This indeed is becoming a crisis of confidence with 62% of the people saying the country is on the wrong course with a majority opposed to the strip mining of our medical system in the name of reform. Most fear further reform, increased taxes and sweeping changes in the nation’s economic landscape.
What is conspicuously missing from public discussion of the economy is the miserable and divided political backdrop against which the economy is functioning and reported to be recovering. As long as households and business view the administration as bent on destroying traditional values and lifestyles and fiscal policy as a predatory tool to channel resources to special interests, confidence will remain low and spending constrained; politics and economics are inextricably linked.
What Krugman and others fail to grasp is that most people loath the dystopian ideals embraced by the current administration and a $trillion here or there will not change this mindset and produce a durable economic recovery built upon faith in the future. And beyond this huge disconncet there remain structural issues as noted by an unnamed author at the Von Mises Institute.
The current economic disaster is the result of the combination of negligence, hubris, and wrong economic theory. For decades, an economic and monetary policy has been practiced based on the illusion of, "It doesn't matter." At first it was, "Deficits don't matter." From that, the policy of "it doesn't matter" got extended to money creation, the credit expansion, the stock-market bubble, and the housing boom. Now, we're being told that buying financial junk by the central bank to beef up banks and brokerages also doesn't matter.
The current financial crisis is not of a cyclical nature. The financial turmoil is the symptom of the structural imbalances in the real economy. Over decades, expansive monetary policy has gone hand in hand with implicit and explicit bailout guarantees, and this has distorted the process of capital allocation. Under such perverted conditions, those investors will win most who cast away the restraints of prudence. It is a game that can go on for a long time — up to the point when the irrationality has become systemic.
The simple fact is that the US economy is burdened with a highly lopsided capital structure as the consequence of a wide discrepancy between consumption and production, which, in turn, is the result of monetary policy. Persistent trade imbalances are the symptoms of this discrepancy. This means for the US economy that lower interest rates and government incentives aimed at boosting consumption work as pure poison. Instead of more consumption, more savings, less consumption and fewer imports are needed.
The current financial crisis reflects that many debtors have reached their debt limit and that creditors are lowering that limit. From now on, business and consumers, governments and investors must work under the restraints of lowered debt ceilings.
PIMCO's Bill Gross Sees a Bleak Future [View article]
While somewhat troubling, I happen to share his view as it seems most consistent with the facts.
I f you take PIMCO's view and compare it CBO forecasts, it is immediately apparent that the CBO is not buying into the new normal or simply ignoring it; they are forecasting nominal growth of 4.5% a year through 2015.
If PIMCO ir right, which I believe they are, and CBO wrong, it has enormous implications for the budget deficit.........which will only get worse. And this will spill over into tax policy, another piece of the new normal.
With the most optimistic forecasts and creative accounting, the administration is being challenged to balance the budget; Obama and the administration will be forced to raise taxes to balance the budget and will be forced to increase them further to fund healthcare reform.
Obama wants to raise income taxes for high earners, impose new levies on business and tax greenhouse emissions, but those moves would not generate enough cash to cover the cost of health care, much less balance the budget, and they have not been fully embraced by Congress. Lawmakers are considering other ways to pay for health reform, including new taxes on sugary soda, alcohol and employer-provided health insurance.
The latest revenue generating idea is the Value Added Tax, a tax imposed upon the profit generated at every level of manufacturing. Effectively it is a national sales tax cooked into the price of a finished product as opposed to 10% slapped on at the register.
Taken together all of these taxes, assuming they pass through Congress, will drain the live out of what was once a robust and vibrant economy. This will come to characterize our new normal, something the Europeans have been dealing with for some time inside their sluggish and sclerotic economies.
Due for a Correction? Market Is Already Priced for Grim Future [View article]
From David Rosenberg:
As we said before, the S&P 500 is priced for 4.0% real economic growth in the coming year. It is far from impossible to see that, but the odds are low — less than 20% in our view. An unprecedented eight point P/E multiple expansion during a five month faith-based rally has left the market at its most expensive level (25x on operating, 130x on reported) in seven years. On a reported basis, this market is nearly three times overvalued as it was during the tech bubble!
At the lows in the equity market last March, the S&P 500 was de facto pricing in -2.5% real GDP and $50 of operating earnings for the year. Guess what? Far from being grossly undervalued at the lows (though some stocks were — especially the financials, which were priced for bankruptcy) the market at the lows was fairly priced on a price-to-book and price-to-earnings basis. Usually at bear market lows, the S&P 500 goes to silly cheap levels. It never did this time around, and five months and 50% later, there is yet again, in 2007-style, tremendous risk in this market. Never before has the stock market surged this far, this fast, between the time of the low and the time the recession (supposedly) ended. What is “normal” is that the rally-ahead-of-the-rec... is 20%. This market is now trading as if we are in the second half of a recovery phase and yet it is not even been fully ascertained that the downturn is over — a one-quarter spurt in automotive production and sales induced by Cash-for-Clunkers is not enough to support the widespread assertion that the recession is behind us (the odds of a fourth quarter relapse, especially in the U.S. consumer, are non-trivial).
I am fairly confident China will become an economic super power, making me bullish on the long-term prospects for China. That said, it must be acknowledged that China faces challenges to growth, even with a population of over 1.3 billion people.
At the root of everything lies the question of whether the country's political structure is conducive to sustained growth. In the west, the classic pattern of development has been for economic change to stimulate demands for political reform and greater democracy. Fear of political change could hold China back; the top-down fiscal package exacerbated the fundamental weakness of the economy in expanding the role of state owned enterprises. The stimulus has rewarded many state owned enterprises and over the long run the role of SOE’s must be reduced while giving wider berth to small, privately held companies which will be more responsive to market changes and better incentivized to innovate.
The most immediate challenge is for China is to move from an export driven economy to a more balanced model in which domestic consumption plays a larger role that it does today. Relative lack of healthcare and the cost of a decent education mean that families save far more heavily than in the west, leaving them with less money left over at the end of the month to spend. China must extend upon its rudimentary social safety net and expand educations, pensions and health care
The very large demographic issue confronting China is interesting and unusual in that it is experiencing the problems of both a developing and developed country; high economic growth along with an aging population. Experts worry that China will become old before it becomes rich; Richard Jackson and Neil Howe wrote a report about demographic trends and they calculated that in 2004, the elderly—here defined as adults aged 60 and over—make up just 11 percent of the population. And by 2040, however, the United Nations projects that the share will rise to 28 percent, a larger elder share than it projects for the United States.
“In absolute numbers, the magnitude of China’s coming age wave is staggering. By 2040, assuming current demographic trends continue, there will be 397 million Chinese elderly people, which is more than the total current population of France, Germany, Italy, Japan, and the United Kingdom combined.” And Andy Xie is concerned that current demographic trends could worsen as a result of the property bubble with higher housing prices forcing many young couples to have fewer children. It is unclear how will address this issue but it is clear the government is worried about the cost of a western European-style welfare state.
Other challenges include the gap between living standards in the cities and in the countryside; the comparison between the wealth of the coastal strip and the poverty of the inland regions; the mismatch between the country's projected growth rate and its energy needs; and the need to improve the structure and regulation of its capital markets. In the longer term, Beijing has to decide how to use China's growing economic clout on the world stage and chart a course for developing its capital markets, including expanding the role of the Renminbi in global currency.
Rally to End Soon, Says Morgan Stanley [View article]
I suffer from mild bouts of insomnia and when I do, as now, my thinking is less than keen and my writing less than clear. For that reason I will simply share insights provided by my economic muse, David Rosenberg:
The market is now overvalued by over 25% but is also extremely overbought having gone 24 sessions without a decline of 1% or more, and 89% of the stocks in the S&P 500 are now trading above their 50-day moving averages (see page M3 of Barron’s). The Dow has advanced in 17 of the past 21 days. I mean, even if you are bullish on the outlook, one would have to admit that such a parabolic move is vulnerable to at least a modest pullback… or more. I know what a broken record sounds like and this has been a confounding and confusing market — for both the bears and many (though not all) of the bulls.
Looking at the fund flows, there is only one conclusion that can be reached: This market is being driven by pig farmers. Retail inflows may have picked up of late, but only fractionally. The focus on the part of the individual investor remains on the fixed-income market, for better or for worse (better from our standpoint, worse from the standpoint of my friend and fellow debater Jim Grant).
Institutional portfolio manager cash ratios are back to the rock bottom levels of around 3½% — where they were back at the market peak in October 2007. The shorts have all but been covered. Foreign investors have been few and far between, based on the latest TICS data. The lack of volume speaks volumes — there are no sellers. Investors of all types have been content to just sit and watch their equity position expand via the price appreciation, but there is scant evidence of any follow-through this year in terms of volume buying.
So, that leaves me with a suspicion that the entities doing the buying are the pig farmers. Who are they pray tell? They are the prop desks at the five large banks. They buy and sell securities, with leverage … to each other! And, these transactions often occur late in the day or in the futures pit after the market closes. There is no sign of any other buyer out there, including the Fed who has been too busy choking on mortgage backed securities and Maiden Lane assets. To repeat, that is why the volumes have been so low.
What we should be aware of about the pig farmers is that they could, at any time, flick the switch in the other direction. What the “trapped longs” may be forced to do — the ones that have been sitting on their hands and have been waiting for the bear market rally to take their portfolio back to where it was at the peaks — at that point is start to sell. That is when the volume picks up … and accelerates the downside pressure.
1) The administration continually warns the world how fragile the recovery is.
2) Reportedly, the Fed is debating resumption of QE on a massive scale.
3) Consumer confidence is edging up but is at levels normally endured during recessions.
4) First quarter growth was down to 2.7% with 70% of the growth coming from rebuilding of inventories.
5) Stimulus will wane in the second half.
6) Based upon April and May personal consumption expenditures, spending is set to increase at annual rate of 1.2%.
7) Credit is contracting.
8) The roof is falling in on new home sales which fell 33% in the last reporting period.
9) High frquency leading economic indicators are nosing over. From Prag Cap: “The 13-week annualized rate of the WLI is now at -23.46%, something that usually only happens in, or prior to, recessions. This is very ominous economic momentum. I haven’t seen anyone look at it this way, I suppose because the ECRI publishes their own smoothed growth rate.” It's happened five other times and in each case the economy either went into recession (1) or was in recession (4)
10) The political landscape is not one that inspires confidence with most Americans saying the nation is on the wrong track. Concerns abound among businesses and consumers that the current administration will strip mine the nations wealth and channel it to special interests. The administration is seen as being hostile to business, except the favored banking cartel.
11) For the most part, the same players are in place that brought us to the edge of financial ruin and it may be unreasonable to think that those incapable of avoiding the great recession possess the talent essential navigating out of the great recession.
I make a habit of being as respectful as possible on this board and others but this article taxes my restraint.
And while there may be an Obama bounce, though that is not certain as many earnings will be released next week, the structural aspects of this decline are worsening as they surface.
Declining estimates of economic growth, rising foreclosures, collapsing industrial production, growing estimates of what is needed in the stimulus package, rising estimates of banking sector losses and growing unemployment are simply the first things that come to mind.
If we face deflation and the corrective actions are not equal to the task, we are some ways off from the streets of Barcelona where the bulls run.
The Coming Consequences of Banking Fraud [View article]
If we look back at recent economic history and look for bubbles that have imploded, we quickly come upon the S&L crisis, the commercial property bubble (Japan), the emerging market bubble (we helped fuel it), the dot.com bubble and most recently the housing crisis.
In each case, successive bubbles were fostered through irresponsibly loose monetary policy that distorts normal market signals, encouraging speculation and consumption. And in each case the bubbles collapsed through tightening of credit to address imbalances and speculative excesses but well after the fact.
The Japanese experience is eerily similar to our recent crisis as that it was brought on by a high rate of domestic savings (we had China) easy money, loose oversight, an influential cartel and lax underwrting standards. Their response was to raise interest rates and then lower them when the scope of damage became apparent; the stock market cratered as did commercial and residential real estate prices.
The Japanese economy stagnated for the next decade and for a variety of reasons, including demographics and aging population, it is only a shadow of its former self. Most of this is a result of a farrago of poor policy responses to the crisis and a stubborn unwillingness to force the zombie banks to writedown indisputably bad assets.
Despite our unwillingness to force the banks to writedown bad assets, the unprecedented scale and scope (global) of current monetary and fiscal policy clearly has the potential to create the next bubble and I believe it will. Understanding that the effects of our monetary policy is not restricted to our shores, the massive injections of liquidity do not have to remain within the US and will trickle towards the next puddle of speculative excess.
If I am correct in where I think it will be.....and its just speculation on my part though alarm bells have already been heard.....it will be a big one. But that's part of the process; each bubble gets bigger, each inflicts ever more damage and each new bubble requires ever greater amounts of liquidity.
Sovereign Default: Stuck Between Dire and Disastrous [View article]
Astonishingly, there is a fifth option that has received scant attention and goes to the core of the problem by reducing the size, reach and cost of the public sector which is the core, underlying problem within Greece’s economy. This option could be mixed with other options to produce a workable solution. Material from the FT:
"Much could be gained from further privatising an economy that is probably the last “Soviet-style” economy in the developed world. To kill the Greek leviathan, one has to starve its gargantuan voracity for intervention in the economy. The state not only runs hospitals, universities and churches but also casinos, lotteries, hotels, marinas, ski resorts, trade fairs, exposition centres, ports, airports, water, electricity and natural gas companies, oil refineries, postal services, transport, banks and insurance companies. The state’s stake in listed companies on the Athens Stock Exchange is worth more than €9bn ($12.3bn). Real estate holdings in major state property-management companies are conservatively valued at more than €300bn and yet yield next to nothing.
Privatisations, therefore, represent a huge untapped opportunity to re-establish discipline in public finances while, potentially, reducing public debt to more manageable levels. The stability program refers to privatisations as a potential source of funds of €2.5bn, or 1 per cent of GDP, in 2010, while doubling that amount over the period 2010-12. Clearly, given the magnitude of state control in the economy, these figures are suboptimal and would mainly be achieved by selling government stakes in state enterprises through the stock exchange."
'The Bears Are Wrong'? I Don't Think So [View article]
Each day the market goes further higher I further the sense I'm living in some kind of surreal existence in which known limits, metrics and boundaries have been repealed. I have NEVER felt a greater disconnect to what I believe to be the fundamentals, both current and prospective, and the steady, parabolic increases in market prices.
The mantra within the bulls camp is that the Fed has our back and will do nothing in the immediate future to spook the markets and upset growth of the bubble. The thinking is that the Fed will continue with its promiscuous policies and continue to flood the system with liquidity under the belief that asset inflation will eventually create jobs and income. I don't think this peculiar thesis, based upon warped and desparate thinking, has been proven and if we turn to Japan we might conclude the thesis is totally flawed.
In the meantime there appears to be an unspoken pact among the pig traders but its just a matter of time before one of the pig traders is advised to take the chips off the table because of rising long term interest rates, or other fears, and move to a different casino. The four other pigs will quickly follow in the manner described Rosenberg and the author.
Niall Ferguson: U.S. Fiscal Crisis Will Likely Occur Within 2 Years [View article]
The other interesting point he made is the sovereign debt crisis will move from the periphery of Europe to its core and then across the Atlantic. And owing to lack of political will, we will do nothing to prevent the crisis and will respond only when overwhelmed by its stupendous force.
What policy makers fail to grasp is that Keynesian thinking has always been detached from debt and capital markets and decision makers are only focusing upon economic growth when.....as the author and Niall Ferguson make clear.......the focus should upon debt. In response, our policy makers reply we will focus upon economic growth in the near term and fiscal reform in the intermediate term.
If Keynesian policies worked and there were an intermediate term when fiscal spending would be contained, this might be acceptable. Bu the problem is twofold: the intermediate term never arrives as witnesses by decade of deficits and, secondly, we should have serious doubts about the efficacy of Keynesian policies as practiced. We run a deficit of 10% of GDP and get 5.6% growth in one quarter and 3.0% in the next with all indicators pointing down.
Bloomberg reported this morning "Governments have proven they can spur expansion by focusing their belt-tightening on spending cuts rather than tax increases, according to studies by Harvard University professor Alberto Alesina and Goldman Sachs Group Inc. economists Kevin Daly and Ben Broadbent."
So, while we pay lip service to the need to address debt levels we never do and we are following macroeconomic policies that will not lead to growth but will increase our debt burden.
Sobering Stat: ARMS Index Indicates Market Is at Peak, Not Bottom [View article]
A host of the technical indicators I use have been warnings but this market is being driven by historically unique forces, including massive deficits and proportionate liquidity injections, or is being supported my the machinations of the Fed. In either case, what in the past have proven to be useful tools are being compromised, if not castrated, in the current setting.
The market is clearly overbought and has risen to unsustainable levels. It was first better than expected earnings, then it was the growth of China, then it was about housing and other reports, then it was we sold a few more cars through the clunker program and now we are starting to take stock of the basics. They have remained unchanged and over the long-run these cannot be abrogated by either liquidity or complicity.
Growth in China is in serious jeopardy and central authorities are genuinely concerned about creation of excess capacity and speculation in commodities, casino's and equities. Recent policy actions, designed to mute some of the excesses, has been initiated over concern of these excesses and the larger unspoken concern over the financial health of the economy. Corporations with deteriorating earnings are borrowing more money; under usual conditions they would be denied additional credit. In parallel, banks are concealing non-performing loans through rolling them over. Some smart people, including Micheal Grant, think China is a ticking time bomb.
Meanwhile, stateside, the core problems of underemployment, consumer spending and bankiing sector health remain unchanged. To an extent consumer spending and underemployment are intertwined; but even if consumers, who have jobs, were not frightened by the economy and the administration's policies they would still want to save and liquidate debt therby containing spending. Prospects for the unemployed are miserable and, unfortunately, government and the apparatchiks of MSM do nothing to either clarify or correct the resports released federal departments and agencies. The bottom line is hiring is still trending down amid a growing potential labor force.
If China follows the path of Japan, the model country that could do no wrong until 1989, and the US consumer spending continues to contract, what will be the catalyst to spur growth and profits? Many times people when confronted by such a question will resort to bromides that touch upon ingenuity, creativity and innovation but it is easy to forget that these essential qualities must be nurtured. A solid investment environment depends on a strong and stable currency, restrained federal spending, less harmful legislation, dependable contract law, limits on taxation and countercyclical capital regulation.
In my humble view things, when looking around the corner, appear rather bleak.
Recovery, Crisis in Confidence and Curing Too Much Debt with More Debt [View article]
1) In Davos and among peers who know the difference between reality and the warped illusion field created by MSM and colored by politics, Larry Summers has removed political spin from our condition and acknowledges that we are amid a statistical recovery and a human recession (depression). He is reported as noting that in the U.S., one man in five between the ages of 25 and 54 is unemployed; even after a reasonable recovery, one in seven or eight will remain jobless. Summers compares that with the employment rate for that group half a century ago: 95%, or just one in 20 jobless.
2) From the article "Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence-especially in cases in which large short-term debts need to be rolled over continuously-is the key factor that gives rise to the this-time-is-different syndrome. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang!-confidence collapses, lenders disappear, and a crisis hits."
John Cochrane does a nice job of pinpointing the day and the reasons confidence was replaced by fear. "Why would Lehman’s failure cause a panic? Why, after seeing Lehman go to bankruptcy court, would people stop lending to, say, Citigroup, and demand much higher prices for its credit default swaps (insurance against Citi failure)?Nothing technical in the Lehman bankruptcy caused a panic.The usual “systemic” bankruptcy stories did not happen: We did not see a secondary wave of creditors forced into bank-ruptcy by Lehman losses. Most of Lehman’s operations were up and running in days under new owners. Lehman creditdefault swaps (cdss) paid off. Sure, there was some mess —repos in the United Kingdom got stuck in bankruptcy court,some money market funds “broke the buck” and had to bor-row from the Fed — but those issues are easy to fix and theydo not explain why Lehman’s failure would cause a widespreadpanic. What is more, Lehman’s failure did not carry any newsabout asset values; it was obvious already that those assets were not worth much and illiquid anyway.
We are left with only one plausible explanation for why Lehman’s failure could have had such wide-ranging effect: After the Bear Stearns bailout earlier in the year, marketscame to the conclusion that investment banks and bankholding companies were “too big to fail” and would be bailedout. But when the government did not bail out Lehman, andin fact said it lacked the legal authority to do so, everyonereassessed that expectation. “Maybe the government will not,or cannot, bail out Citigroup?” Suddenly, it made perfect sense to run like mad.
3) Knowing the above and as a matter of policy, we have determined to preserve the status of TBT; by definition, this will set us up for another crisis as large banks will be encouraged to take outsized risks knowing the government will backstop them. Current reforms, including constraints on proprietary trading and limits on ownership of hedge funds, simply do not go far enough. The financial institutions literally own both congress, through lobbying and campaign contributions, and the Fed; and through this ownership and a revovolving door between Washington and NYC, they have too much influence in Treasury. They have so much influence that's its impossible to contain their pursuit of self interest.
4) Bernanake, a student of the depression, is rewriting history to justify expansionist policies; were he to publicly admit that easy money had a role in the current crisis, it would severely limit his political duty and his duty to the owners of the Fed (banks) to keep the economy going. As I have noted before, the Austrian school of economic is not widely embraced because it lacks elegant mathematical equations and, more importantly, it imposes constraints and limits on the activities of government and the Fed. Under Austrian thinking, the correct course at current jucture is to remove imbalances within the economy; allow asset prices to fall to natural levels, eliminate capacity not aligned with demand; and purge the system of all other malinvestments. To those in power, this is simply unacceptable; things must continue even if we inflict further structural imbalances upon the economy and deepen existing imbalances. There will be a day of reckoning.
The High Probability of an Irrational Gold Bubble [View article]
But I believe gold prices are moving higher due to the public’s opposition to fiat currency, fiscal stimulus and what is generally viewed as continued “money printing”. This is highly irrational in the long-term in my opinion and the potential for gold to turn into a bubble is looking increasingly high.
In the end, however, the Euro crisis will pass. That is unlikely to occur until European leaders recognize that their single currency system is inherently flawed (just as the gold standard was) and that means we could see substantially higher gold prices as investors continue to rush into gold with the belief that gold can serve as a viable reserve currency (something that has already been tested in a global economy and also something that has already failed). All of this increasing worry in Europe is likely to increase the odds of a gold bubble.
How do I see such a scenario unfolding? I believe there is a fairly high chance of an eventual defection and default in Europe. After all, there is no good solution in the region and the debt problems will persist until something forces the EMU’s hand. If this in fact occurs, gold prices could very well reach stratospheric levels. But ultimately, paper money will survive in its current form no matter what happens to the Euro. ______________________... Given the likelihood of your thesis playing out over two years at a minimum and more likely much longer, I think you are a bit head of yourself. Never underestimate the hubris and narcissism behind the drivers and architects of the ECU and eurozone, as they will exhaust every possible option before doing the right thing.
In the meantime, gold will be viewed as a surrogate currency and a substitute to vulnerable currencies with plenty of upside. And the profit window may remain open even longer than allowed by your thesis as I believe it's only a matter of time before the US must square off between the agencies and the capital markets.
This would extend the life as gold as an investment opportunity.
Barney Frank on Housing: No Wonder the Economy's a Mess [View article]
To add to what Bruce has said Frank is emblematic of everything that is wrong with congress and living proof of the need for term limits. Beyond limits, though, we need some type of constitutional provision to fascilitate removal of incumbents when it's clear they are incompentent, pursued conflicts of interest or simply lied.
The Third Depression? [View article]
What is conspicuously missing from public discussion of the economy is the miserable and divided political backdrop against which the economy is functioning and reported to be recovering. As long as households and business view the administration as bent on destroying traditional values and lifestyles and fiscal policy as a predatory tool to channel resources to special interests, confidence will remain low and spending constrained; politics and economics are inextricably linked.
What Krugman and others fail to grasp is that most people loath the dystopian ideals embraced by the current administration and a $trillion here or there will not change this mindset and produce a durable economic recovery built upon faith in the future. And beyond this huge disconncet there remain structural issues as noted by an unnamed author at the Von Mises Institute.
The current economic disaster is the result of the combination of negligence, hubris, and wrong economic theory. For decades, an economic and monetary policy has been practiced based on the illusion of, "It doesn't matter." At first it was, "Deficits don't matter." From that, the policy of "it doesn't matter" got extended to money creation, the credit expansion, the stock-market bubble, and the housing boom. Now, we're being told that buying financial junk by the central bank to beef up banks and brokerages also doesn't matter.
The current financial crisis is not of a cyclical nature. The financial turmoil is the symptom of the structural imbalances in the real economy. Over decades, expansive monetary policy has gone hand in hand with implicit and explicit bailout guarantees, and this has distorted the process of capital allocation. Under such perverted conditions, those investors will win most who cast away the restraints of prudence. It is a game that can go on for a long time — up to the point when the irrationality has become systemic.
The simple fact is that the US economy is burdened with a highly lopsided capital structure as the consequence of a wide discrepancy between consumption and production, which, in turn, is the result of monetary policy. Persistent trade imbalances are the symptoms of this discrepancy. This means for the US economy that lower interest rates and government incentives aimed at boosting consumption work as pure poison. Instead of more consumption, more savings, less consumption and fewer imports are needed.
The current financial crisis reflects that many debtors have reached their debt limit and that creditors are lowering that limit. From now on, business and consumers, governments and investors must work under the restraints of lowered debt ceilings.
PIMCO's Bill Gross Sees a Bleak Future [View article]
I f you take PIMCO's view and compare it CBO forecasts, it is immediately apparent that the CBO is not buying into the new normal or simply ignoring it; they are forecasting nominal growth of 4.5% a year through 2015.
If PIMCO ir right, which I believe they are, and CBO wrong, it has enormous implications for the budget deficit.........which will only get worse. And this will spill over into tax policy, another piece of the new normal.
With the most optimistic forecasts and creative accounting, the administration is being challenged to balance the budget; Obama and the administration will be forced to raise taxes to balance the budget and will be forced to increase them further to fund healthcare reform.
Obama wants to raise income taxes for high earners, impose new levies on business and tax greenhouse emissions, but those moves would not generate enough cash to cover the cost of health care, much less balance the budget, and they have not been fully embraced by Congress. Lawmakers are considering other ways to pay for health reform, including new taxes on sugary soda, alcohol and employer-provided health insurance.
The latest revenue generating idea is the Value Added Tax, a tax imposed upon the profit generated at every level of manufacturing. Effectively it is a national sales tax cooked into the price of a finished product as opposed to 10% slapped on at the register.
Taken together all of these taxes, assuming they pass through Congress, will drain the live out of what was once a robust and vibrant economy. This will come to characterize our new normal, something the Europeans have been dealing with for some time inside their sluggish and sclerotic economies.
Due for a Correction? Market Is Already Priced for Grim Future [View article]
As we said before, the S&P 500 is priced for 4.0% real economic growth in the coming year. It is far from impossible to see that, but the odds are low — less than 20% in our view. An unprecedented eight point P/E multiple expansion during a five month faith-based rally has left the market at its most expensive level (25x on operating, 130x on reported) in seven years. On a reported basis, this market is nearly three times overvalued as it was during the tech bubble!
At the lows in the equity market last March, the S&P 500 was de facto pricing in -2.5% real GDP and $50 of operating earnings for the year. Guess what? Far from being grossly undervalued at the lows (though some stocks were — especially the financials, which were priced for bankruptcy) the market at the lows was fairly priced on a price-to-book and price-to-earnings basis. Usually at bear market lows, the S&P 500 goes to silly cheap levels. It never did this time around, and five months and 50% later, there is yet again, in 2007-style, tremendous risk in this market. Never before has the stock market surged this far, this fast, between the time of the low and the time the recession (supposedly) ended. What is “normal” is that the rally-ahead-of-the-rec... is 20%. This market is now trading as if we are in the second half of a recovery phase and yet it is not even been fully ascertained that the downturn is over — a one-quarter spurt in automotive production and sales induced by Cash-for-Clunkers is not enough to support the widespread assertion that the recession is behind us (the odds of a fourth quarter relapse, especially in the U.S. consumer, are non-trivial).
Jim Rogers on the Next 10 Years [View article]
At the root of everything lies the question of whether the country's political structure is conducive to sustained growth. In the west, the classic pattern of development has been for economic change to stimulate demands for political reform and greater democracy. Fear of political change could hold China back; the top-down fiscal package exacerbated the fundamental weakness of the economy in expanding the role of state owned enterprises. The stimulus has rewarded many state owned enterprises and over the long run the role of SOE’s must be reduced while giving wider berth to small, privately held companies which will be more responsive to market changes and better incentivized to innovate.
The most immediate challenge is for China is to move from an export driven economy to a more balanced model in which domestic consumption plays a larger role that it does today. Relative lack of healthcare and the cost of a decent education mean that families save far more heavily than in the west, leaving them with less money left over at the end of the month to spend. China must extend upon its rudimentary social safety net and expand educations, pensions and health care
The very large demographic issue confronting China is interesting and unusual in that it is experiencing the problems of both a developing and developed country; high economic growth along with an aging population. Experts worry that China will become old before it becomes rich; Richard Jackson and Neil Howe wrote a report about demographic trends and they calculated that in 2004, the elderly—here defined as adults aged 60 and over—make up just 11 percent of the population. And by 2040, however, the United Nations projects that the share will rise to 28 percent, a larger elder share than it projects for the United States.
“In absolute numbers, the magnitude of China’s coming age wave is staggering. By 2040, assuming current demographic trends continue, there will be 397 million Chinese elderly people, which is more than the total current population of France, Germany, Italy, Japan, and the United Kingdom combined.” And Andy Xie is concerned that current demographic trends could worsen as a result of the property bubble with higher housing prices forcing many young couples to have fewer children. It is unclear how will address this issue but it is clear the government is worried about the cost of a western European-style welfare state.
Other challenges include the gap between living standards in the cities and in the countryside; the comparison between the wealth of the coastal strip and the poverty of the inland regions; the mismatch between the country's projected growth rate and its energy needs; and the need to improve the structure and regulation of its capital markets. In the longer term, Beijing has to decide how to use China's growing economic clout on the world stage and chart a course for developing its capital markets, including expanding the role of the Renminbi in global currency.
Rally to End Soon, Says Morgan Stanley [View article]
The market is now overvalued by over 25% but is also extremely overbought having gone 24 sessions without a decline of 1% or more, and 89% of the stocks in the S&P 500 are now trading above their 50-day moving averages (see page M3 of Barron’s). The Dow has advanced in 17 of the past 21 days. I mean, even if you are bullish on the outlook, one would have to admit that such a parabolic move is vulnerable to at least a modest pullback… or more. I know what a broken record sounds like and this has been a confounding and confusing market — for both the bears and many (though not all) of the bulls.
Looking at the fund flows, there is only one conclusion that can be reached: This market is being driven by pig farmers. Retail inflows may have picked up of late, but only fractionally. The focus on the part of the individual investor remains on the fixed-income market, for better or for worse (better from our standpoint, worse from the standpoint of my friend and fellow debater Jim Grant).
Institutional portfolio manager cash ratios are back to the rock bottom levels of around 3½% — where they were back at the market peak in October 2007. The shorts have all but been covered. Foreign investors have been few and far between, based on the latest TICS data. The lack of volume speaks volumes — there are no sellers. Investors of all types have been content to just sit and watch their equity position expand via the price appreciation, but there is scant evidence of any follow-through this year in terms of volume buying.
So, that leaves me with a suspicion that the entities doing the buying are the pig farmers. Who are they pray tell? They are the prop desks at the five large banks. They buy and sell securities, with leverage … to each other! And, these transactions often occur late in the day or in the futures pit after the market closes. There is no sign of any other buyer out there, including the Fed who has been too busy choking on mortgage backed securities and Maiden Lane assets. To repeat, that is why the volumes have been so low.
What we should be aware of about the pig farmers is that they could, at any time, flick the switch in the other direction. What the “trapped longs” may be forced to do — the ones that have been sitting on their hands and have been waiting for the bear market rally to take their portfolio back to where it was at the peaks — at that point is start to sell. That is when the volume picks up … and accelerates the downside pressure.
John Hussman: Recession Warning [View article]
2) Reportedly, the Fed is debating resumption of QE on a massive scale.
3) Consumer confidence is edging up but is at levels normally endured during recessions.
4) First quarter growth was down to 2.7% with 70% of the growth coming from rebuilding of inventories.
5) Stimulus will wane in the second half.
6) Based upon April and May personal consumption expenditures, spending is set to increase at annual rate of 1.2%.
7) Credit is contracting.
8) The roof is falling in on new home sales which fell 33% in the last reporting period.
9) High frquency leading economic indicators are nosing over. From Prag Cap: “The 13-week annualized rate of the WLI is now at -23.46%, something that usually only happens in, or prior to, recessions. This is very ominous economic momentum. I haven’t seen anyone look at it this way, I suppose because the ECRI publishes their own smoothed growth rate.” It's happened five other times and in each case the economy either went into recession (1) or was in recession (4)
10) The political landscape is not one that inspires confidence with most Americans saying the nation is on the wrong track. Concerns abound among businesses and consumers that the current administration will strip mine the nations wealth and channel it to special interests. The administration is seen as being hostile to business, except the favored banking cartel.
11) For the most part, the same players are in place that brought us to the edge of financial ruin and it may be unreasonable to think that those incapable of avoiding the great recession possess the talent essential navigating out of the great recession.
The Bull Run Begins This Week [View article]
And while there may be an Obama bounce, though that is not certain as many earnings will be released next week, the structural aspects of this decline are worsening as they surface.
Declining estimates of economic growth, rising foreclosures, collapsing industrial production, growing estimates of what is needed in the stimulus package, rising estimates of banking sector losses and growing unemployment are simply the first things that come to mind.
If we face deflation and the corrective actions are not equal to the task, we are some ways off from the streets of Barcelona where the bulls run.
The Coming Consequences of Banking Fraud [View article]
In each case, successive bubbles were fostered through irresponsibly loose monetary policy that distorts normal market signals, encouraging speculation and consumption. And in each case the bubbles collapsed through tightening of credit to address imbalances and speculative excesses but well after the fact.
The Japanese experience is eerily similar to our recent crisis as that it was brought on by a high rate of domestic savings (we had China) easy money, loose oversight, an influential cartel and lax underwrting standards. Their response was to raise interest rates and then lower them when the scope of damage became apparent; the stock market cratered as did commercial and residential real estate prices.
The Japanese economy stagnated for the next decade and for a variety of reasons, including demographics and aging population, it is only a shadow of its former self. Most of this is a result of a farrago of poor policy responses to the crisis and a stubborn unwillingness to force the zombie banks to writedown indisputably bad assets.
Despite our unwillingness to force the banks to writedown bad assets, the unprecedented scale and scope (global) of current monetary and fiscal policy clearly has the potential to create the next bubble and I believe it will. Understanding that the effects of our monetary policy is not restricted to our shores, the massive injections of liquidity do not have to remain within the US and will trickle towards the next puddle of speculative excess.
If I am correct in where I think it will be.....and its just speculation on my part though alarm bells have already been heard.....it will be a big one. But that's part of the process; each bubble gets bigger, each inflicts ever more damage and each new bubble requires ever greater amounts of liquidity.
Sovereign Default: Stuck Between Dire and Disastrous [View article]
"Much could be gained from further privatising an economy that is probably the last “Soviet-style” economy in the developed world. To kill the Greek leviathan, one has to starve its gargantuan voracity for intervention in the economy. The state not only runs hospitals, universities and churches but also casinos, lotteries, hotels, marinas, ski resorts, trade fairs, exposition centres, ports, airports, water, electricity and natural gas companies, oil refineries, postal services, transport, banks and insurance companies. The state’s stake in listed companies on the Athens Stock Exchange is worth more than €9bn ($12.3bn). Real estate holdings in major state property-management companies are conservatively valued at more than €300bn and yet yield next to nothing.
Privatisations, therefore, represent a huge untapped opportunity to re-establish discipline in public finances while, potentially, reducing public debt to more manageable levels. The stability program refers to privatisations as a potential source of funds of €2.5bn, or 1 per cent of GDP, in 2010, while doubling that amount over the period 2010-12. Clearly, given the magnitude of state control in the economy, these figures are suboptimal and would mainly be achieved by selling government stakes in state enterprises through the stock exchange."
'The Bears Are Wrong'? I Don't Think So [View article]
The mantra within the bulls camp is that the Fed has our back and will do nothing in the immediate future to spook the markets and upset growth of the bubble. The thinking is that the Fed will continue with its promiscuous policies and continue to flood the system with liquidity under the belief that asset inflation will eventually create jobs and income. I don't think this peculiar thesis, based upon warped and desparate thinking, has been proven and if we turn to Japan we might conclude the thesis is totally flawed.
In the meantime there appears to be an unspoken pact among the pig traders but its just a matter of time before one of the pig traders is advised to take the chips off the table because of rising long term interest rates, or other fears, and move to a different casino. The four other pigs will quickly follow in the manner described Rosenberg and the author.
Niall Ferguson: U.S. Fiscal Crisis Will Likely Occur Within 2 Years [View article]
What policy makers fail to grasp is that Keynesian thinking has always been detached from debt and capital markets and decision makers are only focusing upon economic growth when.....as the author and Niall Ferguson make clear.......the focus should upon debt. In response, our policy makers reply we will focus upon economic growth in the near term and fiscal reform in the intermediate term.
If Keynesian policies worked and there were an intermediate term when fiscal spending would be contained, this might be acceptable. Bu the problem is twofold: the intermediate term never arrives as witnesses by decade of deficits and, secondly, we should have serious doubts about the efficacy of Keynesian policies as practiced. We run a deficit of 10% of GDP and get 5.6% growth in one quarter and 3.0% in the next with all indicators pointing down.
Bloomberg reported this morning "Governments have proven they can spur expansion by focusing their belt-tightening on spending cuts rather than tax increases, according to studies by Harvard University professor Alberto Alesina and Goldman Sachs Group Inc. economists Kevin Daly and Ben Broadbent."
So, while we pay lip service to the need to address debt levels we never do and we are following macroeconomic policies that will not lead to growth but will increase our debt burden.
Sobering Stat: ARMS Index Indicates Market Is at Peak, Not Bottom [View article]
The market is clearly overbought and has risen to unsustainable levels. It was first better than expected earnings, then it was the growth of China, then it was about housing and other reports, then it was we sold a few more cars through the clunker program and now we are starting to take stock of the basics. They have remained unchanged and over the long-run these cannot be abrogated by either liquidity or complicity.
Growth in China is in serious jeopardy and central authorities are genuinely concerned about creation of excess capacity and speculation in commodities, casino's and equities. Recent policy actions, designed to mute some of the excesses, has been initiated over concern of these excesses and the larger unspoken concern over the financial health of the economy. Corporations with deteriorating earnings are borrowing more money; under usual conditions they would be denied additional credit. In parallel, banks are concealing non-performing loans through rolling them over. Some smart people, including Micheal Grant, think China is a ticking time bomb.
Meanwhile, stateside, the core problems of underemployment, consumer spending and bankiing sector health remain unchanged.
To an extent consumer spending and underemployment are intertwined; but even if consumers, who have jobs, were not frightened by the economy and the administration's policies they would still want to save and liquidate debt therby containing spending. Prospects for the unemployed are miserable and, unfortunately, government and the apparatchiks of MSM do nothing to either clarify or correct the resports released federal departments and agencies. The bottom line is hiring is still trending down amid a growing potential labor force.
If China follows the path of Japan, the model country that could do no wrong until 1989, and the US consumer spending continues to contract, what will be the catalyst to spur growth and profits? Many times people when confronted by such a question will resort to bromides that touch upon ingenuity, creativity and innovation but it is easy to forget that these essential qualities must be nurtured.
A solid investment environment depends on a strong and stable currency, restrained federal spending, less harmful legislation, dependable contract law, limits on taxation and countercyclical capital regulation.
In my humble view things, when looking around the corner, appear rather bleak.
Recovery, Crisis in Confidence and Curing Too Much Debt with More Debt [View article]
2) From the article "Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence-especially in cases in which large short-term debts need to be rolled over continuously-is the key factor that gives rise to the this-time-is-different syndrome. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang!-confidence collapses, lenders disappear, and a crisis hits."
John Cochrane does a nice job of pinpointing the day and the reasons confidence was replaced by fear. "Why would Lehman’s failure cause a panic? Why, after seeing Lehman go to bankruptcy court, would people stop lending to, say, Citigroup, and demand much higher prices for its credit default swaps (insurance against Citi failure)?Nothing technical in the Lehman bankruptcy caused a panic.The usual “systemic” bankruptcy stories did not happen: We did not see a secondary wave of creditors forced into bank-ruptcy by Lehman losses. Most of Lehman’s operations were up and running in days under new owners. Lehman creditdefault swaps (cdss) paid off. Sure, there was some mess —repos in the United Kingdom got stuck in bankruptcy court,some money market funds “broke the buck” and had to bor-row from the Fed — but those issues are easy to fix and theydo not explain why Lehman’s failure would cause a widespreadpanic. What is more, Lehman’s failure did not carry any newsabout asset values; it was obvious already that those assets were not worth much and illiquid anyway.
We are left with only one plausible explanation for why Lehman’s failure could have had such wide-ranging effect: After the Bear Stearns bailout earlier in the year, marketscame to the conclusion that investment banks and bankholding companies were “too big to fail” and would be bailedout. But when the government did not bail out Lehman, andin fact said it lacked the legal authority to do so, everyonereassessed that expectation. “Maybe the government will not,or cannot, bail out Citigroup?” Suddenly, it made perfect sense to run like mad.
3) Knowing the above and as a matter of policy, we have determined to preserve the status of TBT; by definition, this will set us up for another crisis as large banks will be encouraged to take outsized risks knowing the government will backstop them. Current reforms, including constraints on proprietary trading and limits on ownership of hedge funds, simply do not go far enough. The financial institutions literally own both congress, through lobbying and campaign contributions, and the Fed; and through this ownership and a revovolving door between Washington and NYC, they have too much influence in Treasury. They have so much influence that's its impossible to contain their pursuit of self interest.
4) Bernanake, a student of the depression, is rewriting history to justify expansionist policies; were he to publicly admit that easy money had a role in the current crisis, it would severely limit his political duty and his duty to the owners of the Fed (banks) to keep the economy going. As I have noted before, the Austrian school of economic is not widely embraced because it lacks elegant mathematical equations and, more importantly, it imposes constraints and limits on the activities of government and the Fed.
Under Austrian thinking, the correct course at current jucture is to remove imbalances within the economy; allow asset prices to fall to natural levels, eliminate capacity not aligned with demand; and purge the system of all other malinvestments. To those in power, this is simply unacceptable; things must continue even if we inflict further structural imbalances upon the economy and deepen existing imbalances. There will be a day of reckoning.
The High Probability of an Irrational Gold Bubble [View article]
In the end, however, the Euro crisis will pass. That is unlikely to occur until European leaders recognize that their single currency system is inherently flawed (just as the gold standard was) and that means we could see substantially higher gold prices as investors continue to rush into gold with the belief that gold can serve as a viable reserve currency (something that has already been tested in a global economy and also something that has already failed). All of this increasing worry in Europe is likely to increase the odds of a gold bubble.
How do I see such a scenario unfolding? I believe there is a fairly high chance of an eventual defection and default in Europe. After all, there is no good solution in the region and the debt problems will persist until something forces the EMU’s hand. If this in fact occurs, gold prices could very well reach stratospheric levels. But ultimately, paper money will survive in its current form no matter what happens to the Euro.
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Given the likelihood of your thesis playing out over two years at a minimum and more likely much longer, I think you are a bit head of yourself. Never underestimate the hubris and narcissism behind the drivers and architects of the ECU and eurozone, as they will exhaust every possible option before doing the right thing.
In the meantime, gold will be viewed as a surrogate currency and a substitute to vulnerable currencies with plenty of upside. And the profit window may remain open even longer than allowed by your thesis as I believe it's only a matter of time before the US must square off between the agencies and the capital markets.
This would extend the life as gold as an investment opportunity.
Barney Frank on Housing: No Wonder the Economy's a Mess [View article]