1.45, or 16%. Companies were forced to cut production drastically in the first quarter, so bloated inventories could be whittled down. Although the ratio dipped to 1.43 in February, production levels will remain low, until the ratio falls further. The large decline in production will contribute to a fairly weak first quarter, and depress second quarter GDP too.
As noted last month, there is a good chance that GDP will post a positive print in the fourth quarter of this year, and maybe in the third quarter. Most of the ‘gain’ will be statistical nonsense, but that won’t deter most economists from getting excited. In the last 2 years, the 80% plunge in housing starts has subtracted about .9% from GDP each quarter. If housing starts stabilize near February’s level in coming months, the .9% hit to GDP will become 0%. If inventories are brought down by the fourth quarter and are in line with sales, the decline of 1% to 2% to GDP from production cuts in the first and second quarter could also improve to 0%. In the fourth quarter last year, personal consumption fell an extraordinary -2.99%, as consumers turned into Grinches.
But consumer spending improved in the first quarter, as government income transfers of $127 billion offset the decline in wages and salaries of $89 billion. In the second quarter, social security recipients will receive a onetime $250 payment in May. Tax refunds are up 11% from last year, and the decline in gasoline prices is also providing a boost to incomes. Consumers will use the extra disposable income to pay down debt, and increase savings and spending. All of these factors should help swing personal consumption to a positive for GDP in coming quarters.
In the second quarter of 2008, GDP grew 2.8%, which is a respectable number. Despite this growth, job losses continued each month, and a self sustaining economic expansion failed to take hold. The most important issue in the next 12 to 15 months is whether the rebound in the second half of 2009 and first half of 2010 will gain enough traction to launch a self sustaining economic recovery. There are many reasons why I remain skeptical.
In the first three months of 2009, more than 2 million jobs were lost, causing the unemployment rate to jump from 7.6% to 8.5%, the highest since November 1983. The unemployment rate increased in March in 46 states, with California, the world’s eighth largest economy, hitting 11.2%, the highest since January 1941.
Underemployment, which combines the unemployed, with involuntary part time workers and discouraged workers, reached 15.6%. As noted in recent months, post World War II recessions have on average caused personal income to fall between 4% and 7%, and this one has further to go. Wages and salaries shrank at a 4% annual rate in the first quarter, and according to Deutsche Bank, payroll-tax withholding receipts collected by the Treasury Department are down 8.2% from a year ago. This suggests that personal income growth will remain weak in coming months, and shave more than $250 billion from total income and future demand. Changes in temporary jobs lead reversals in the overall labor market by 6 to 10 months. In 2007, a continuous decline in temporary jobs and hours worked led me to forecast a decline in jobs in 2008. When non-farm jobs fell in January 2008, most economists were shocked, and the stock market sold off sharply. In March, employers cut 71,700 temporary workers, so any real improvement in job growth is many months away.
Most economists are quick to note that unemployment is a lagging indicator, and they’re right. But the magnitude of the job losses shouldn’t be dismissed so glibly, given the impact they are having on the banking system. The American Bankers Association reported that 3.22% of consumer loans were delinquent at the end of 2008. That is the highest level since the ABA began tracking overall loan delinquency rates in the mid 1970’s. And that was before 2 million jobs were lost in the first quarter.
An average of 5,945 bankruptcy petitions were filed each day in March, up 9% from February and 38% from a year ago. The soaring job losses since last September are certainly behind the increase in bankruptcies.
The surge in job losses are working their way up the income ladder, with an increasing number of middle income and upper middle income workers being affected. This is pushing many of those who previously were considered prime credit risks over the edge. Two-thirds of mortgages in the U.S. are held by the best credit risk, prime borrowers. According to the American Bankers Association, 5.06% of prime borrowers have missed at least one mortgage payment. Since prime borrowers are such a large group, this represents 1.8 million mortgages. Although the delinquency rate for sub prime mortgages is up to 21.9%, it only accounts for 1.2 million mortgages.
In the fourth quarter, a number of states mandated a freeze on foreclosures, and a number of banks, not wanting to be a modern day Mr. Potter during the holidays, voluntarily suspended foreclosures. According to RealtyTrac, foreclosure filings increased to 341,180 in March, up 17% from February, and up 46% from a year ago. After the foreclosure moratorium expired in California, notices of trustee sales, which precede foreclosure sales, climbed more than 80% to 33,178 in March from February. Moody’s Economy.com estimates more than 2.1 million homes will be lost this year, up from 1.7 in 2008.
Existing home sales have declined 33.3% since peaking in September 2005. The median price has dropped 28.7%, after peaking in July 2006 at $230,900. In February, existing homes sales increased 4.4%, and the median home price advanced 2.4%. The ratio of monthly sales to the inventory of homes for sale was 9.5 months, versus 5 months in a healthy market. However, 45% of the sales in February were foreclosures, and that proportion will remain high in coming months. Since foreclosed sales represent forced selling, the persistently high level of foreclosures will continue to push home prices lower. As home prices fall another 5% to 10% or more, more home owners will realize that their mortgage exceeds the value of their home. An increasing number are simply choosing to walk away, since they have nothing to lose.
According to RealtyTrac, job losses result in a home foreclosure 10% to 15% of the time. If job losses narrow from the monthly average of 670,000 in the first quarter to 325,000, almost 3 million more jobs will be lost before year end. That will translate into another 300,000-450,000 foreclosures, and an unemployment rate of almost 11%. But what if that estimate of job losses is too optimistic?
New research by the Federal Reserve and Boston University of credit spreads of 900 non-financial companies from 1990-2008 predicted changes in the economy ‘phenomenally’ well. Based on their initial research on low to medium risk corporate bonds with more than 15 years to maturity, the researchers went back to 1973 and found the analysis still worked well. With the massive widening of corporate bond spreads last fall, the researcher’s model predicts the economy will lose another 7.8 million jobs by the end of 2009, and industrial production will fall another 17%. In the spirit of optimism, let’s assume this ‘phenomenal’ model is off by 35%, due to the extreme nature of this credit crisis. That still results in another 5.1 million lost jobs, and an 11% drop in industrial production. In that scenario, the unemployment rate climbs to near 12.5%, the underemployment rate breaches 20%, and another 500,000-750,000 foreclosures result.
The International Monetary Fund (IMF) now estimates the U.S., European, and Japanese financial sectors face losses of $4.1 trillion. Banks are confronting losses of $2.5 trillion, insurers $300 billion, and other financial institutions $1.3 trillion. To date, the banking sector has written down $1 trillion of expected losses. The IMF estimates that U.S. and European banks need to raise $875 billion in equity by next year to return to pre-crisis levels.Over the last week a number of banks have reported first quarter earnings, which was a pleasant surprise. Citigroup said it made $1.6 billion. One of the ways Citigroup achieved this gain was booking a profit of $2.7 billion on the decline in Citi’s own debt. Say what? Under accounting rules, Citi was allowed to book a one-time gain equivalent to the decline in its bonds because, in theory, it could buy back its debt cheaply and save $2.7 billion over time. Of course, Citi didn’t actually do that. Even though more consumer loans went bad in the first quarter, Citi reduced its loan loss reserve from $3.4 billion in the fourth quarter to $2.1 billion in the first quarter, thereby picking up another $1.3 billion of ‘earnings’. And the recent change in mark to market accounting enabled Citi to book an additional $413 million in ‘profit’ on impaired assets. Without theses one-time adjustments, Citi’s $1.6 billion in first quarter profit becomes a $2.8 billion loss.
According to a Wall Street Journal analysis of Treasury Department data, the 19 banks that received tax payer funds made or refinanced 23% less in new loans in February versus last October. Why lend money when all you’ve got to do is make a few adjustments and make even more money.
Between 2000 and 2008, the major credit card companies increased the number of credit cards issued to small businesses from 5 million to 29 million. During that period, many small business owners increasingly relied on their cards to provide short term financing for their business. Spending on small business credit cards increased from $70.4 billion in 2000, to $296.3 billion, according to the Nilson Report. Over the last 15 months, business bankruptcy filings have risen faster than consumer bankruptcies, with the average charge-off rising to $11,000 from $7,000, according to Equifax, Inc. In response, the card issuers have been aggressively scaling back, and have reduced available credit lines by almost $500 billion. Just another example of how the availability of credit to the economy is evaporating, despite all the Fed’s efforts.
Industrial production fell 1.5% in March, and is down 12.8% from a year ago. Capacity utilization fell to 69.3%, the lowest since records began in 1967. As I discussed in detail in January, excess capacity is a powerful dynamic. Companies are forced to reduce or eliminate budgeted investments in new equipment, compete for every dollar of revenue, even if it means accepting thinner profit margins, and reduce costs through job cuts. The amount of excess capacity that has been created by the depth of this economic contraction is unprecedented. What most inflation bugs and investors fail to understand is how long it will take to work off the current over hang of excess capacity. If the output gap grows from the current 7% to 10% next year, Goldman Sachs estimates it could be 2015 before all the excess capacity is used up, and that’s if GDP grows 4.75% per year! Ironically, one of the reasons the economy is not likely to grow that fast is that business investment will be weaker than in prior business cycles. With so much excess capacity, businesses won’t need to materially increase business investment for the next 2 or 3 years.
The economy needs to create 125,000 jobs each month, just to absorb the number of new entrants into the labor market. If job growth were to average 325,000 per month in coming years, it would still take four years to replace all the jobs lost in this recession. With so much excess labor capacity, wage growth will be weak for the next few years, which will make it harder for consumers to increase savings and spending. The combination of less credit availability, weaker business investment and consumer spending will be headwinds whenever the economy emerges from this recession.
The Untied States is mired in the deepest cyclical contraction since at least World War II, and arguably the depression. Falling home prices led us into this crisis, and home prices are still falling. The financial crisis in 2008 has become the economic crisis in 2009, as more than 2 million jobs were lost in just the first quarter, with another 3 to 5 million likely before year end. With the unemployment rate headed over 10%, and maybe up to 12% next year, the default rate on every type of consumer credit – (prime mortgages, Alt-A mortgages, Option Arm mortgages, sub-prime mortgages, home equity lines, credit cards, auto loans, student loans) – is headed much higher. Commercial real estate values are plunging, and corporate default rates are set to soar. Although every bank will ‘pass’ the government’s stress test, some banks will fail the real world stress test, and need billions more in capital. Sooner or later, the Treasury Department will likely have to go hat in hand asking for more money from Congress for some of the banks. For the first time since World War II, the global economy will contract in 2009, so there aren’t many places to hide. Although it is welcome to see a few ‘green shoots’, in this case, those green shoots are unlikely to yield a bountiful harvest in 2010.
In addition to the daunting cyclical problems challenging the economy, there are a number of significant secular issues I’ve discussed before that will make it even more difficult for a self sustaining recovery to develop in 2010. Between 1982 and 2007, the amount of Total debt grew from $1.60 to $3.53 for each $1.00 of GDP. This was made possible as the cost of money fell from 15% to 20% in 1982 to the generational lows of the last few years. As interest rates fell, consumers were able to take on more debt, without their monthly payments increasing very much.
Household debt has increased from $.44 in 1982 to $.98 for each dollar of GDP in 2007. However, there is no more relief coming from lower rates, so consumers are going to have to pay for their debt from income. From the mid 1990’s until 2007, most consumers had the luxury of believing that their homes and 401Ks would provide most of what they would need for their retirement. The saving rate fell from over 8% 15 years ago to near 0% in 2007. The last 18 months has convinced them they need to increase their savings. The saving rate has rebounded to near 4% in the last six months, which is one reason why the economy has been so weak. As debt levels increased over the last 25 years, GDP was boosted as consumer’s bought cars, bigger homes, second homes, went on nice vacations, and basically lived the good life. However, since 1966, each dollar of additional debt has given the economy less of a boost. In 1966, $1 dollar of debt boosted GDP by $.93. But by 2007, $1 dollar of debt lifted GDP by less than $.20.
The message from these facts is fairly clear. Debt levels are high, and any increase in interest rates will impose a bigger burden on the economy and quickly stunt growth. Consumer debt is already so high and interest rates are so low that it will be difficult for consumers to add debt. This means economic growth will be far weaker than the debt induced growth of the last 25 years. As consumers increase their savings, GDP will be lowered by .70% for each 1% consumers increase their saving, since consumer spending represents almost 70% of GDP. In addition, the banking system remains crippled. Lending standards are high and are not coming down with the economy remaining weak. The need for additional capital will lower future lending by several trillion dollars, as banks work to repair their balance sheets and lower their leverage ratios from 30 to the low teens. The securitization markets provide more credit than the banking system, but they remain on life support. Credit availability will remain constrained well into 2010, which represents a headwind than will mute some of the lift from fiscal stimulus.
The diminishing boost given to GDP from each additional $1.00 of debt since 1966 strongly suggests that adding more debt will not return the economy to prosperity. I am reminded of a movie from the 1950’s, ‘The High and the Mighty’. It starred John Wayne and Robert Stack and was about an airline flight from Honolulu to San Francisco. During the flight, one of the engines fails, but they are past the point of no return, so they must try to make it to San Francisco. Over the last 60 years, the United States has used a combination of fiscal stimulus and monetary policy to soften each recession and spur the subsequent recovery, with a fair amount of apparent success. From 1982 until 2007, the U.S. only experienced two shallow recessions that each lasted just 8 months. This stretch of 25 years may be the best 25 years in our economic history. But much of this prosperity was bought with debt, as the ratio of debt to GDP rose from $1.60 to $3.50 for each $1.00 of GDP. Sometime in the last 25 years, we passed the point of no return. Unfortunately, Hollywood won’t get to write the script on how this ends.
STOCKS
The stock market has been rallying because investors believe there will be a recovery in the economy before the end of 2009. This leads them to ignore any bad news now, since better news is just around the corner. If I’m right, there will be GDP growth by the fourth quarter, if not in the third quarter. This suggests that the market can make further upside progress in coming months. The market fell for 17 months, between October 2007 and March 2009. This suggests the market should work its way higher for at least 5 months or so, maybe longer. My expectation has been that this rally should take the form of an up phase, a pullback, and then another up phase. As noted last month, I didn’t expect the initial rally phase to exceed 878 on the S&P. So far, the high has been 875.63. I also expected the S&P to pullback to 760-780, which it did for literally a few minutes on March 30.
Although I think the S&P will exceed 878 in coming months, the economic fundamentals are far worse than most investors realize. Of course, this has been the case since this crisis began in August 2007. From an investment point of view it means this is no time to let one’s guard down. If you buy something, use stops. If I’m right, and the rebound in the economy does not launch a self sustaining recovery, there is a moment of realization coming for most investors. That’s what happened after the market rallied in April and May of last year in anticipation of a second rebound in the economy. When it failed to show up, the market reversed lower, after peaking in late May. Markets experience their largest moves when expectations are not met.
The S&P reached 845.61 on April 2 and closed at 843.55 on April 22. It’s been 3 weeks, and the market hasn’t made much progress, but it hasn’t given any ground either. Investor’s willingness to buy each dip has been in over drive, so each attempt at a sell off has lasted no more than 2 days. That’s impressive, even if it’s reflective of a herd mentality driven by misplaced optimism. The choppiness of the past 3 weeks is likely to continue, as sideline money uses any dip to buy. Eventually, the S&P should drop below 800, but hold above 760. Investors can buy in this range, using a decline below 740 as a stop. Conversely, investors can buy, if the S&P climbs above 872, using a decline below 825 as a stop. If the S&P closes above 878, a quick rally to 940 should follow. The high yield bond funds recommended last month (FAGIX, NNHIX, VAGIX) are up 4% to 6%. Use a trailing 1.5% stop.
BONDS
In a very real sense, the decision by the Federal Reserve to buy longer term Treasury bonds means this market will remain distorted for an extended period. My guess is that the Fed will intervene if and when the 10-year Treasury yield approaches 3.1%. But bonds will also be supported by weak economic data, and the lack of inflation.
DOLLAR
Since the bottoming last July, the Dollar cash index has made a series of higher lows and higher highs. That is the definition of an up trend. After making a new recovery high in early March, the pullback in the Dollar was given a shove, when the Federal Reserve announced its decision to employ quantitative easing on March 18. The Dollar then rebounded an almost perfect .618% of its 6.99 point decline to 86.94 on April 20. Since the rebound looks ‘corrective’, it implies that the dollar will fall to at least 82.50. As long as it holds above 80.30, the longer term trend is still up.
GOLD
Over time inflation has been defined as too much money chasing too few goods. Our problem now is that there is too little money chasing too many goods everywhere in the world, and that dynamic isn’t likely to change anytime soon. The Federal Reserve has committed to quantitative easing and many investors have assumed the expansion of the Fed’s balance sheet from $900 billion to almost $3.5 trillion has to be inflationary. But the massive levels of excess capacity throughout the global economy are going to keep a lid on price increases and wages for a long time. Japan is the second largest economy in the world, and their experience with quantitative easing for more than a decade has not led to inflation, as they are still battling deflation. And, if the U.S. stock market has another leg up in its bear market rally, gold will lose some of its financial instability luster.
I still think gold has the potential to drop below $700 in coming months. Investors can short Gold in a number of ways, depending on risk tolerances. The most conservative way would be to short GLD, which is the ETF tied to gold, or by buying DZZ, which is the 2 to 1 short gold ETF, or by shorting Gold futures, which is the most aggressive. Irrespective of the route, use a print of $1004.50 on June Gold as a stop. Short GLD above $94.00, buy DZZ below $20.70, and short Gold above $960.00.
E. James Welsh
And, last but not least, Willem Buiter's post at his FT blog, Maverecon, entitled Green shoots, grounds for cautious pessimism:
I am not going to use this opportunity to deepen the gloom by exploring at length the possible consequences of a worldwide pandemic of a virulent form of swine flu. Just a few depressing words will have to suffice. From an economic perspective, a flu pandemic amounts to at least a temporary reduction in the effective supply of labour. If flu-related mortality is high, there will be a permanent reduction in labour supply. The dependency ratio rises (temporarily or permanently, depending on whether mortality increases). Trade and travel are interrupted. A flu pandemic therefore represents an adverse supply shock. Notional consumption demand need not decline materially, but effective consumption demand may well be depressed if many would-be shoppers cannot reach the sellers of goods and services or arrange for delivery. Investment is bound to suffer.
A flu pandemic therefore also represents an adverse shock to aggregate demand. It is bad news on both the demand and supply side. It will however, impact favourably on global warming. Now you know. In what follows I will analyse global economic prospects on the assumption that there will not be a global swine flu pandemic.
The real economy downturn in the US is about 1½ years old; the UK recession has been with us for at least three quarters; the rest of Europe, Japan and most emerging markets and developing countries have juvenile recessions, barely a couple of quarters old.
As regards the overdeveloped world, or at least the North Atlantic part of it, the odds are that this contraction of real economic activity will be deeper and last longer than other post-war recessions. The reason is that other post-war recessions were either the results of central banks murdering a boom that threatened price stability or of an exogenous oil price increase (Opec I and II). Following both types of downturns, the financial system (markets, banks and other systemically important institutions) were, on balance, in good shape (cyclically adjusted!). Banks suffered as a result of the decline in demand for external financing by households and non-financial enterprises caused by the recession, and from the increase in arrears, defaults and other delinquencies that come with an economy-wide slowdown. But the capacity of the system for providing intermediation services and external financing for households and non-financial enterprises was typically in reasonable shape.
Not so today. The crossborder North-Atlantic financial system had collapsed before the downturn in the real economy got going in earnest. Indeed, the financial collapse was the primary cause of the recession in the USA, the UK, Iceland and most of the rest of Western Europe. We know from the studies of Reinhart and Rogoff and of Laeven and Valencia that real economy contractions that follow a financial crisis tend to be both longer and deeper than those that don’t. Specifically, following deep financial crises, the unemployment rate rises an average of 7 percentage points over the down phase of cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, and the duration of the GDP downturn averages around 2 years.
US real GDP growth was -0.2 percent in 2007, Q4 (on the previous quarter), but became positive again the next two quarters (0.9 percent growth in 2008Q1 and 2.8 percent in 2008 Q2). Since then, growth has been negative, with -0.5 percent in 2008Q3 and -6.3% in 2008Q4. The Reinhart-Rogoff downturns are measured from previous peak GDP, which was 2008Q2. If the US conforms to the average of the post-World War II serious financial crisis countries studied by Reinhart and Rogoff, negative GDP growth would persist until 2010Q2. Growth after that would be slow and hesitant. The 2008Q2 level of GDP would be regained at the earliest around the middle of 2012. Unemployment would still be far above the 2008Q2 level at that time.
There is little reason to assume the US will do better than the average achieved post-world war II. Its room for discretionary fiscal stimuli has been more than exhausted. Almost two years have been wasted since the beginning of the financial crisis as regards getting past toxic assets off the balance sheets of the banks. The US regulators and Treasury have put the interests of the unsecured creditors of the banking system ahead of those of current and future tax payers and beneficiaries of public spending. Worse than that, by failing to come up with the required amount of up-front fiscal resources to clean the balance sheets of the zombie banks, recapitalise the banks and, where necessary, guarantee new lending and borrowing, the US authorities have relegated most of the banking system to a state of limbo in which far too little new lending to the real economy is undertaken. The sloth-like speed of the stress tests and the six months grace period granted banks deemed short of capital to come up with new capital on their own, contribute further to my sense that the authorities in the US are doing everything they can to make sure that the US gets as close as possible to emulating Japan’s lost decade.
Bank profitability
What limited bank lending takes place is often at high interest rates, and is funded at government-subsidised rates (about $340bn worth of borrowing by banks has so far been guaranteed by the state). These tax-payer-engineered high spreads on limited new lending, plus the welcome transfusion of taxpayers’ money through AIG paying off its counterparties at 100 cents on the dollar gave a useful boost to many banks’ Q1 profits. Add to that the under-provisioning by many banks for new loan losses, plus the new latitude granted by the FASB to banks wishing to window-dress the depressed mark-to-market value of some of their securities, plus the wonderful accounting convention that permits banks to count as revenue reductions in the market value of their traded debt caused by a loss of market confidence in their creditworthiness, and the banking profitability green shoot is visibly wilting on the vine.
Disguising the new damage done to the banks’ loan book by the contraction of the real economy will become harder as time passes. By the end of the year, I expect that the combination of the stress tests and the reluctant revelation of new bad loans may bring us to the point that even the authorities can no longer shrink from restructuring the insolvent components of the banking system by forcing the unsecured creditors to swap their debt and other claims for equity. Only then can the banking system as a whole begin to function normally again - one hopes under very different rules of the regulatory game.
The inventory cycle
The inventory cycle is short and sharp. Statistically, inventory accumulation and decumulation often account for more than 100 percent of the business cycle. This is unlikely to be the case in the current cycle. Final demand (private consumption, private fixed investment, exports and government spending on goods and services) is contributing to the downturn and will have to turn around to achieve a sustained recovery.
With financial intermediation in tatters, external finance for would-be financial deficit units, households or firms, will be hard to find and expensive. Most households have suffered massive losses of financial wealth and will want to restore their financial health by saving more. Other final demand components are also unlikely to become buoyant in a sustained manner anytime soon. Private fixed investment is likely to be week for the next couple of years because of prevailing excess capacity and limited availability and high cost of external funds. US export growth inn unlikely to be a major source of demand.
Government spending will grow quite rapidly, but the dire fiscal condition of the Federal government effectively precludes further discretionary expansionary fiscal measures. Federal government deficits significantly larger than those envisaged here would unnerve the financial markets and trigger a buyers’ strike in the US Treasury debt markets, either because of a fear of default (quite unlikely) or because of a fear of large-scale irreversible future monetisation and inflation (quite likely). I know it’s not priced in the long-term US government bond yields yet, but this would not be the first time financial markets have been wildly irrational in recent years - so just you wait.
Asset price stabilisation
House prices continue to fall. While house price changes don’t have an aggregate wealth effect, they do affect the capacity of households to borrow, because property, unlike human capital, makes rather good collateral. Until house prices stabilise, it is hard to see consumption reviving. Even with the recent (in my view premature) recovery in the US equity markets, stock market wealth in the US has come down spectacularly from its previous peak, and is now, in real terms, at about its 1996/1997 level. Talk of a lost decade…
Europe
In Europe, the UK is in many ways the US with a half-year lag. The size of its banking sector relative to the economy and to the fiscal capacity of the government and the absence of global reserve currency status for sterling makes the UK more vulnerable than the US to a triple crisis - banking, exchange rate and sovereign debt. The ability of the UK authorities to raise future taxes or slash public spending is, however, likely to be greater than that of the US, whose political system is polarised to the point of paralysis. The US, like the UK, is therefore at risk of a ‘sudden stop’ (an unwillingness of anyone to fund the sovereign and an unwillingness of the rest of the world to fund either the private or public sectors of the US), as long as US political infantilism, especially in the US Congress, guarantees a veto for any sensible (or even just arithmetically feasible) proposal for solving the scary fiscal unsustainability problem of the US.
The rest of Western Europe is dead in the water. The ECB is paralysed, partly by fear of the zero lower bound on interest rates among some of its Governing Council, partly because of the absence of a ‘fiscal Europe’, capable of recapitalising the ECB/Eurosystem should it suffer a serious capital loss as a result of private sector credit exposure incurred as a result of its monetary, liquidity enhancing and credit enhancing operations. Countries that have fiscal credibility and could do more as regards Keynesian fiscal stimuli, like Germany and France, refuse to do so. The recession in Western Europe started about a year after that in the US. It will last at least as much longer. The banking system of Western Europe (ex-UK) has been even more reluctant than that of the US and the UK in owning up to the disastrous state of its balance sheet. At least €500bn additional capital will be required to keep the continental West-European banking system on its feet. More will be required if it is to actually start lending in earnest again.
Japan
I don’t understand the Japanese economy. Never have. Probably never will. Will they be a locomotive for the rest of the world? Everything’s possible but not everything’s likely.
Japan’s public debt to GDP ratio is 180% of GDP and rising. Yet even long-term rates on nominal public debt remain very low. The main reason is, I believe, that while the Japanese state runs a massive financial deficit, the Japanese private sector runs an even more massive financial surplus. The consolidated financial position of the country has been one of persistent current account surpluses. Private financial wealth is huge and the net international investment position of the country is a large positive number. (Italy has a milder version of the same configuration of private and public saving and borrowing propensities).
So if the markets believe that the Japanese political system is and will be capable of achieving, sooner or later, the large resource transfer from the private sector to the public sector that is required to make the public finances sustainable, the overall financial position (flows and stocks) of the country is what matters. And these consolidated national flows and stocks still look pretty good. This in contrast to the US and the UK, where looming fiscal deficits combine with low private saving propensities to create enduring doubt about fiscal sustainability. As regards Italy, I am less than fully confident that the Italian tax payer/beneficiary of public spending will do as (s)he is told by the nation’s fiscal authorities, now or in the future.
Emerging markets
The prospects of the emerging markets depend, first, on their dependence on external demand, second, on their dependence on external finance and, third, on the scope for expansionary domestic demand management and the ability of the authorities to use it intelligently and flexibly.
No emerging markets suffered the destruction of their banking systems prior to going into recession. Their contractions are the result of the external transmission of the north-Atlantic financial crisis and contraction, through trade linkages, through deteriorating terms of trade (especially for commodity producers), through falling remittances, through the financial markets and through the parent banks of foreign-owned local subsidiaries and branches restricting the availability of re-financing and new funding to their local subsidiaries and branches.
The emerging markets that are best poised to enjoy a speedy recovery (following a V-shaped recession) are those that do not depend excessively on external finance and on external demand.
China certainly fits the bill as regards lack of dependence on external finance. Like many other emerging markets that suffered through the Asian and Russian crises of 1997-1998 or observed it closely, China self-insured against an interruption of external financing flows by building up massive liquid foreign exchange reserves. Chinese reserves today even exceed those of Japan. India, Brazil, Korea, Malaysia, Singapore and Taiwan also built up large foreign exchange reserves.
China does not fit the bill, however, as a candidate for a sustained early recovery because of its external trade dependency. Growth in demand for its exports will not revive anytime soon. The country is not large enough to pull itself up by its own boot straps, unless it achieves a radical restructuring of its production and a shift in the composition of final demand away from exports and towards domestic final demand.
China recognises this and has thrown the kitchen sink at the problem. Although it is hard to understand the exact size of the fiscal stimulus it has provided, there is no doubt that this stimulus was large. Interest rates have been cut. Credit growth, including bank lending to state enterprises and to construction has exploded. The problem with this approach is that the composition of the demand stimulus and production boost is completely wrong. The government has simply done more of whatever it was doing in the past: increased investment in the production of exportable goods and heavy industry (metals and chemicals), increased production of semi-finished manufactured goods and increased investment in infrastructure. The inevitable result of this investment boom will be increased excess capacity in exportables and unprecedented environmental destruction.
China is missing a huge opportunity. Its short-run imperative (boost demand through a fiscal stimulus) coincide with its long-run imperative (reduce the national saving rate and the external current account surplus). This stands in sharp contrast to the US and the UK, where the short-run imperative (boost demand through a fiscal stimulus) conflicts 180 degrees with its long-run imperative (save more and reduce the external current account deficit). China saves too much in the household sector, the corporate sector (especially the state enterprises) and the public sector. It badly needs an unfunded pay-as-you go social security retirement scheme to boost consumption by the old. China’s fiscal position is such that the country could introduce the benefit (pension) part of the social security scheme for a number of years without having the social security tax in place!
China’s rapidly greying population and the one-child policy mean that, without a credible, universal, publicly funded social security retirement scheme, it is individually rational to save like crazy, because neither the state nor your children will be able to look after you in old age.
Another way to boost public consumption (and reduce household saving), is to guarantee decent quality medical care for all regardless of ability to pay. Saving to pay for private tuition for one’s (only) child is another important driver of private saving in China. Providing better quality public education could free private resources for consumption.
But a boost to consumption demand (private and public) of this nature requires a matching change in the structure of production towards consumer goods and services and away from heavy industry. China hasn’t even begun to address this shift of demand towards non-traded goods and imports and of production towards consumer goods and services. Even if its ultra-old-school demand stimulus does not get killed (yet) by environmental constraints (clean fresh water, clean air, clean soil etc.), it will certainly be killed by mismatch constraints as the country adds massively to its capacity to supply goods nobody wants.
The green shoots we may be seeing in China will therefore not endure unless the country manages, very rapidly, a radical change in the composition of its production and consumption. That is possible, but not likely.
A country like India - much less dependent than China on external demand but rather more dependent on external finance - could also recover rather soon, and in a more sustainable way, especially if it finds a way to further stimulate domestic saving. But its weight in the world economy is slight - not enough to be a locomotive, not even the little engine that could.
Other emerging markets, like Brazil, have been hit hard by the global downturn and by the freezing up of key financial markets despite being net foreign creditors and running external surpluses prior to the crisis. Brazilian corporates were heavily exposed to the international financial markets, often at short maturities. While the central bank, thanks to its large foreign exchange reserves, was capable of preventing large-scale defaults, the financial squeeze on Brazil’s corporations, plus the terms of trade shock and the decline in export demand has caused the country’s industrial production to fall off a cliff. One would expect it to be able to recover sooner than the US or Western Europe, if it can direct demand towards domestic sources.
Eastern Europe (including the CIS) is the most dramatic victim of the made-in-Wall-Street/City-of-London/Zurich crisis. Virtually all countries in the region were heavily dependent on external financing and on foreign trade. Some, especially in the CIS, are major commodity exporters. Western banks are often the parent banks of the local branches and subsidiaries. As the barbarians threatened Rome, headquarters withdrew the Legions from the provinces. Parent banks are ruthlessly cutting the access to funds of their subsidiaries and branches in CEE. No help will come anytime soon, with the members of the old EU barely capable of keeping their own trousers up.
Conclusion
The only reasonably convincing evidence of ‘green shoots’ comes from China. That, however, is unlikely to be sustainable, as it is very much the result of a ‘same-as-it-ever-was’ package of fiscal, monetary and credit policy measures by the Chinese authorities. The export- and heavy-industry led expansion they have successfully engineered is the way of the past. It will go nowhere, unless China transforms the composition of both production and demand in the directions that are unavoidable (and also desirable) for a country at its level of economic development. Apart from China, the only green shoots I have seen were in the salad bar of the hotel I am staying at.
Subscribe to:
Posts (Atom)