July - 2009 Economic Brief

Recovery called into question by exploding U.S. debt
Worries about the U.S. government's skyrocketing debt are prompting doubt about a turnaround for the economy. Government bonds have come under heavy selling pressure, driving up yields. A recovery could be derailed by increased borrowing costs for consumers and businesses, economists said. Financial Post (Canada)/Reuters (28 May.)

Industrial production takes surprise 1.1% drop in U.S.
Output from factories, mines and utilities in the U.S. fell 1.1% in May compared with April, the Federal Reserve said. Economists polled by Reuters had expected a 0.9% decline. Reuters (16 Jun.)

Let’s see, where were we...

In early September 2008, the Bernanke Fed did an abrupt about face, 180 degree turn by a little less than $1 trillion. The percentage increase in the monetary base was the largest increase in the past 50 years by a factor of 10. Now, the currency-in-circulation component of the monetary base is a smidgen less than 50% of the monetary base. The amount of currency has increased by 10%, while bank reserves (non-currency) have increased 20 fold.

So, in March, in a desperate attempt to jump-start the credit markets, Bernanke dared go where no other Fed Chairman had gone before. He dropped short-term rates to zero. He committed to buying $300 billion in long term Treasury securities plus another $100 billion in government agency securities.He even promised to buy up to another $750 billion of mortgage-backed securities.

Total new commitments in that one announcement alone: $1.15 trillion.

However, despite the Fed's giant purchases, Treasury Bond prices have continued to plunge instead of rising or stabilizing as Bernanke had hoped.

Total Fed purchases so far: $130.5 billion.

Catch-22

Low interest rates are absolutely crucial to any possible economic recovery stateside while the free market demands higher interest rates to compensate for risk of inflation (e.g. Federal Reserve is buying its own US Treasuries).

And despite the Fed's mammoth mortgage bond purchases, we've just seen a sudden collapse in mortgage bond prices.

Total Fed purchases so far: A whopping $507 billion!

Plus,

The Treasury alone will need to issue a whopping $1.84 trillion in net new Treasury securities this year — just to finance the deficit expected by the Obama Administration.

That excludes any costs for future credit that goes bad (among the trillions that the government now guarantees to save GM, AIG, Fannie and Freddie, the entire banking sector and many other companies) or the hundreds of billions now being demanded by cities and states! Hello, good-bye, California!

California close to paying bills with IOUs
Within a week, California will have to start issuing IOUs to pay its bills, the state's controller said. "Next Wednesday, we start a fiscal year with a massively unbalanced spending plan and a cash shortfall not seen since the Great Depression," Controller John Chiang said. State Treasurer Bill Lockyer said he will draw funds from a reserve account to meet the state's debt-service obligations. Reuters (24 Jun.)

Keep this in context:

The Fed's Flow of Funds Report for the first quarter of 2009, demonstrate, beyond a shadow of a doubt, that the credit market meltdown, which struck with full force after the Lehman Brothers failure last September, actually got a lot worse in the first quarter of this year.

This directly contradicts Washington's thesis (spin) that the government's TARP program and the Fed's massive rescue efforts began to have an impact early in the year. Go figure!

The first quarter brought the greatest credit collapse of all time.

Who is suffering the biggest and most pervasive losses?
U.S. households and nonprofit organizations!

In U.S. households alone, the losses have been massive: $1.39 trillion in the third and fourth quarters of 2007... a gigantic $10.89 trillion in 2008 ... $1.33 trillion in the first quarter of 2009 ... $13.87 trillion in all, by far the worst of all time.

And don’t forget:

The king of off-balance sheet accounting would have to be the U.S. government. You see, the “official debt” doesn’t include the very real obligations our country owes for Social Security and Medicare. Add these and a few other entitlement programs to the equation and the United States’ TOTAL debt is in the neighborhood of $100 trillion.

The Fed’s solution is to step in and buy our own debt, when other countries and institutions are unwilling or unable to do so. But this creates a catch-22. This amounts to nothing more than printing dollars. And the more dollars we print to buy our own debt, the weaker the dollar becomes and the less likely that foreign countries are willing to buy.

The main reasons investors sell — fear of inflation and damage to the U.S. government's credit — are, themselves caused by the Fed's own buying. In other words, the more the Fed buys, the more our bond investors are motivated to sell.

The U.S. is a debt-thirsty (addicted?) nation at a time when the global pool of liquidity is drying up. That is a prescription for much higher Treasury rates down the road and other even more uncomfortable consequences.

For example, more and more of the world markets think about another world currency, other than the US dollar.

U.S. Treasury Secretary Tim Geithner met with Chinese leaders just a couple of weeks ago. His top goal is to reassure them their money invested in U.S. dollars is safe. China holds $740 billion in U.S. government bonds and is just now closely inspecting the merchandise.

U.S. dollar's position shaky
The financial crisis has brought a sense of urgency to the debate over whether the U.S. dollar should play such a dominant role in the world's economy. Brazil, Russia, India and China called for a "more diversified" international monetary system. If the dollar is ousted as the world's reserve currency, it might raise the cost of government borrowing. But it could also usher in a boom for U.S. exporters by making their products more cost competitive. The Washington Post (24 Jun.)

The People's Bank of China — the central bank for 1.3 billion people and America's biggest creditors — has just issued an economic report calling on the world to replace the U.S. dollar as the world's reserve currency ... and for the International Monetary Fund to issue a new, single "super-sovereign currency."

Wall Street should be in a good mood today as it closes the books on one of the best quarters in three generations. Keep in mind, however, that celebrations on the Street never last long.

How do we explain buyers paying high prices for bank stocks that are fundamentally broke?

With investors who ignore the fundamentals, such as the surge we just saw in unemployment, 9.4%, not to mention the already mentioned “DEBT”; and they seem to be easily seduced by Washington and Wall Street spin.

Mass layoffs in May tie March's record high in U.S.Mass layoffs -- at least 50 job losses by a single employer -- grew to 2,933 last month, from April's 2,712, the U.S. Labor Department reported. That is practically a tie with March's figure, which set a record. Yahoo!/Reuters (23 Jun.)

They don’t call this rally a “sucker’s rally” for nothing (although using such a term as “bear market rally” would probably be grounds for dismissal at a mainstream brokerage). It rose on fumes. It certainly didn’t rise on earnings. Take a look at the S&P’s earnings in the past 20 months. They’ve nosedived from $80 to $7 – the biggest drop ever recorded.

According to Ibbotson Associates, of the 74 rolling 10-year periods since 1926 (i.e., 1926-1935, 1927-1936, and so on), U.S. large-cap stocks posted negative returns in just three of them. The first two were 1929-1938 (-0.89% compound annual return) and 1930-1939 (-0.05% compound annual return), and involved the Depression. The third loser decade was the most recent -- and the worst. From 1999-2008, U.S. large-cap stocks "returned" a compound annual average of negative 1.38%.

And how do we explain that by the end of 2008, household debt in the U.S. was $13.8 trillion (which has doubled since the year 2000), nearly equal to our $14.3 trillion GDP – do they spin it as near economic recovery or one heck of a stimulus factor for the economy.

Good News:

In April, 2009, the personal saving rate in the U.S. surged to 5.7 percent, a 15-year high. That represents a massive trend change and has important consequences for the future.

Even the Baby Boomer Generation, some 78 million strong, have realized that planning on rising stock and real estate prices to meet their future needs has led to huge losses. They've suddenly realized that consumption and indebtedness are not the way to prosperity.

And, the $64,000 question is: If we reduce consumer debt we also preclude a sustainable profit recovery for the banks (the economy and the stock market). What to do?

For its efforts, the government has bought a rally of nearly 40 percent in the S&P 500 since the March lows.

While stock prices have been enjoying what I see as just another bear market bounce ... the U.S. bond market has been crumbling under the weight of Washington's increased spending and interest rates on the rise.

The problem is:
No government, even one run amuck with spending and money printing, can replace $13.87 trillion in losses by households.

If interest rates continue to increase, any hope for economic recovery could be cut off at the knees ... the ultimate outcome could be soaring borrowing costs for consumers and businesses alike.

Oil remains the key wild card. If oil prices level off, the inflationary bullet may be dodged. If they continue to rise, stagflation could certainly follow.

U.S. consumer confidence loses bit of ground
The Conference Board's sentiment index, an indicator of consumer confidence in the U.S., edged down last month. Economists who anticipated a modest move toward greater optimism were caught off guard. Consumer confidence was still higher than the record low in February. Bloomberg (30 Jun.)

Food for thought:

Grain shortage sets U.S. up for soaring food prices
The stage is set for rising food prices and grain shortages in the U.S., triggered by depleted stocks of corn and soybeans, analysts said. "The dynamics for higher food prices are already in place, but they are being masked by problems in the larger economy," said Greg Wagner, senior commodity analyst at AgResource. Los Angeles Times/The Associated Press (10 Jun.)


Note to readers: One may wonder how it is that I accumulate such a mass of information, let alone have the time for this blog. First, it is purely self-interest as I too have to navigate these markets and since I am making the time to do the reading and discovery, why not share it with a larger audience, and so I do. Second, my sources are many and varied and what I do is take the best of the best, cut and paste, and string together a somewhat coherent thesis. In reference to my sources this month, they include in no particular order: Gregory Spear's Market Commentary, DailyWealth Reader, The Daily Crux, Money and Markets, Investorsdailyedge.com, Moody’s, Bloomberg, The New York Times, The Associated Press, Financial Times, The Globe and Mail (Toronto), Financial Week, International Herald Tribune, Reuters, The Washington Post, The Wall Street Journal, Martin Weiss, Sharon Daniels, Russell McDougal, Jon Herring, Claus Vogt, and Andrew Gordon.