April - 2010 Economic Brief

Review:



The same day the health care bill passed, U.S. government debt lost its "risk-free" status. Specifically, investors were willing to accept a lower interest rate to lend money to billionaire Warren Buffett's company, Berkshire Hathaway, for two years than to lend to the U.S. Treasury for the same period of time.

The huge run-up in equities we've seen over the last year is merely proof the US central bank is still powerful. The stock market rebound that's lifted shares in the United States started the same week the Federal Reserve began its $2 trillion program of "quantitative easing" – which simply means printing up money and buying debts with it. What is a person who started investing in 1982 to make of it? From then until 2007, he'd had a full quarter-century of gains. If the market fell, as it did in 1987 or from 2000-2002, it always snapped back.

The fact that a 25-year bull market for stocks had never happened before in history that probably means little to him. After all, it happened to him. It was the experience of his entire life.

But what if a 25-year bull market was an anomaly? A once in a lifetime event? For someone who, say, turned 30 around 1982 and is now nearly 60, this is a hard thing to contemplate. All your life things have been a certain way. You've come to accept them as normal. Any change is thus temporary. That is, until it isn't, and you are left holding on to past dreams. A new leg down in the general market could take down all stocks, even the mining stocks.

I know it can be hard for people to visualize what they grew up with completely being turned on its head. But investment history teaches us that this is exactly what happens, time and time again.
Don't jump to the conclusion that the credit crunch will immediately topple the U.S. economy or stock market. With all the money that Washington has pumped in, a weak recovery can continue and stocks could still enjoy an extension of their rally.
But it cannot last. In the long term, corporate profits cannot be sustained without credit.

Having said that, the S&P 500 and Nasdaq made new highs for the year mid-month after the U.S. and Japanese central banks sent clear signals that the easy credit environment will continue virtually indefinitely.



Fed repeats vow to keep rates near zero for an "extended period"
Source: CNBC
The Federal Reserve reiterated its pledge to keep interest rates close to zero for an "extended period" but offered a slightly more positive outlook for the U.S. economy. Fed officials said spending on software and equipment by businesses has "risen significantly," while the employment market is "stabilizing." "The data flow has been on the positive side," said Ethan Harris, an economist at Bank of America Merrill Lynch. "But the Fed needs to see something more fundamental in the economy to start hiking rates. The current path is not enough." CNBC (16 Mar.) , Financial Times (tiered subscription model) (16 Mar.) , Bloomberg (16 Mar.)

The belief is that economic weakness is not a decisive negative for the market right now because the Fed will keep rates low. Implicit in this thinking is the belief that Fed policy trumps the current economic conditions because the Fed has a history of being able to control/correct the economy via monetary policy. The market therefore trusts the Fed. If it should come to pass that the economy fails to recover despite the heroic actions of the Fed, it will usher in a new, problematic era for the U.S. financial markets and if you are a regular reader you already know my take on this.

To keep rates low, the Fed is printing money like there’s no tomorrow, then using that money to buy bonds.

Meanwhile, with consumers being responsible for 70% of the economy, this just came in from Bloomberg: “Confidence among U.S. consumers unexpectedly declined for a second month in March, a sign Americans are discouraged about the labor market. The Reuters/University of Michigan preliminary consumer sentiment index fell to 72.5 from February’s final reading of 73.6.”


DEBT:
$12,444,406,402,604 – US Debt as of April 1st


U.S. states are suffering from problems that plague Greece
Many of the problems that pushed Greece to the verge of default are showing up in U.S. states, according to The New York Times. Governments are using complex derivatives to compensate for a revenue shortfall, turning to accounting devices that hide debt and searching for ways to pay benefits promised to retired public employees. If buyers of state governments' bonds come to fear default, the matter might get worse, as it did for Greece, economists said. The New York Times (free registration) (29 Mar.)

U.S. adds $600 million to foreclosure-crisis fund
A special fund that helps U.S. states prevent residential foreclosures will get an extra $600 million, the Obama administration said. The funding will go to North Carolina, South Carolina, Ohio, Oregon and Rhode Island. The money is on top of $1.5 billion previously allocated to California, Nevada, Arizona, Michigan and Florida. The Washington Post (30 Mar.)





Country Deficit % of GDP

Iceland 15.7%
Greece 12.7%
Britain 12.6
Ireland 12.2%
Spain 11.4%
U.S. 10.6%
Portugal 9.3%
Poland 7.5%
Italy 5.3%
Canada 4.8%
Germany 3.3%

Ever since America's Declaration of Independence, deficit spending has been a recurring theme in Washington that invariably returns with a vengeance, especially during wartime. But it took 169 long years and seven major wars — from 1776 to 1945 — to rack up a cumulative deficit that matches the gaping budget hole of just 28 short days in February, in fact, last month's deficit of $221 billion was more than TRIPLE the sum total of ALL deficits during the six years under Nixon.

In just one week last month (ending 2/26), the U.S. Treasury issued a grand total of $236 billion in government debt issued in a single week, the most in the history of the world.

This means that Uncle Sam borrowed new money — and replaced old debt — at the rate of $390,212 per second ... $23.4 million per minute ... and $1.4 billion per hour — around the clock! What’s the impact? Credit is actually being sucked OUT of the consumer and corporate economy at a torrid pace, because Uncle Sam is continuing to hog most of the available credit.

Tight credit for small business might cripple recovery, economists say
The contracting availability of bank loans for small businesses might stop the U.S. recovery, economists said. While big corporations have access to the bond market, smaller companies get most of their credit from banks. Total lending by U.S. banks dropped 7.4% last year, the severest decline since 1942. The Wall Street Journal (15 Mar.)

But the kicker is that total household and government debt outstanding is at a new all-time high and has grown 21% over the past three years (and more than doubled in the past ten).

In other words, we’re still in the thick of it. And we expect it could get much worse before it gets better. Simply, absent energetic lending from foreigners, the only way the Treasury is going to be able to keep spending will be to engage in overt monetization. And that will be the starting gun on the next, and most damaging, phase of this crisis, in which the credit crisis morphs into a currency crisis.

Revised data show China, not Japan, is biggest owner of U.S. debt
The U.S. Treasury Department revised its statistics on the ownership of Treasury securities and concluded that China is still the No. 1 investor in U.S. government debt. Last month, the Treasury said China's reduction in holdings had put Japan in the top position. According to the latest data, China owned $894.8 billion in Treasuries at the end of December, considerably more than the previous estimate of $755 billion. Xinhuanet.com (China) (28 Feb.)

Although China has retained its spot as the biggest foreign holder of U.S. Treasury debt in January it trimmed its holdings for a third straight month.

The string of declines is likely to underscore worries that the U.S. government could face much higher interest rates to finance soaring budget deficits.
And out of the ether, CEO Jamie Dimon of JPMorgan told attendees at the bank’s annual meeting that "there could be contagion" if the country’s biggest state, California, can’t pay back all its debt.


JOBS:

Absolutely stunning inter-active unemployment map:

See what 30 million unemployed look like.



U.S. nonfarm payrolls shrank by 36,000 in February, but this figure is better than the 75,000 decline that was expected.
On March 18, with very little pomp and circumstance, president Obama passed the most recent stimulus act, the $17.5 billion Hiring Incentives to Restore Employment Act (H.R. 2487),


BONDS:

So on TOP of massive budget deficits ... on TOP of the biggest rise in U.S. debt ever ... and on TOP of increasing sovereign credit risk, you have an economic rebound underway. That's going to put even more pressure on bond prices, and help to push interest rates higher.

The data released today for January 2010 shows tepid improvement in foreign investor interest in purchasing U.S. assets. The biggest summary of cross-border flow is still just slightly negative for the last 12 months, and well off its 2006 peak of a trillion dollars per year. This should be a pressure for rates to rise, because there is less credit supplied to our markets, especially our corporate bond markets.




BANKS:

Regulators shut 7 banks in 5 states; 37 in 2010. These seven banks add up to about $1.3 billion for the FDIC.

Were one to ask the man on the street – or, indeed, most politicians and bankers – who creates the money that rules our lives they would reply “the State”. They would be wrong. It is true that governments create legal tender – the physical notes and coins that circulate in an economy – but that represents, at its highest, only 3 per cent of the total money in circulation in the global economy. It is the commercial banks, largely unaccountable and privately owned, that create the world’s money.

Governments do not control the single most important mechanism when it comes to their economies: the production and distribution of money. That role has been diverted to the banks, which manufacture money out of nothing and charge interest on that conjured-up money. Beyond an interest rate cut or a token change in VAT rates our politicians have no real power to direct their country’s economy.

Likewise all sorts of financial instruments and “products” are devised by the experts – collateralised mortgage obligations, put and call options, floating rate notes, preference shares, convertible bonds, semi-convertible bonds and endless other “derivatives” – but in essence they are mere variations of the same basic three card trick.

It is true that money is manufactured in the manner I have described – in other words by creating loans to the banks’ clients – surely just as much money is destroyed every time a loan is repaid? This is true to an extent. However, the point to be grasped is that while money is indeed created and destroyed in vast amounts every second of the day, the interest on that money remains un-destroyed and accumulates within the system – and at a compounded rate.

While there is no limit to the number of zeros we can create on a computer, there is a limit to the amount of oil in the ground, the wheat in the fields and the livestock in our farms.

Capitalism, banking and growth become inseparable, but logic dictates that the virtual economy must eventually peel away from the real one and sooner or later the day of reckoning arrives – when the gulf separating these two economies is too large to be sustained – for no power on earth can match the power of compound interest in the ether.

Consider the tale of the Chinese emperor and his chess opponent. The emperor asks what reward would satisfy him if he wins; the opponent replies that a single grain of wheat, doubled for each of the 64 squares on the chess board, would suffice. The emperor, imagining that he has a good deal, loses, only to learn that he now owes his adversary the equivalent of 2,000 times the current annual worldwide production of wheat.

Money breeds more money. Indeed, the banks never really want their loans to be repaid. So long as the interest is funded it is to their benefit for the capital to remain outstanding on their books as “assets” and for the debts to be rolled over. Every time the IMF or World Bank extends a line of credit to some impoverished nation, are they being “charitable” or simply perpetuating the enslavement?

But the system relies entirely, as do all Ponzi schemes, on the assumption of continued growth, hence its inherent instability. Once that growth is threatened the edifice collapses. Likewise with the banks – lend 10 times more money than you possess and when the economy grows, or at least pretends to grow, it’s Porsches galore, but when the lack of growth is exposed it requires only 11 per cent of the loans on your books (in value terms) to be bad and you are bust. The truth is not that these institutions have suddenly become insolvent but that they were never really solvent in the first place.

It is a simple and devastatingly effective swindle, but largely invisible because it has become so deeply embedded in our culture. The consequences of that swindle – the desperate need for economic growth; the environmental and cultural despoliation it engenders – require some radical thinking one encounters nowhere in any of today’s political parties.


REAL ESTATE:

Fannie Mae will seek $15.3 billion in aid from U.S. government
Fannie Mae reported a $16.3 billion fourth-quarter loss, its 10th straight quarterly loss, and will seek $15.3 billion from the U.S. Treasury Department. "Our financial results for 2009 reflected the continued adverse impact of the weak economy and housing market, which has resulted in record mortgage delinquencies and contributed to our recording significant credit-related expenses and net losses during each quarter of the year," Fannie Mae said in a filing with the Securities and Exchange Commission. Bloomberg (27 Feb.)

Refinancing help for U.S. homeowners gets 1-year extension
Homeowners who have seen the value of their house fall dramatically have an extra year to take advantage of a little-used program by the U.S. government. The Federal Housing Finance Agency said the Home Affordable Refinance Program, scheduled to expire June 10, will be extended to June 30, 2011. Google/The Associated Press (01 Mar.) , Housing Wire (01 Mar.) , American City Business Journals/South Florida (01 Mar.)

Since values are falling, many commercial property owners will not be able to refinance. The problem is widespread too since commercial real estate loans are usually the bread and butter of local banks. Only ten major banks made up the bulk of the housing lending market. Yet, according to The Wall Street Journal, more than 3,000 banks and savings institutions have more than 300% of their risk-based capital in commercial real-estate loans. And almost $100 billion of their loans coming due in the next three years may have difficulty getting new financing.


POLITICS and TAXES:

Combined, corporate tax withholdings and individual tax withholdings, these two items posted a multi year low of $34 billion, less than the previous recent low from February 2009 when the first leg of the Greater Depression was allegedly at its zenith. So, there is less tax revenue this year, judging from February’s numbers, and more spending. Something has to give, you can’t have it both ways for long.



Taxes on your investments will increase automatically on December 31st, 2010 whether congress votes on it or not! The Bush tax cuts that lowered taxes on dividends from 35% to 15% and capital gains from 20% to 15% gains are set to expire.

Possible War strategy

Is war just around the corner? While in theory it would make perfect sense to distract Americans from the long road to US insolvency, and other more pressing issues such as the endless criminality all around us, in practice we have so far heard merely rumors. The Herald of Scotland, however, may have credible proof that a US-led attack on Iran approaches and could be just days away. The newspaper has procured proof of an arms shipment to Diego Garcia, which consists of "of 195 smart, guided, Blu-110 bombs and 192 massive 2000lb Blu-117 bombs...put in place for an assault on Iran’s controversial nuclear facilities.


USX DOLLARS:

James Turk reports that the Federal Reserve is vastly understating the growth of the U.S. money supply. Turk writes: "When deposit currency created by the Federal Reserve is added to the traditional definition of M1... M1 after adjustment is actually 170% higher at $2,918 billion. Its annual growth increases to 29.5%, nearly three times the rate reported by the Fed and, more importantly, an annual rate of growth in the quantity of dollar currency that is approaching hyperinflationary levels."

Traders call the Canadian dollar a "commodity currency." Reason is, a large portion of Canada's economy is devoted to exporting commodities. Canada is the sixth-largest oil producer in the world, and the No. 1 foreign supplier of oil to the U.S. Canada is also a major producer of gold, copper, wheat, aluminum, and timber.

This "resource factor," plus the soundness of Canadian banks, has sent the Canadian dollar soaring... while the British pound and the euro are tanking. The value of the "Candol" has gained more than 20% in the past 12 months. This is an enormous move for a major currency.

Many people would like to see a world with currencies backed by "real assets" like gold and silver... rather than ones backed by "full faith and credit." That might happen someday. But for now, the Canadian dollar is about as close to a "backed by hard assets" currency as you can get. This underpinning of value supports the uptrend you see below.





Canadian dollar jumps well above 98 cents against the US dollar,
And we have gone from peak oil prices, to the housing crisis, to the commercial mortgage crisis, to a currency crisis. Go figure!

What’s going on?

The commitment to low rates in both Japan and the U.S. reflects a competition for the honor of having the world's premier carry trade currency. Why would they/we do that? Countries with low interest rates attract borrowers, who then sell the currency to invest in assets in other countries. The currency sales keep the carry trade currency relatively weak.

A weak currency inflates the value of assets within the carry trade country, so it functions as is a good substitute for inflation during a period when there is no real economic growth. That is the case in Japan and the U.S. at this time. In an asset-based economy (where people's net worth is leveraged to real estate and stocks) it creates the illusion of improving prosperity.


REGULATORY SUPERVISION:

Not even the most wild-eyed "conspiracy theorist" could have imagined the rampant criminality that characterizes Wall Street and the Federal Reserve today. This 11-minute clip is headlined "Why aren't these guys in handcuffs yet?"... and is definitely worth your time. The link is here.

Merrill Lynch says it warned regulators about LehmanFormer executives at Merrill Lynch said they notified officials at the U.S. Securities and Exchange Commission and the Federal Reserve about an issue related to the way Lehman Bros. was calculating a measure of its financial health. The executives said they contacted regulators for competitive reasons as they were coming under increasing pressure from investors and trading partners about their liquidity. Financial Times (tiered subscription model) (18 Mar.)

Inspector's report casts doubt on SEC's effectiveness
H. David Kotz, inspector general for the U.S. Securities and Exchange Commission, released a report that casts further doubt on the ability of the agency to oversee and police Wall Street and public companies. Kotz scrutinized the SEC's decision making in regard to launching investigations. "The SEC needs to open investigations based on evidence, rather than unsupported allegations, so as not to waste the agency resources and focus needed for investors and market integrity," said Sen. Charles Grassley, R-Iowa. The Washington Post (23 Mar.)


GOLD:


Over the last six months, we've seen gold outperform long-dated U.S. Treasuries by roughly 15%. I expect this trend to continue and accelerate over the next six months as the Fed stops supporting the U.S. Treasury market at the end of this month.
The man who earned $1 billion in a single day betting against the British pound in 1992 has just raised his bet against the dollar and all paper currencies by a staggering 152%!

According to Bloomberg, George Soros has more than doubled his gold holdings in the last three months of 2009, increasing his stake in the yellow metal by 152%.


QUOTES OF THE MONTH:

“Government is not the solution to our problem. Government is the problem.” – Ronald Regan 1980

“Rising prices of precious metals and other commodities are an indication of a very early stage of an endeavor to move away from paper currencies...What is fascinating is the extent to which gold still holds reign over the financial system as the ultimate source of payment.” - Alan Greenspan, 9 September 2009

"If core sovereigns such as the U.S., Germany, U.K., and Japan 'absorb' more and more credit risk, then the credit spreads and yields of these sovereigns should look more and more like the markets that they guarantee. The Kings, in other words, in the process of increasingly shedding their clothes, begin to look more and more like their subjects. Kings and serfs begin to share the same castle." - PIMCO Chief Investment Officer and "bond guru" - Bill Gross

“Gold is quietly, at the edge, becoming the world’s second reservable currency, supplanting the euro and rivaling the dollar. [This] trend shall continue months, if not years, into the future.” - Dennis Gartman The Gartman Letter, 18 March 2010

Population...



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, my colleagues, 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. It has been said, "When you take stuff from one writer it's plagiarism; but when you take it from many writers, it's research." In reference to my sources this month, they include in no particular order:

Chris Wood, Monty Agarwal, Brian Hunt, Chris Weber, Tyler Durden, Greg Spears, Mike Larsen, Darius Guppy, Martin Weiss, Doug Casey, Porter Stansberry, Justin Ford, CNBC, Financial Times, Bloomberg, New York Times, Washington Post, Wall Street Journal, Xinhuanet, American City Business Journal/South Florida.