Decline and Fall of Western Civilization

is this a depression?

2012-01-10T13:01:00.007-06:00

the answer is yes -- but the claim is heavily reliant on definition.

so what is a depression? i would argue that the condition of depression -- separate from recession -- has little to do with GDP, employment rates, and the bevy of macroeconomic data that is commonplace in analyzing the national economy. standards such as a 10% unemployment rate or four or more consecutive quarters of contraction are arbitrary markers that seek to delineate recessions from bad recessions without marking a difference of type.

that there is a difference of type should now be clear. richard koo was among the first to my knowledge to articulate that difference, but with the spread of his ideas anyone paying much attention to macroeconomics should now realize that his concept of a "balance sheet recession" is not at all like a standard recession. (his latest paper on the faltering fiscal policy response is at real-world economics review.)

we might then define a depression as an episode of prolonged private sector deleveraging. and there can be no question that that is exactly the current condition, not only in the united states but virtually the entire first world.

within that episode there may well be periods of expansion as well as recession -- much like the roaring but forgotten expansion of 1933-36 or the rather more tepid US expansion of 2009 through today. indeed there is no reason that the economy of a country might not grow on a real per capita basis during a depression with the help of productivity gains.

but throughout a depression episode it must be realized that, in order to satisfy the balance of payments, the public sector must run a fiscal deficit which inversely corresponds to the private sector's newfound preponderance toward surplus (that is, savings and debt repayment in excess of investment and net exports) in order to prevent a deflationary collapse of income. if the government fails to do so -- through tax cuts or spending initiatives -- a sudden lapse back into recession is the sure and immediate consequence.

i am provoked to restate all this, much of it familiar, as i listen to the litany of 2011 retropsectives and 2012 prospectives that have accompanied the turn of the year. i've heard any number of forecasts for better and worse, but i've yet to hear one that clearly outlines the reality of the american economic situation, which is this:

if the federal government continues to run a deficit in the area of 9% of GDP, we will continue to lumber along a slow growth trend with vacillations over and under the trend as private sector deleveraging either decelerates or accelerates. this will continue until the private sector has reduced its vast debt hoard to something far more sustainable on a discounted cash flow basis -- a process likely to take many years.

if instead the federal government undertakes to reduce its deficit -- either by raising taxes or allowing tax breaks to lapse or reducing spending -- we will see private sector incomes drop, delinquencies and defaults rise, deleveraging accelerate to compound the public contraction, and recession thereby powerfully return as the deflationary circuit broken by 2009's ARRA spending reasserts itself.

in other words, the economic forecast for the united states in 2012 (and 2013 and some years beyond) hinges entirely on the political calculus of washington. any and all such forecasts are entirely reliant on that one factor.

updated: the most important chart in the world

2011-09-22T14:35:00.004-05:00

an update on what i deemed in october 2008 to be the most important chart in the world, via ed harrison of credit writedowns.

we have a long way to go.

food stamps

2010-12-08T16:06:00.003-06:00

with SNAP enrollees as a ratio of the total population, expressed as a percentage of the forty-year mean ratio. we're clearly in uncharted waters, particularly when you consider that food stamp enrollments were subject to welfare reforms and the secular trend in enrollment was probably down going into the financial crisis.

the hidden message of the consumer credit statistical release

2010-12-08T13:29:00.009-06:00

yesterday saw the federal reserve's g.19 statistical release on consumer credit. some have noted the rebound in consumer credit off the worst months of 2009 with a measure of hope regarding consumer balance sheets. and indeed yesterday's headline showed further improvement, making for a positive three-month average change in overall consumer credit outstanding.

but there's a fly in the ointment, it would seem. one of the sticking points of the release to me was the massive growth in "student loans" -- running at over 80% year-on-year, an expansion of a very material $120bn. this is a stock, not a flow, and the idea that the amount of outstanding sallie mae loans had nearly doubled in a year is silly. so the question became what was driving the anomaly?

with the help of @Alea_ i managed to track down the difference. via firedoglake:

The Federal Family Education Loan program (FFEL) allows private financial institutions to provide students with loans, but the government assumes the risk of default, and pays the financial fees while the student attends college. This amounts to privatized gains combined with socialized loans. The CBO found that compared to the William D. Ford Federal Direct Loan program, an alternative system in which the government just directly provides students with loans, FFEL loans cost the government 10 to 20 percent more (PDF). Eliminating the unjustified subsidies and government financial backing for the FFEL program by expanding the existing direct loan program is projected to save $67 billion over the next decade.

Under the FFEL program, financial institutions like Sallie Mae, Bank of America, National Education Loan Network (NELNET) JPMorgan Chase, Wachovia, and Wells Fargo would originate these FFEL loans with students, and then sell them on the secondary credit market. In 2008, the credit market dried up, and the private lenders had nowhere to sell these government guaranteed loans. So, the government stepped in to buy up these loans and protect a program that was already a massively wasteful corporate boondoggle.

The bailout was authorized with HR 5715 Ensuring Continued Access to Student Loans Act (ECASLA). The bill allowed for the Department of Eduction to produce three different programs, the Loan Purchase Commitment Program, the Loan Participation Purchase Program, and a buyer-of-last-resort Asset-Backed Commercial Paper Conduit.

this purchase program -- which amounted to the department of education buying privately-originated student loans that were intended to be securitized but now could not be -- was radically expanded in 2009 and 2010, with a purchase amount target of about (you guessed it) $120bn. (the reporting of the actual purchases is here.)

in other words, what is being included in the g.19 as an expansion of student loans (and thereby consumer credit) is really in fact a bailout of several large banks and finance companies stuck with immovable loans.

so what does the picture of consumer credit look like with the influence of these asset purchases removed? as you can see, there's been very little letup in the pace of consumer deleveraging. the blue columns show the YoY change of unadjusted consumer credit as reported -- obviously a big collapse, but more recently an attenuated contraction that resembles recovery. the red columns show the same less the line items including student loans; clearly, there's not only no attenuation but year-on-year contraction in still picking up pace.

also of interest i think is the monthly sequential version of this same chart. we can easily see the seasonal waves of consumer credit expansion leading up to the holidays and contraction in the winter months. looking at the blue as-reported columns, late 2008 was extraordinary for its lack of holiday credit expansion, which of course shows up as the massive year-on-year contraction is was in the previous chart. ever since there's been contraction for the most part, but (as noted) attenuating through to the recent months which have shown three months of actual sequential consumer credit growth.

what's also apparent in the red columns, however, is how the ECASLA loan repurchase program has in 2010 completely distorted the true picture of consumer credit.

i've previously noted here the softening of leading economic indicators since april of 2010. i've also highlighted how the employment ratio derived of the household survey of the employment report has deteriorated markedly over roughly the same period (along with other LEI, such as CFNAI and the philly fed ADS). now we can also see that consumer debt deleveraging, after dissipating through the middle of 2009, has begun to reintensify powerfully in the last few months despite being "hidden from view" by the ECASLA bailout.

meanwhile, via paper economy (h/t @merrillmatter), we've also seen what appears to be a reintensification of deleveraging in the commercial paper market. and we're seeing evidence of renewed downturns in both commercial real estate pricing and residential house prices.

i've mentioned many times before steve keen and his three-party stock-flow model for banking economies (demonstrated here), one of the conclusions of which is that the change in aggregate demand flow is equal to the sum of the change in GDP flow plus the second derivative (or acceleration) in debt -- this is also known as the "credit impulse" formulation of aggregate demand. what the g.19 is giving evidence of is a renewed deceleration in consumer debt levels (that is, faster deleveraging) which should negatively impact aggregate demand. and that impact is, i expect, going hand-in-hand with contracting LEI and deterioration in EMRATIO.

it is also, i must imagine, behind the recent government move to initiate a second round of quantitative easing and an attempted extension of some economic stimulus measures. the administration must know as well as anyone that the rolloff of stimulus measures will be subtracting from GDP in coming quarters if they are not sustained; and that, if that rolloff is paired with a renewed deleveraging impulse, a powerful recession is all too likely. from a starting point economy that, as measured by per capita real final sales, hasn't really recovered at all, such an outcome could be politically, economically and spiritually devastating.

EMRATIO back to recession low

2010-12-03T09:11:00.012-06:00

following up on last month's analysis, this morning's non-farm payrolls release did little to assuage me on the household survey data.

on an absolute level, the EMRATIO is back down to its recession low point from december 2009 at 58.2% as household data continues to be frighteningly bad. more importantly than the absolute level, however, is the continuing steep reversion from the april high point. as was highlighted last month, EMRATIO hasn't backed off a local high to this extent without the US economy entering recession since the 1960s, a period characterized by a much higher share of manufacturing employment and therefore generally more volatile overall employment dynamics. current FRED page here, employment situation data index here.

downturns in EMRATIO tend to lead -- on the way down -- aggregate weekly hours worked, civilian employment and total nonfarm payrolls by a handful of months -- which is why and how i used it in september 2007 to help call the recession that began in december of that year.

no one, and i mean almost literally NO ONE, in the financial world is looking for the united states to return to recession now, only a few months after double dip fears ran rampant. a shot of quantitative easing and massive expansion of the ZIRP-funded, dollar-based risk carry trade wiped away many of those fears, along with relatively strong manufacturing data as production has caught up with restocking following inventory drawdowns incurred in 2008 and early 2009. but i think we're now seeing the onset of exactly that.

it's becoming clearer now that japan is well on its way into a double dip, with new orders, PMI and net exports heading south rapidly under a strengthening yen. the euro periphery and PIIGS have seen what can only be called a bond market crash in recent days, an event likely to catapult the lot, weak and stagnating economies all, into a severe double dip. with important sources of global demand like these contracting, it is hard to see how a soft US economy will not be impacted at least marginally.

but i think the bigger story is soft domestic demand, as households continue to delever rather than borrow, as government deficits succumb at the margin to first the deceleration and then contraction of stimulus spending as well as nascent austerity measures (such as the refusal of emboldened house republicans to extent unemployment benefits, an imminent shutoff of $80bn annual systemic income spigot). the framework established by richard koo would see even mild reductions in government deficit spending support of systemic income as both deflationary and recessionary, and i expect some of both. pictured here are real final sales as denominated by civilian employment (in red) and by total population (in blue). while sales have picked up from the low point of the recession, that expansion has only really kept pace with population growth off the low. meanwhile, the income recovery driving real final sales (as reported in the BEA's personal income report) have clearly been dependent on a massive expansion of transfer payments as well, which helps explain what looks like a large jump in spending per employed person. with congress now refusing extensions that would maintain this expansion and with an eye on transfer payments of all kinds, we need payroll and compensation growth to sustain income. (for context, transfers are have jumped from about 22% to 29% of the size of compensation received during the recession. PCTR is also up over 18% of personal income from 14%. cutting off extended unemployment benefits probably step-change reduces the flow of personal income in the area of 1%.)

as mentioned earlier, manufacturing has been restocking drawn-down warehouses throughout the economy after 2008's "sudden stop" in production, but that catch-up is now all but over. i think soft demand is now feeding through the manufacturing chain, showing up in some fattening inventories and softening new orders. we're already seeing examples, such as DRAM pricing, of supply simply exceeding demand after the restocking jolt ended.

This decrease has all happened in the wake of the PC industry suffering right after it experienced explosive shipment growth mid-year. Back in September, Samsung, the world’s number one manufacturer of memory, was one of the first to say that hubris off the back of midyear shipments growth will likely lead to supply far exceeding demand, leading to a steady decline in DRAM prices. True to their predictions, this has happened, with DRAMeXchange simply confirming this.

just this morning the census bureau's factory orders figure came in disappointing, though within the range of the uptrend. this is another metric normally led by EMRATIO to the downside, though orders usually lead EMRATIO in recovery.

which metric we're being led by at the moment is not altogether certain, and depends very much on whether a consumer-demand expansion is in the cards. i tend to think continuing disappointment in hiring in response to a lack of end demand alongside reductions in government transfer payments will exacerbate the "non-recovery" in per capita real final sales, increase the private sector's balance sheet remediation prerogative and weaken orders as recession returns.

EDIT: doug short via business insider is following the ECRI weekly leading index and wondering if it isn't also signaling recession. It had fallen below (-10), and has since recovered to (-2.4).

The question, has been whether the latest WLI decline that began the the Q4 of 2009 is a leading indicator of a recession or a false negative. The published index has never dropped to the current level without the onset of a recession. The deepest decline without a near-term recession was in the Crash of 1987, when the index slipped to (-6.8).

short also looks at the philly fed ADS business conditions index and CFNAI from the chicago fed, neither of which rebounded as strongly as did ECRI WLI (probably because they do not have monetary policy components, as the ECRI black box likely does) and both of which are behaving quite poorly in their latest readings.

the per capita recovery in real final sales

2010-12-02T14:12:00.006-06:00

as measured by those who work (in red), we're buying more than ever, as those with jobs support those without.

as measured by those who simply are (in blue), there's been virtually no recovery in spending at all.

FRED page here.

tobin's Q update

2010-12-02T09:36:00.004-06:00

doug short posts a series of long term charts of tobin's Q, calculated today from the federal reserve's z.1 release.

this chart is of absolutely no use to traders. however, for longer-term investors, i think there may be no other more useful context.

and the message is unambiguous -- since 1995, it has been an excessively risky time to be in or get into the stock market. and of course it has since been a rather wild ride, in which you would have been far better off to have been in government bonds.

of course, that hasn't been true of every cyclical iteration of tobin's Q -- see 1966-1982, for example. but it is nevertheless food for thought.

the steep yield curve of the 1930s

2010-11-09T09:51:00.008-06:00

richard shaw seeking alpha ran an article back in 2007 with a providential chart of the yield curve spread dating back to 1927.

what's worth noting is that the curve steepened throughout the deleveraging of the early 1930s with absolutely no inflationary implication, and stayed steep through the second world war. this feeds directly into the rationale of removing the yield curve from leading economic indicators during deleveraging cycles.

a steep curve is normally indicative of a large spread to be harvested by banks if they have the wherewithal to lend. lending growth drives growth in financial assets, income and aggregate demand, and can indeed foment inflation if such growth outpaces capacity. as such, it has a rightful place among leading economic indicators under normal circumstances.

but "normal circumstances" is very far from where we are today. other factors in a balance sheet recession -- notably the lack of private sector loan demand as the private sector attempts to improve balance sheets and the lack of borrowers creditworthy on the stricter standards of banking resultant of banks protecting themselves from further losses -- are driving net financial assets down in a secular deleveraging. and there can be little doubt that we are in fact deleveraging.

ft alphaville highglights the steepening US curve along with a multifaceted take on how the shape of the curve could influence bank behavior, but the critical observation remains that there is no loan demand -- that is, loan demand is net negative, with the private sector preferring even with very low interest rates to reduce debt -- meaning that the steep curve the federal reserve is trying to engineer will have no beneficial effect.

LEI deconstructed, update

2010-11-08T10:48:00.004-06:00

following on standard analysis previously discussed, conference board leading economic indicators (.pdf) with monetary factors removed continued to deteriorate in september.

here also is the component contribution breakdown, month-by-month. top chart is the "real economy" factors, bottom the excluded "monetary" factors. obviously the distorted yield curve has been the primary difference.

EMRATIO issuing a warning

2010-11-05T09:42:00.006-05:00

i've already gone through a bear case for leading indicators, and that remains unchanged. now i want to examine another indication of economic weakness that played a major role in forecasting a recession in september 2007 -- EMRATIO.

the bureau of labor statistics publishes the ratio of its estimate of the employed population against the total population of the country on a monthly basis in the non-farm payrolls report that was released this morning. while the headline figure of payrolls was a positive surprise, the EMRATIO, as it's known, headed lower alongside labor force participation, retreating to 58.3%.

this is, incidentally, down from a highwatermark of 64.7% in 1999 and 63.5% in 2007 -- the implication being, in a country of nearly 300mm souls, over 15mm people have lost their jobs (voluntarily or no) since the start of the depression.

anyway, it is the change in EMRATIO that can act as a convincing indication of the onset of recession. EMRATIO has now fallen about nine-tenths of the percent from its april peak reading. this graph illustrates all comparable declines in EMRATIO from a local peak back to 1966.

as you can see, EMRATIO hasn't backed off its local peak to this degree without entering a recession since the mid-1960s. and it is worth noting that the united states was a very different kind of employer fifty years ago than it is today -- while manufacturing output has remained around 15% of total output over the years, the fraction of the workforce employed in the highly-cyclical and therefore more-volatile manufacturing sector has been radically reduced by mechanization. in other words, in a service economy the level of employment tends to be somewhat stickier -- it was easier to generate a drop in EMRATIO in the 1960s than today, and the volatility of the series back then reflects that.

so what are the possible positive spins of this development? the onset of the retirement of the baby boomers -- a person born in 1945 turned 65 this year -- is likely to tip the trend down in EMRATIO as a product of natural demographics. so it is likely that dips in the ratio will be steeper than was normal for the period from 1970 until recently. there's also been reports of significant migration out of the united states of foreign workers from latin america as jobs have become very difficult to find, changing the cost-benefit of leaving one's family. to the extent that such people are captured by the report, that exodus might have an effect on EMRATIO, though it would be difficult to quantify.

but it's also worth noting that these effects, regardless of their source, still represent a relative decline in the number of workers in the united states. many have cited the ageing demographics of japan as a contributing source of their twenty-year economic malaise and the repeated and persistent disappointments that have characterized it, helping to drive the deleveraging of the yen economy. just because declines in EMRATIO may not be entirely a result of net corporate firings does not make them economically positive.

moreover, consider that if a lack of available labor was really the driving force behind the drop, one would expect to see accelerating costs of employment as well as jobs-hard-to-get measures being relatively low. clearly that isn't the case now. to the contrary, the pace of increase of average hourly earnings YoY is near a local low (EDIT: krugman makes this point today as well) while the conference board survey of consumer confidence indicates "jobs hard to get" rose in the most recent report to 46.1% of respondents, stubbornly high and near its cyclical peak.

all things considered -- particularly in the context of very slow and fading real final sales, the consumer metrics institute leading data and the leading economic indicators excluding the yield curve -- this contraction in EMRATIO is guilty until proven innocent. we can all certainly hope for a benign outcome, but my expectation continues to be for a return to recession (and possibly a surprisingly deep one) in coming quarters.

the task of depression is margin compression

2010-10-14T08:26:00.004-05:00

serious economic downturns can be characterized any of inflation, deflation or price stability. what they all have in common is margin compression -- where the change in the price level of raw inputs and unleveraged assets rises relative to the price level of finished goods and leveraged assets. while many consider the great depression of the 1930s to have been a deflationary event (and it surely was) it is instructive to note that commodities deflated by far less than finished goods, and those by far less than the value and income generated by financial assets. what made the economy of the 1930s so destructive was the inability of businesses, beginning in late 1930, to sell products in any meaningful quantity at prices that covered their cost of manufacture. this has been true in every serious depression to my knowledge.

today, the federal reserve is attempting -- brazenly -- to raise the general price level of the economy as a whole by exchanging financial assets with the private sector, substituting income-generating instruments for newly-created cash reserves. this is an effort to undo some of the tremendous balance sheet damage in the private sector, as well as improve terms of trade for american exporters (as the trade value of the dollar is expected to fall under such circumstances). an examination of the fed's h.4.1 will show that the size of the fed's balance sheet continues near an all-time high of $2.3tn. more asset purchases are likely underway -- the fed's POMO schedule of acquisitions continues relentlessly, and an explicit program of quantitative easing is expected in response to ongoing economic weakness.

here's why i think the fed may be forced to relent.

the leveraged asset market that the fed would like to raise from the dead it cannot touch. housing is titanically oversupplied, and the fed's efforts to cheapen rates have served mostly to increase the percentage take of the banks in refinancing rather than increase purchasing power of new buyers.

chris whalen spoke on this point sharply last week. banks used to take a half-point in loan-making; now they are taking 400-500bps in an effort to raise their income. little or no economic benefit is flowing to the borrower at this point from declines in long-end interest rates. moreover, because of ZIRP, the actual cash flow through the banks is declining precipitously -- while interest margins remain wide, dollars earned are shrinking. this as non-interest expenses -- the cost of foreclosing on millions of delinquent loans, which is turning banks into REITs -- is exploding. whalen forecasts the large banks (JPM, BAC, WFC) to actually go cash flow negative in the next six months (though the suspension of foreclosures thanks to the surfacing MERS lien perfection issue may delay this).

the upshot is that borrowers can no longer refi in large numbers to their benefit, and banks are in no position to make new loans to purchasers. there is little benefit from QE here except to the banks' balance sheet.

on the commercial side, with a large output gap, high unemployment and significant unutilized capacity, there is no prospect of wage inflation -- average hourly earnings have not rebounded. without real final sales approaching something like strong growth, companies that are in a position to borrow to either invest, hire or raise wages have little incentive to do so. what capex growth that has been seen recently has been largely self-funded and from depressed levels; what borrowing that exists is being done in the corporate bond market, largely refinancing to cut down the income stream to creditors.

the result is that systemic income growth is dependent almost entirely on government fiscal stimulus -- a significant portion of which has flowed overseas through our again-growing current account deficit. the lack thereof has aggravated the decline in systemic credit as few borrowers either want or have the cash-flow capacity to increase borrowing as income remains sparse -- quite the opposite -- and has pushed borrowers toward default.

but the effect of the fed's actions on inelastic raw inputs is another story altogether. anyone looking at the commodity markets can attest to the power of the fed to spark speculative fervor with zero rates, cash substitution and debasing intentions. in spite of record stocks in storage thanks to depressed demand, oil is trading over $80/bbl. yet less elastic agricultural commodities have put in a far more impressive advance. this is where the fed's activities have been felt, and a reflexivity loop all but ensures that, for so long as the fed continues, a large part of its liquefaction will flow into raw inputs. there is already talk of popular unrest and the prospect of food riots in emerging markets.

so this is what the fed is accomplishing. it can do little to overcome the continuing deleveraging of the private sector as banks shed loans, which continues to drive down property prices. it can do little to increase income in the economy -- indeed, by increasing the take of banks in an effort to offset their as-yet-unrealized losses, it is redirecting income from the private sector into loss cancellation to the tune of $750bn a year on whalen's estimate, with deflationary implications offset only by expansive fiscal deficits. but, by devaluing the currency and encouraging speculation in raw inputs, it has raised the operating costs of the private sector (households and businesses alike) significantly within the dollar economy.

in short, the fed seems to have become a vehicle of margin compression and profit destruction -- increasing costs relative to revenues, reducing income, amid a deleveraging cycle.

if this policy is pursued further, we may well see margins compress further as commodity prices rise relative to all else while income stagnates or falls, driving huge numbers of private sector participants cash-flow negative and into bankruptcy. i've sometimes said before, with respect to the inflationary implications of QE, "call me when the fed balance sheet gets to $10tn" -- and in light of the above reasoning it's frightening that, as noted by ed harrison, paul krugman gets into the same ballpark. taken up something on the order of that target, i don't expect quantitative easing to avoid or even curtail bankruptcy and depression. the work of depression is margin compression -- and QE may be less a deterrent to that than a facilitator.

and all the while, there remains the latent but significant risk scenario that such moves will spur capital flight from the united states.

LEI deconstructed, update

2010-10-08T15:31:00.005-05:00

i haven't run this analysis in a year's time, but it's worth updating now. on twitter i've become vocal in the belief that the united states is headed into a severe double dip that will end all reasonable debate as to whether we are or are not in a depression. the theoretical basis for the notion emerges from the work of richard koo, whose framework of a balance sheet recession leaves little room for expansion given the rolloff of fiscal stimulus spending. i've further been amazed and disturbed by the continuing development of steve keen's stock-flow macro model, which has made enormous strides in the last year.

but, while theory is fine for hypothesis, there is no substitute for evidence. unfortunately there's been enough to convince me.

i last mentioned here the consumer metrics institute's GDP predictor in march. it has since marked out a horrifying path of collapse since peaking in october of last year (coincidentally about the time i last updated this study). CMI has helpfully overlaid the continuing contraction in their real-time transaction data atop the 2008-9 recession in this chart, to frightening effect. this is not theoretical exposition; a large decline in real transactions of consumer goods is behind this movement. i see this as confirmation of thesis.

a second confirmation emerges from a deconstruction of the ECRI's leading indicators on the methodology previously described. with a broken credit mechanism -- total loans and leases is still declining, as it has been for two years now -- and unprecedented federal reserve bank intervention in funding markets, i feel a handful of the LEI components -- yield curve, m2, stocks and the consumer expectations that largely follow stocks -- probably represent broken signals better designed for standard post-war recessions than the depression we're experiencing.

removing their contribution to the LEI reveals the weakness of the stimulus-fueled inventory cycle "recovery" of 2009-10. moreover, for much of this year, the "real" component aggregate was demonstrating outright contraction, with the level peaking in april 2010 -- a sharp warning of an impending return to recession, even as the ECRI LEI as reported set a new high in the last reading of the series. this of course mirrors the contraction reported in CMI data.

a number of regional manufacturing indeces (philly fed, empire state) has also shown a sharp slowdown in the last two months, with inventories again starting to build -- these being coindcident-to-lagging indications of economic activity, it would seem likely that contraction in consumer activity is starting to feed back into the manufacturing chain as CMI has for some time expected. house prices have continued to decline after a tax-credit-induced respite and jobs data has also disappointed, showing little or no recovery in the labor market. i expect these data series will now begin to show more severe deterioration through the end of the year -- following the CMI data and the rate of federal stimulus spending down -- and to remain very weak until the united states government is compelled to return to accelerating deficits in order to offset the debt deflation of the private sector.

auerback on inflation and hyperinflation

2010-08-31T12:30:00.003-05:00

from the fiscal sustainability teach-in of april 2010, marshall auerback (along with a great panel in Q&A) discusses the preconditions of hyperinflation within the context of two commonly cited examples, weimar germany of robert mugabe's zimbabwe, as well as a reference to the collapse of the american confederate currency in 1865.

the upshot: hyperinflation requires real-world destruction of the ability to either produce a significant amount of goods or procure same through import. weimar lost the ruhr valley -- which employed 25% of its workforce and created most of its ability to generate foreign exchange -- while being asked to pay a colossal war indemnity in gold or foreign exchange. zimbabwe, similarly, through misguided and corrupt implementation of land reform, destroyed well more than half of its ability to produce food. the confederacy was invaded and unable to prevent the destruction of most of its production capacity as well as its ability to tax.

literally none of these preconditions now exist in the united states or indeed any western state with a self-directed currency. barring the breakdown of civil order removing a huge slice of american productive capacity, hyperinflation is not a realistic outcome of our situation -- which is indeed highly deflationary, with systemic private sector delevering meeting insufficient government deficit spending to reduce demand, expand the output gap, and increase both balance sheet damage and savings prerogative.

that's not to say the united states will not experience bond market volatility. the dollar economy has long run a current account deficit that has rendered the american banking system dependent on foreign deposits for funding. the dollar itself will likely have to fall in value against the currencies of some of its major trading partners in order to close current/capital account imbalances in the long run. but that is very far from hyperinflation or even inflation. similar events and worse befell several nations in the great depression without ever generating serious inflation.

the united states is also an industrial nation in a world that may be experiencing the onset of resource scarcity. real goods may cost more in real terms in the future as a result. this decidedly won't be a result of either fiscal or monetary policy but rather material restrictions.

the western world is trapped in the aftermath of a crushing debt bubble collapse. richard koo has termed the phenomena a balance sheet recession, and his (correct) analysis of this profoundly deflationary problem yields a solution of utilizing government spending to offset and enable private sector saving in order to break the paradox of thrift and effect balance of sectorial flows without triggering a powerful deflation to force the requisite government deficits into existence. this is not a growth strategy but a survival mechanism, a way to assist the private sector with balance sheet repair.

we ignore it to our peril -- as we are beginning to see, now that government fiscal stimuli put in place in 2009 are waning and economic weakness is rapidly returning.

and yet ignore it we will. as befits the social mood of deflation, austerity has become the watchword not only for households and businesses but wrongheadedly for governments as well. a public which incorrectly thinks sovereign finances are just household finances writ large demands as much. that, in a democracy, means very little fiscal policy response is likely at least between now and november's elections.

by that time, if my expectation is met and no further expansionary fiscal action is taken, i expect the united states will be deeply mired in a shocking economic contraction that will exceed the frightening expectations of even the pessimists -- and the question as to whether or not we are in fact experiencing a global depression will be altogether resolved.

consequences of a shift in carry trade funding

2010-05-11T15:26:00.008-05:00

minyanville:

Chances are no one will remember where they were or what they were doing on August 24, 2009, when three-month dollar LIBOR traded under three-month yen LIBOR, or on March 5, 2010, when the situation reversed and yen once again became cheaper to borrow. These dates are marked with green and magenta vertical lines, respectively, in the charts below.

The yield inversion of August 2009 was critical for the continuation of the global bull market; not only did it open the much larger pool of lendable American funds up to global yield hogs for purposes of investment and general merrymaking, it opened up global carry trades to the even larger pool of lendable Chinese reserves. The switch in funding for these carry trades had some adverse effects on Japan, including an unwelcome appreciation of the yen and a rise in its sovereign CDS costs.

The return trip in March preceded the incipient move by China to revalue the yuan by about three weeks; this is a coincidence as much as Pearl Harbor or 9/11 were accidents. All previous moves by China with respect to the timing and pace of yuan levels have been choreographed carefully behind the scenes with us, inter alia; those who protest that this is not how things should be run in a democracy are advised to grow up and stop dreaming.

Once the yen became cheaper to borrow, dollar/yuan-based carry trades started to be unwound. Unfortunately, this unwind intersected with the euro’s weakness, and the unwinding of carry trades into the euro zone and related blocs started to feed on itself as these unwinds always do. Put a lot of corn in a yield hog’s mouth and you will be um, amazed, at journey’s end.\

The linkages between the yen carry trade into the euro and global bourses (I love that word. Bourses, bourses, bourses, bourses) became very direct after mid-2007 when global interest rates started their decline toward zero and all assets started to become priced in ersatz money. They weakened somewhat between August 2009 and March 2010 as the dollar became cheaper to borrow, but things have reasserted themselves over the past two months. ...

... [W]hat is going on outside of your window is an unwinding of global carry trades produced by central banks’ collective belief that pushing rates to zero, counterfeiting their own currencies, and encouraging risky behavior is the answer to all problems. Maybe they believe past performance does not predict future results.

beyond driving the value of the dollar as the currency was first sold heavily on the international market to fund the trade, tapping much larger reservoirs of funds sparked a huge second leg in emerging market risk assets. for example:

the yen too is clearly driven by the carry trade, and was in process of funding a heavier share of it when the eurozone contagion exploded.

the transfers of funding in these trades clearly take time, and both currencies fund risk asset purchases. but what the expansion of the trade to dollar funding, first with the arrival of ZIRP in the US and then the yield cross described above, also may mean is that the unwind in progress has further to run, possibly much further. the exuberance of both USD and JPY in recent days hints as much -- both currencies fund quite a lot of third-market assets, and the carry trade is far larger than it ever was or could have been when it preoccupied me prior to 2008.

it's also clear that large traders -- see red lints in COT data beneath currency charts -- anticipated these shifts in carry trade funding and positioned accordingly.

extension of the egalitarian defense

2010-03-29T09:39:00.006-05:00

james livingston's articulation of how societies with concentrated wealth maldistribute their way into vulnerability was one of the more memorable posts of the last few years to my mind (subsequently referenced here here here and perhaps especially here).

an additional effect of wealth concentration was today postulated at naked capitalism, titled 'high income disparity leads to low savings rates', which goes over the notorious research from citi citing the rise of an american plutonomy. from citi:

In a plutonomy, the rich drop their savings rate, consume a larger fraction of their bloated, very large share of the economy. This behavior overshadows the decisions of everybody else. The behavior of the exceptionally rich drives the national numbers – the “appallingly low” overall savings rates, the “over-extended consumer”, and the “unsustainable” current accounts that accompany this phenomenon….

Feeling wealthier, the rich decide to consume a part of their capital gains right away. In other words, they save less from their income, the wellknown
wealth effect. The key point though is that this new lower savings rate is applied
to their newer massive income. Remember they got a much bigger chunk of the
economy, that’s how it became a plutonomy. The consequent decline in absolute savings for them (and the country) is huge when this happens. They just account for too large a part of the national economy; even a small fall in their savings rate overwhelms the decisions of all the rest.

an extension of this postulate is that societies with high wealth disparities should can tend to run high current account deficits, as low savings drives a need for capital importation as well as accommodating high consumption. this, citi feels, is reflected in the data.

ponder for a moment the deeply-held sentiment, explored by richard duncan, that imbalances in the current and capital accounts are what drive global debt bubbles and concomitant busts, and citi's ruminations amount to another avenue of indictment for excessive wealth concentration -- and perhaps further a rational impetus for a measure of redistribution.

alternatively, we might instead simply wait for an L-shaped financial markets crash to disproportionately destroy the wealth and income of the wealthy.

booms and depressions since 1775

2010-03-24T12:00:00.002-05:00

via big picture, a link to a chart in 'business booms and depressions from 1775', published 1944 and archived by FRASER.

intermediate-term downturn/consolidation prospects

2010-03-12T10:09:00.006-06:00

i won't attempt to defend this. it is a weekly closing price screen of the nasdaq 100 components showing the percentage of issues trading either above (demand, green), below (supply, red) or net of (demand-supply, yellow) their volatility envelopes. i've highlighted with green lines positive divergences which indicate institutional accumulation/waning downside momentum; vice versa with red lines. circles indicate points following such divergences where the spread between the demand-supply line and its moving average starts shifting down meaningfully.

the last upturn circle in the series registered in the last week of march 2009. the most recent downturn circle PROVISIONALLY registered in the second week of february 2010. its possible demand moving higher here plays out as it did in 4q2007 with a final bump up in price before weakness materializes. i am definitely drawing that final circle with a measure of anticipation, which could easily be reversed.

but i also do so thinking the probability is good that one will have an opportunity to buy the market at lower prices at some point in the intermediate-term future.

this is not foolproof. it doesn't mean there's a crash coming. even if the signal plays out it might mean a noisy multimonth consolidation of some kind, a la 1q2004-2q2005. but that's what i think i see.

consumer metrics institute daily growth indicator

2010-03-11T15:19:00.005-06:00

via clusterstock, the work of the consumer metrics institute.

Although McGuckin et al indicated that the above problems had been addressed in 2001, it is clear that the statistical methods still used in constructing the LEI differ substantially from the experiences of real people in the real world. The Consumer Metrics Institute exists to provide alternative and more timely approaches to leading indicators, using the demand side of the economy to move our indexes as far 'upstream' as possible.

their march 8 commentary:

The contraction that began on January 15th in the 'demand' side of the economy moderated somewhat over the prior week. As we have mentioned before, the two most recent prior contractions behaved very differently. In 2006 a contraction event was relatively shallow and resulted in the GDP growth rate bottoming at a very meager but positive .1% in the third quarter of 2006. In contrast to that mild event, the 2008 'demand' side contraction reached an annualized 'growth' rate below -6% at the end of August, 2008, with the 'production' side GDP subsequently bottoming at a -6.4% annualized contraction rate during the first quarter of 2009. These two contraction events registered very differently in the equity markets: the 2006 event was largely ignored, the 2008 event was not.

To help investors understand the nature of the current 2010 contraction event, we have constructed a new chart (the "Consumer Metrics Institute's Contraction Watch" chart ~~above~~ here) that shows the first 90 days of the 2006, 2008 and 2010 events superimposed (with the 2010 event still less than 60 days old at this time). Clearly the 2006 and 2008 events look different. We will be able to watch the 2010 event unfold on a day-by-day basis over the next 6 weeks, and the chart should provide us with a much better idea of how it compares with its two predecessors in an almost real-time mode.

By March 6th our 'Weighted Composite Index' completed an extraordinary two week round-trip excursion from essentially neutral readings to nearly 5% year-over-year contraction and back again to neutral. Again the two weakest sectors we monitor were Housing and Retail. The Housing Index (chart on left below) continued to bump along with a very nearly double-digit year-over-year shrinkage in consumer demand, with the Home Loans Sub-Index having shrunk to the lowest level recorded since September 2008. And by March 6th the Retail Index (chart on the right below) had returned to levels indicative of a greater than 6% year-over-year decrease in consumer demand. This number is substantially different from the self reported sales figures from the retail industry, which suffer from 'survivor bias' as a consequence of focusing on 'same store sales in stores open at least a year'. The closing of select stores or entire chains are simply unreported, while the traffic shifted to remaining stores generates a positive spin. Our substantially more negative numbers, however, have been matching sales tax collections, which have no survivor bias. We believe our internet based sample is a fair representation of the entire 'demand' side of the economy, and the sales tax numbers seem to confirm that conclusion.

worth following, i think. of particular pragmatic interest is this.

is the consumer relevering?

2010-03-09T14:53:00.003-06:00

via econompic, if we are it isn't in the data yet.

is there a real estate bubble in china?

2010-03-09T14:40:00.003-06:00

we might get an answer in coming weeks and months.

China to Nullify Loan Guarantees by Local Governments:

China plans to nullify all guarantees local governments have provided for loans taken by their financing vehicles as concerns about credit risks on such debt increases.

China Cracks Down On The Shadow Banking System That Is Inflating Its Real Estate Bubble:

China would step up work to monitor non-banking financing, said the China Banking Regulatory Commission (CBRC) Tuesday in a statement on its web-site.

More focus would be put on businesses in connection with trust companies and the real estate sector to prevent banks from using non-banking financing to circumvent policies, said Liu Mingkang, chairman of the CBRC.

the everything indicator

2010-03-08T16:07:00.003-06:00

via james hamilton.

Of particular interest at the moment is the fact that the HHMSW index, unlike most other indicators, shows a renewed deterioration subsequent to the initial recovery in the first part of 2009, a somewhat surprising result given the current steeply-sloping yield curve, low TED spread, and booming stock market. The surprising contrary inference from the HHMSW index appears to be due to two factors. First, the HHMSW index is based on the deviation of the financial indicators from what one would have predicted given recent economic conditions. Many indicators have not improved as much as one would have expected given the return to GDP growth, and the departure from a typical recovery pattern is viewed by the index as a highly pessimistic development. Second, the HHMSW index makes use not just of the yields themselves but also of the quantities of various assets, and many of these show little improvement so far. For example, issuance of new asset-backed securities remains quite low.

welling@weeden koo interview

2010-02-12T15:35:00.006-06:00

via zero hedge -- richard koo is interviewed by the excellent welling@weeden.

Maybe. But with its massive store of savings, Japan didn’t have to worry about depending on the kindness of creditors in China and the Mideast as its bond rates scraped along at zero. The U.S. does.

The truth is that Japan was actually in that same precarious position, a decade ago. With Japanese government debt skyrocketing because of massive fiscal deficits, all of the ratings agencies, the IMF, the OECD — they all issued horrendous warnings against Japan. Japanese bond investors remember very well that JGBs were downgraded repeatedly, to the point where Japan’s debt was rated lower than that of Botswana, because the ratings agencies were so sure that at some point the whole thing would come crashing down and that interest rates would soar. But it never happened. And the reason is easy to understand, once you grasp the concept of a balance sheet recession. The amount of money that the government has to borrow and spend to sustain GDP is exactly equal to the amount of excess savings generated within the private sector of the economy. So that money is actually available within the private sector, even in the U.S., even in the U.K. And the U.S. is no longer a low savings rate country; the last statistic was over 6%, higher than Japan. What’s more, with companies also increasing their savings, there’s no “crowding out” and banks are only too happy to lend to the government, as the last borrower standing — and also because they don’t have to keep as much capital against loans to the government as they would against private sector loans, allowing the banks to rebuild their profits and balance sheets.

It sounds almost too good to be true —

It’s not. I believe that as more and more people in the U.S. realize that this is the mechanism at work, the fear of interest rates rising will be increasingly reduced, and I won’t be surprised to see long bond rates in the U.S. falling from where they are now. In any event, whether you start with a high savings rate or a low savings rate, once a country enters a balance sheet recession because the private sector is paying down debts, you end up having excess savings in the private sector and it is those excess savings that the government has to borrow and spend. It doesn’t have to borrow externally. So the U.S. doesn’t have to borrow from China or anywhere else. But because that’s contrary to the mind set for the last 10 or 20 years, it’s very hard for people to come around to that realization.

changes in employment

2010-01-08T14:32:00.001-06:00

some excellent twitter comments of late from deepfoo analytics regarding perceptions and reality regarding unemployment.

combined EUC and NSA continuing claims higher now than it has been for most of the year. SA's assuming people got seasonal work

People who are using the SA continuing claims numbers only are fooling themselves. EUC program over last year, up +2.88 million

EUC/CC data issue less a markets one & more a risk that admin will do nothing based on imprving #s, when they are getting worse

to be sure, the unemployment situation is far from the accelerating freefall of a year ago -- there is a technical recovery underway resulting from the combination of significant government stimulus, a monster inventory correction cycle following a "full-stop" in production in 4q2008, and what trader mark of fund my mutual fund cannily noted as

1 in 7 Americans not bothering to make a home payment anymore, the "self stimulus" plan should help spending incl retail

investors and financial media do not mention this stimulus period. Many Americans sit in homes without making mortgage.

what this is perhaps not, however, is a durable credit expansion and self-sustaining recovery. there is obviously a cycle afoot whereby job cuts reduce nominal incomes, incomes then reduce asset prices, which thereby make loans riskier and fuels credit contraction, which leads then to more job cuts, lower incomes and lower asset prices and so forth.

perhaps the best hope for breaking this cycle from here is a business-led investment recovery, as viewed by accrued interest.

Its not impossible. Business spending can and does occur in the absence of strong consumer demand. We know that businesses have spent very little on capital replenishment.

[T]he drop off [in non-residential investment] is much more severe this recession than in 2001 or 1991. In fact, fixed investment as a percentage of GDP (9.5%) is at its lowest point since the early 1960s (although about the same as the 1990-1991 recession.) Since 1960, the average capital spending level as percentage of GDP is 11%. In order to get capital spending up to 11%, businesses would have to increase capex by 16%! Again, this could add considerably to GDP without a serious ramp-up in consumer spending. In fact, I'm modeling that fixed investment adds something like 1.1% to GDP in 2010.

Bottom line: I think GDP grows above 4% on average in 1Q and 2Q 2010, then drops off a bit into the mid 3's for the second half.

this (or any) kind of expansion has to translate at some point into job recoveries if incomes (and not just profits) are going to be bolstered and the housing market slowly recover -- and that is the key operation, as without a housing market recovery (or at least stabilization) of some kind loan performance at banks will continue to deteriorate and send hundreds if not thousands more banks to the FDIC. moreover disposable incomes will continue to erode and final end-user demand -- to which the corporate sector is mostly a leveraged passthrough -- will decline, undermining any recovery effort.

in short, if we're going to avoid a double dip that will remove all doubt that we are in a depression, this business-led recovery that creates household income has to come off in spite of massive excess capacity. (and probably more, such as principal reductions for underwater debtors handcuffed to further government recapitalization of banks damaged thereby.) wall street is clearly pricing in not only that recovery but (to judge by the stock market, if it is in any way linked to the fundamental economic backdrop at all) that the profits of the recovery will be retained for the benefit of the capital structure and therefore shareholders. that likely won't suffice for a durable recovery.

so if employment growth is key to stabilizing and repairing the economy, getting the proper picture of employment is critical. zero hedge and paper economy both take up the issue of the unemployed falling off continuing claims rolls as their benefits expire. much has been made of the slow improvement in initial jobless claims, but that is still quite far from improving employment. adding unadjusted (so as to nullify the seasonal adjustments which, as deepfoo notes, are very likely inappropriate under these circumstances) continuing claims with extended claims we can see that the ranks of the unemployed receiving benefits are near all-time highs, over 10.6mm in december.

and that isn't the total. there's a difficult-to-assess number who have fallen outside the boundaries of these benefit programs as well, whose incomes have gone missing. henry blodget relays the new york times:

About six million Americans receiving food stamps report they have no other income, according to an analysis of state data collected by The New York Times. In declarations that states verify and the federal government audits, they described themselves as unemployed and receiving no cash aid — no welfare, no unemployment insurance, and no pensions, child support or disability pay.

Their numbers were rising before the recession as tougher welfare laws made it harder for poor people to get cash aid, but they have soared by about 50 percent over the past two years. About one in 50 Americans now lives in a household with a reported income that consists of nothing but a food-stamp card.

that's a further two million people who have been pushed outside the margin by the depression. and there's more. many older workers have been pushed into retirement sooner than they would have expected or liked, and are taking a hand in bringing forward by several years the inflection point whereupon social security has become a cash flow drag upon the federal government finances. there are also legions of newly-minted workers fresh from school with very few job prospects and no claim on any benefit.

i've tended to look at EMRATIO (which is seasonally adjusted, bear in mind) to get a better picture of the problem than tracking the unemployment rate. as a ratio of total employment to total population, it isn't perfect -- but it does avoid some of the sampling pitfalls that come with trying to count what isn't there. EMRATIO is still collapsing hard, returning to levels not seen since before women really started to enter the workforce, and shows that some 5% of the population which was working in 2007 today is not. in a country of 310mm people, that's 15.5 million. and still growing rapidly.

and that's still not all. as calculated risk highlights again this month, employed part time for economic reasons is at stunning highs of over 9.2mm. there are some 5mm people here who have had their wages and hours cut, in most cases severely, from two years ago which the economy would have to re-employ to bring incomes back to former levels.

others have also commented on the immensity of this problem for a society that hasn't sustained growth of 3mm jobs in a year for over a generation. even in the unsustainable bubble economy of the 1990s -- the fastest payroll growth rate period in living memory -- the united states averaged about 2.8mm. indeed its questionable as to whether a new layer of structural, or permanent, unemployment has been created. and i myself (with apologies to accrued interest) am doubtful that the inventory correction cycle will extend into a lengthy business-led recovery with the kind of damage being wrought to the job-creating small business engine of this country by the contraction of the banks. ed harrison helpfully points out that recalculation may mean persistent unemployment as malinvestment is unwound and the labor force retrained, but of course that creative reorganization of resources can trigger deep depressions following massive misallocations such as we saw over the last several years.

fearsome as it is, at least having a robust picture of changes in employment beyond the headline unemployment rate reported by the BLS will help discern whether job growth is helping to get us out of the trap.

iraqi oil production plans

2010-01-06T13:00:00.004-06:00

via clusterstock and the oil drum:

There is a great deal of controversy about the potential of Iraq's western desert, which is largely unexplored. IHS has claimed that there might be as much as 100Gb there in addition to the known reserves, but since none of this has been confirmed with drilling, it remains speculative (and Laharrere for example doesn't accept this estimate). Big Gav had an Oil Drum post Iraq's Oil: The Greatest Prize Of All? some time back with more background.

However for my purposes today it's enough to note that even if there is only 90Gb, with an initial 5% depletion rate (in line with industry practice) that could support a rate of 12 million barrels/day (the depletion rate is what fraction of the known reserves are produced in a year). So the announced Iraqi plans would not seem to be precluded by lack of reserves. As we will see below, the field by field reserve estimates and production plans that have been made public also seem generally consistent with the plan.

again, this is why the united states got into, is in and will never leave iraq, which will remain an imperial protectorate of the united states until or unless someone dislodges it by force or the oil is gone. iraq was invaded using terrorism as a very flimsy pretext in order to take the high ground in a resource war which the plateauing of global oil production has made inevitable. setting aside all other arguments, saddam hussein proved to be a terrible developer of what are probably the world's last underutilized easily accessible large oil resources -- and primarily for that reason in the context of the production plateau was removed and put to death.

This next graph shows annual average Iraqi oil production over the long term - since the beginning (with a gap for 1956-1964 which falls between my two data sources). I deliberately made the y-axis scale run from zero to 12 mbd to emphasize that Iraq has never produced anywhere close to its potential.

Production was increasing rapidly and roughly exponentially until 1979 when Saddam Hussein took power. Since then, it's been one war or crisis after another, and production has never even reached the 1979 level again, let alone continued up close to the now proposed 12mbd.

god knows if ethnically-divided iraq is capable of staying out of civil war in order to make the announced production plans workable. i would expect the united states to step into iraqi affairs whenever necessary from its entrenched military base set within the country to make it possible for the oil majors to do their stuff. but the political divisions within the country haven't gone away. the mahdi army remains there. and one should expect that western confrontation with iran could result in a rapid destabilization of iraq.

what does negative net national savings mean?

2010-01-05T12:13:00.005-06:00

mike mandel published this disconcerting blog post recently which includes a depressing chart of net national savings -- that is, the aggregate of private and public sector savings as a percentage of GDP.

what does this mean?

it's often stated, particularly loudly by keynesians wary of debt deflationary spirals, that the net fiscal surplus (deficit) of a currency union (such as the united states) must be zero. for example, ed harrison:

Simply put, if you look at all of the households and businesses that make up the private sector and aggregate them together, you can determine if the private sector has a net surplus or a net deficit in any individual time period. And if the private sector has a net surplus, the combined foreign sector and public sector must have a deficit for that time period. The sector financial balances move in concert.

harrison cites scott fullwiler.

Most importantly, the economy’s financial flows are a closed system, so one sector’s deficit is another’s surplus, and vice versa. There is no way around it, just as it is impossible for every country in the world to have a trade surplus—at least one country must have a trade deficit for the others to have surpluses. Thus, “national saving” as defined in the textbooks (private saving + government surplus + foreign saving) is a misleading concept in our monetary system, since if the government is “saving” some other sector (or combination of them) must not be, by definition.

Private Sector Surplus or Net Saving = Government Deficit + Current Account Balance

The trade balance (exports – imports) is not the precise term to use when considering all financial flows, the current account balance is. For the US, the two very close in magnitude. We’ll call equation 3 the Sector Financial Balances (SFB) equation. Again, this is an accounting identity, not theory. Disagreeing with it is akin to believing the earth is flat. For examples of this framework directly in use on this blog, see here and here.

which is, to paraphrase fullwiler, that mandel in taking the sum of public and private savings to mean something is engaging in a mistake of neoclassical economics by conflating the two -- when in fact public saving is essentially the identical opposite of its private counterpart (less the current account balance). as such, the only meaningful measure of net national savings is the current account balance.

as mandel is trying to sum public and private sector savings, those being equal but opposite net of the current account balance, his result should then resemble the current account balance. the two graphs resemble one another broadly, but with some outstanding differences. recent months show a large contraction in the current account deficit with further "dissavings" in mandel's data. and there's also a bulge in mandel's net savings graph during the late 1990s that is not reflected in the current account balance, as well as another one between 2004-7. why?

i suspect on cursory inspection financial sector leverage. without having seen his data, mandel is aggregating government, household and corporate savings data -- but doesn't explicitly mention the financial sector, which is often separated. mandel's measure of savings is higher across the board for the period -- one of continuous financial sector expansion -- and particularly at odds with the current account balance during periods of extensive financial balance sheet growth. as such financial liability expansion also creates assets and income in a stock-flow model, which would then show up in savings, it would go a long way toward explaining the difference had mandel overlooked financial sector balances, both on- and off-balance sheet. it would further explain the lack of any "net savings" improvement since the start of the crisis -- as the financial sector was suddenly and rapidly thrown into delevering, assets were being destroyed and money disappearing from the system. the resultant loss of savings in spite of the government's best efforts could explain how the current account deficit suddenly improved while "net savings" actually declined.

fullwiler goes on to construct an sector financial balance (SFB) model of aggregate demand in figure 6 which he then applies to the leverage-based economic expansion of the 1990s.

First, the economy starts the mid-1990s at point A. The effects of previous and then new agreements between Congress and the President to reduce deficits shifts the Gov Def + Curr Acct line down, as do the financial crises in Asia that lead weakened those nations’ economies and currencies to thereby substantially lower the trade balance. However, instead of GDP falling as a result of these two leakages from aggregate demand, a number of factors including the massive rise in the stock market and “new economy” expectations leads to a historically large increase in the private sector’s willingness to leverage (which continued in the 2000s during the real estate boom after a short recession in 2001-2). This willingness to leverage shifted the PSFB (private sector financial balance) line down markedly, raising real GDP growth and lowering unemployment. The economy ends the decade at a point like B, with a government budget surplus and current account deficit combining to equal a negative private sector balance.

moving toward a new basel consensus

2009-12-29T09:24:00.008-06:00

via alea -- patience wheatcroft in the wall street journal on the reform of the basel rules.

The backlash was inevitable, and what is now being advocated is the full Taliban approach, with exposure kept to the minimum. Much more stringent capital requirements will be imposed, with strict limitations on what will qualify as Tier One capital. The capital requirements for counterparty risks arising from derivatives and securities financing will be strengthened. Liquidity minimum standards will be introduced.

Leverage will be much more strictly limited and, in a move that could have wide-ranging consequences, there will be a requirement to use the good times to build up capital buffers for when the (inevitable) bad times come.

The U.K.'s prime minister, Gordon Brown, may have regularly proclaimed that he had done away with boom and bust, but the foolishness of his rodomontade is now painfully clear and regulators will want to be prepared for the turning of the economic cycle.

That will mean that, as the committee foreshadowed in the autumn, pay outs to staff and investors will be firmly sublimated in favor of shoring up the business.

However unjust the bankers and their investors might feel this to be, the taxpayers who have been forced to provide so much to prop up otherwise bankrupt financial institutions are unlikely to be sympathetic, even though many of their pension funds have in the past been beneficiaries of dividends from bank shares. Now the call is for caution.

There is still time for the banks to continue their current fling since the Basel recommendations are only aimed for implementation at the end of 2012, and then with some element of phasing. But a new, much tougher, regime is on its way.

much of what has been going on since march last has been the desperate effort of governments to not only keep western banking afloat but to construct a temporary paradigm in which banks can accrue capital at the expense of savers, borrowers and investors in order to aid in the necessary recapitalizing of large insolvent banking institutions before the absence of once-expected cash flows renders the (hopefully) temporary suspension of prudential accounting moot. perhaps the easiest of these steps to appreciate is the use of liquidity in the reflation of asset prices -- both of equities so as to allow titanic dilutive floats of common equity, and of securitizations and lower-quality debt instruments so as to prevent large writedowns on asset books as well as provide massively profitable opportunities in trading. (junk debt, it should be noted, is completing its best year ever by a wide margin.)

such helpful extensions of the government balance sheet will surely if quietly continue. for example, perhaps the most notable development of the holiday season was the quiet removal of treasury bailout caps on fannie mae and freddie mac.

The government's decision to provide unlimited support to Fannie Mae and Freddie Mac probably presages more aggressive action to prop up the U.S. housing market.

The government may put a mortgage-modification effort, called the Home Affordable Modification Program, or HAMP, into overdrive in coming years, pushing for reductions in the principal outstanding on home loans overseen by Fannie and Freddie, Bose George, an analyst at Keefe, Bruyette & Woods, wrote in a note to investors Monday. ...

KBW's George initially found the extra support "perplexing," he said, because Fannie and Freddie are unlikely to need more than $200 billion of government money each.

During the depths of the recession in March 2009, the Government Accountability Office estimated that the bailouts of the two companies would cost taxpayers $389 billion, the analyst noted. Since then, house prices have stabilized and have begun to creep up in some areas.

Instead, unlimited taxpayer support will give the government "more flexibility in potentially taking more aggressive action to support the housing market," George wrote.

HAMP has so far had little effect on foreclosures. So the government may push for an enhanced version of the program that includes reductions in the principal outstanding on mortgages, the analyst said.

Principal reductions are controversial because they leave banks and other major mortgage lenders with bigger losses and lessened capital. The industry prefers modifications that lower interest payments in other ways, such as extending the maturity of home loans.

Aggressive reductions in principal on mortgages overseen by Fannie and Freddie could leave the companies with significant losses and cut further into their waning capital bases. But Treasury can pump more money into the institutions to make up for that, George said.

debt forgiveness is in the end just another avenue for debt reduction, and an overdue one at that. i don't imagine it will have much salutary effect on home prices, which are in the process of returning to historical discounted cash flow relations to incomes and rents -- indeed acquiescing to principal writedowns is an implicit acknowledgment that house prices cannot be returned to anything like their former level. to the extent that mortgagor might be subsequently be free to relocate without creating a credit event, it may even increase housing supply and pressure prices further.

this should impair bank balance sheets mightily, as in most cases banks have (much like fannie and freddie) avoided marking real estate loan portfolios to loss expectations which will be realized in debt forgiveness. but this can be seen as the other side of the bailout coin -- the massive 2009 government aid in recapitalization and the continuing use of the fed, treasury, FDIC and GSEs to lighten the blow by transferring debt and debt guarantees to the government balance sheet is groundwork preparing banks for the losses to come. it seems the major banks will be nursed through this transition and slowly recapitalized on the other side to comport with more pragmatic and robust post-basel-2 standards. at least, that would seem to be the plan.

but will it hold? that's the real question, and it depends very much on whether the assessment of the federal reserve, treasury and administration about the nature and depth of the problems afflicting the capital markets -- particularly of cash flows and the leverage applied to them -- are accurate. if the impairment of the banks is being underestimated (and indeed even if it isn't) the tail risk of precipitating a currency event with a debt issuance shock looms -- one that, while not constituting an event of default, may nevertheless impair american access to internationally traded commodities.

the public remarks of government officials very likely do not betray the fullness of their comprehension of the issues, given the nature of what j.k. galbraith famously called "incantation". but neither is it likely that ben bernanke grasps how inefficacious monetary policy is and will remain for so long as net loan demand is negative and banks are deleveraging, building investment portfolios or even retiring wholesale funding rather than making new loans.

i suspect the fed hopes to have kickstarted in early 2009 with very easy monetary policy a self-sustaining if mild and fragile growth cycle akin to those sparked by his predecessor, increasing incomes and thereby creating the cash flows needed to sustain asset prices and retire debt out of earnings without a massive series of deflationary writedowns. such an invention would allow both the fed and treasury to, perhaps gently and incrementally, withdraw their monetary and fiscal support without relapse.

but i fear that's probably wrong. instead, i think they are misreading a strong inventory correction which followed a near-full-stop in late 2008, one which is probably closer to its end than beginning, as growth in real retail sales is yet to be observed. indeed the most recent retail figures from the fed show flat-to-slightly-down year-over-year through november -- and this in spite of the augmentation of a series of fiscal stimuli (including the quasi-fiscal stimulus of permanent fed asset purchases) and a significant weakening of the dollar from the crisis peak, in comparison to a post-crash economy of late 2008 which had already been in recession for a year.

and here again we return to the linchpin of the entire construction -- fiscal stimulus. the household balance sheet is profoundly damaged; any foray into debt forgiveness would indicate that the government understands and accepts that. loan growth to the consumer sector is highly unlikely for some time to come. corporate cash flows depend much on household spending, and so the reduced flows that result from the move to balance sheet repair necessitate a corporate deleveraging in kind. and the banks, for their part, are eager to deleverage themselves and willing to buy riskless government debt for the purpose to retracting from risk and avoiding capital charges. into this paradox of thrift only government spending can prevent a fall in incomes, therefore deposits, therefore leverage, therefore asset prices, therefore again incomes and so forth.

without any further action, the impact of the ARRA fiscal stimulus package will be waning in all future quarters as it continues to disburse but with reduced intensity. as has been repeated ad nauseum, this will mean a diminishing impact on GDP growth reverting to a drag on GDP growth in 2h2010. so too between now and the end of the first quarter will planned fed asset purchases trail off to zero. if my presumptions above are correct, this will mean a return to the deflationary dynamics of the paradox of thrift as 2010 progresses -- which means negative GDP growth, deepening negative change in real sales, decreased employment and lower asset prices (in the case of the most leveraged assets, much lower) in a double-dip that should definitively end any semantic argument about whether or not the current economic process constitutes a depression. and that would shatter the outlook and plan of the fed to marshal the financial system back to health, incurring huge further losses in the banks and GSEs alike.

in the event, as i don't see the political will for further fiscal stimulus, i don't expect the adoption of anything like more stringent capital rules for the banks would be welcome anytime soon -- perhaps its just as well that implementation isn't until 2012, and i imagine it might be delayed more still.

the hazards of wealth concentration

2009-12-14T14:50:00.007-06:00

nathan's economic edge links to max keiser's interview with steve keen, which begins at 12:40.

i want to focus on one point brought up immediately after the start, where keen comments on the effect on velocity of the concentration of wealth.

If you have an economy with a certain stock of money turning over at a particular speed that's the level of output it can support. and if you then have a transfer of wealth from those who have to spend it very rapidly, like workers who turn their money over basically 26 times a year, and it goes into the hands of the bill gates' of the world ... then they spend far more slowly than that, turning over their accounts once every ten years, you actually slow down the rate at which money is turning over and [lower] the level of output it can actually support.

this is perhaps relevant to the postulation of the origin of the crisis forwarded by historian james livingston.

Look first at the new trends of the 1920s. This was the first decade in which the new consumer durables--autos, radios, refrigerators, etc.--became the driving force of economic growth as such. This was the first decade in which a measurable decline of net investment coincided with spectacular increases in nonfarm labor productivity and industrial output (roughly 60% for both). This was the first decade in which a relative decline of trade unions gave capital the leverage it needed to enlarge its share of revenue and national income at the expense of labor.

These three trends were the key ingredients in a recipe for disaster. At the very moment that higher private-sector wages and thus increased consumer expenditures became the only available means to enforce the new pattern of economic growth, income shares shifted decisively away from wages, toward profits. At the very moment that net investment became unnecessary to enforce increased productivity and output, income shares shifted decisively away from wages, toward profits. ...

So the "underlying cause" of the Great Depression was a distribution of income that, on the one hand, choked off growth in consumer durables--the industries that were the new sources of economic growth as such--and that, on the other hand, produced the tidal wave of surplus capital which produced the stock market bubble of the late-1920s. By the same token, recovery from this economic disaster registered, and caused, a momentous structural change by making demand for consumer durables the leading edge of growth.

keen is offering that wealth concentration slowed the natural velocity of money by diminishing the savings available to consumers and concentrating it into pools of low-turnover investment capital. this trend of declining multiplicity was observable, as noted in the statistics kept by the federal reserve bank of saint louis. the diminishment of economic turnover (and real wages) was masked by the rising indebtedness and the associated growth of the FIRE economy -- until that debt boom collapsed, once debt service cost began to test the limits of output to support it. this is of a kind with livingston's view that the reduction in wages diminished real economic activity while supporting a capital markets bubble vulnerable to perturbation.

UPDATE: mark thoma offers bruce bartlett:

I have never understood how I am worse off if the top 1% of households increase their share of national wealth or income as long as the absolute level of wealth and income of the other 99% is unchanged.

read my blog, mr bartlett, and you would understand! increasing inequality of income distribution slows the velocity of money, increasing the need of counteractive debt/endogenous money creation and giving impetus to credit booms and their inevitable terminating crises.

greece downgrade

2009-12-08T15:27:00.004-06:00

just a placeholder for edward hugh's take on greece. it's taking its time, but southern europe is slowly but inevitably slipping into deep depression and (unlike the united states) government insolvency behind an inability to devalue currencies to finance monstrous government debts that only inclusion in the euro made possible to borrow.

We might be forgiven for getting the impression that to date rather than acting as a stimulus to deep economic reform, Euro membership has rather acted to reward those countries who would get into more and more debt, with ever less sustainable economic models, by supplying them with funding at far cheaper rates of interest than the markets would otherwise make available. It is this particular clockhand that Europe’s leaders would now dearly like to turn backwards, and this is why I have little doubt that it is in Greece that a stand will now be taken. If not, then that longest of long runs may arrive rather sooner than some of us, at least, are comfortable with.

i'd wager that with sustained economic pressure over the course of coming quarters and years the end result will be greece, italy, ireland, portugal and spain all (the PIIGS, in the parlance) leaving or being ejected from the currency union -- with fairly incredible turmoil in global capital markets as a likely adjunct.

signs of a correction to the reflation trade

2009-12-07T08:25:00.004-06:00

bloomberg:

S&P 500 options to protect against declines in stocks over the next year cost 22 percent more than one-month contracts, the highest since 1999, data compiled by London-based Barclays Plc and Bloomberg show. ... The last time the average gap between one-year insurance and 30-day contracts was higher was five months before the S&P 500 began a 49 percent plunge in March 2000 during the collapse of the Internet bubble.

those last five months were a doozy, though. further, as noted by adam warner on twitter:

Options has called 30 of the last 2 $VIX explosions, will post later on it.

a yet better indication might be the commitments of traders data. jason goepfert:

Speculators continue to like the Nasdaq 100. Really, really like it.

The chart below shows commercial hedger positions in Nasdaq 100 futures, but by definition, large and small speculators are taking the other side of the trade. The bottom like is that "smart money" hedgers are net short to one of the most extreme degrees in the history of this data (going back to 2000).

The other three weeks highlighted on the chart are 12/01/04, 12/05/05 and 10/15/07.

daily NYSE reported short interest also shows a massive spike in specialist short sales on friday (december 4). these often mark short-term tops.

i think the VIX contango really only gains a lot of meaning with context like this.

the third aspect to watch closely will be the dollar, which is probably funding a significant global carry trade.

dividend trend comparison

2009-12-05T20:14:00.002-06:00

this is a post too good to lose track of -- hbl at thought offerings is tracking earnings and dividends in comparison to the great depression.

Earnings have dropped more rapidly than during the Great Depression (dramatically so if you count reported rather than operating earnings), but they appear to have begun a recovery much sooner than occurred back then. Trailing 12-month dividends are still falling slightly faster than during the Great Depression, which is particularly remarkable given how much more severe deflation was then compared to now. These trends underscore that contrary to some claims, this is no crisis of confidence!

Since dividend changes tend to lag earnings changes, rising earnings could mean dividends will level out and start increasing soon (and in fact the quarterly fall in dividends from Q2 to Q3 was small). However, if earnings are being over-reported thanks to factors such as relaxed accounting rules or optimistic loan loss assumptions, dividends should ultimately reveal the truth about underlying cash flows.

And while we should all hope that this recovery can be sustained, there is a significant probability (details of which I hope to discuss in a separate post) that this is a temporary upturn in a longer term depression. A renewed fall in GDP, persistent unemployment, and intensifying deflationary pressures would not be good news for any fledgling recovery in earnings and dividends.

the tail risk to the united states in the GFC

2009-12-05T13:53:00.004-06:00

first i should apologize -- regular blogging has taken a detour of late as other responsibilities intrude. i remain active on twitter, but haven't secured the time i'd like (and need) for more reflective discourse. i hope to change that.

about a month ago, edward harrison and marshall auerback, posting at harrison's excellent credit writedowns blog, posted a series of entries regarding aspects of modern monetary theory. MMT, sometimes labeled with the more archaic term chartalism, is an education unto itself -- but one worth earning. it has begun to make academic inroads, though it perhaps unfortunately has little immediate prospect of policy implementation. (then again, neither did keynes' ideas in 1930.) more importantly, MMT offers a lens through which one can focus on current important issues regarding systemic debt and currency.

harrison initially posted on the example of japan, riffing on an article by ambrose evans-pritchard, deriding the example of fiscal and monetary reflation without a measure of asset holding company liquidation and aggressive systemic reform as a macro reflationary failure which failed to boost incomes and spending.

auerback disagreed, arguing instead that japan's adherence to its export model suppressed domestic incomes and left it vulnerable to the global financial crisis (GFC).

The Japanese should have gone for domestic demand-led growth instead of export-led growth. When export growth reversed, the economy went into depression. Even Richard Koo, who has often spoken of a balance sheet recession and has the right approach on Japan, never imagined that such a thing would happen. But it’s easy enough to resolve; simply support domestic incomes with the right tax cuts to sustain domestic demand at desired levels to sustain output and employment.

One can always sustain domestic demand by altering the fiscal balance. In truth, it is as simple as debiting and crediting accounts on the Bank of Japan’s master yen account spread sheet.

auerback here importantly introduces MMT conceptions of government accounts.

[T]he notion that the country is in a ‘debt trap dynamic’ as Ambrose Evans-Pritchard suggests is ludicrous. Debt is serviced by data entries by the BOJ - debits and credits to securities accounts and transactions accounts at the BOJ. The BOJ can spend/credit accounts at will. It’s just data entry. Spending is not constrained by revenues (this is fiat currency, not a gold standard). In a worst case, ‘over-spending’ causes inflation. But, that happens to be what they are trying to accomplish. Getting some inflation would be considered a success. Moreover, it can easily be reversed by tightening fiscal policy if it comes to that.

harrison subsequently noted the true nature of sovereign default when a government issues its own currency, using the case of russia's surprise 1998 default which sparked the LTCM crisis.

Russia’s was not an involuntary default by a country which issues debt in its own fiat currency. Russia was a perfect example of a voluntary default due to huge foreign currency debt and foreign exchange reserve losses (see Wikipedia for a pretty accurate and thorough account on the events of the 1998 Russian financial crisis).

Russia defaulted voluntarily, an event which the geniuses at Long-Term Capital Management failed to model correctly. Moreover, the immediate stress on Russia was not the rouble-denominated debt but the mountain of foreign currency obligations via an unrealistic currency peg which were draining reserves. Similar events unfolded in Argentina a few years later as their currency board crumbled and the Peso was devalued by three-quarters.

Again, the point is that a government can always make good on its own fiat currency obligations if it chooses to do so. The real question is why a country might voluntarily default on its own currency debt or involuntarily on foreign currency debt. The answer usually has to do with taxes. In Argentina and Russia, the government was unable to prove that its taxation policies were benefitting its citizens, creating rampant tax evasion, especially in the monied classes. Capital flight took form as many dodged taxes. Capital flight eventually turns into currency revulsion which creates the pre-conditions for depression, as Latvia, Estonia and Lithuania learned most recently.

The relationship these examples from the Baltics, Argentina and Russia have with Japan and the United States is taxes. When taxes seem unfair or excessive, the citizens evade taxes and eventually revolt; you end up with a situation like Russia circa 1998, Argentina circa 2002 or Zimbabwe circa 2007.

there is an extraordindary amount of discourse in the american public square currently about the prospect of a government debt default. for the moment, it is entirely spurious -- the US is nowhere near any such threshold, and much of the talk is driven either by plain ignorance or by opportunist electioneering in advance of 2010 and 2012. harrison and auerback here instead outline something closer to the reality of government finance.

much of the long history of sovereign debt default as illustrated by rogoff and reinhart is, from my view, misunderstood. the gold standard is a much stricter mistress, and governments adhering to it really could be put in a position of necessary default out of an inability to redeem debt and currency in specie. that is not, however, the monetary system we now operate under.

more recently, countries or currency unions got into similar trouble by borrowing heavily in contracts denominated in or (often through the operation of foreign banks) funded by currencies that they could not print. this was the case in mexico in 1994, argentina in 2001 and is currently the case in the baltics. the potential for such societies to devalue their currency, effecting a "soft default" either to create the ability to repay government debt or ease the ability of the private sector to do so, is high. the united states in both its private and public sectors borrows in its own currency.

as the issuer of the currency in which its debt is denominated, there is no way for the united states government to default on its debt which is not elective. it simply cannot be compelled to default; it has to decide to out of fear of the consequences of servicing the debt. one of the tenets of MMT is that in a fiat currency system there is no material difference between government debt issuance and government currency issuance -- both are promissory notes, one interest-bearing, one not, both backed by the full faith and credit of the government. MMT economist bill mitchell regularly highlights the use of government debt as a useless archaism of the gold standard. governments would do as well to simply spend without issuing debt, with the limitation on spending being not any illusory fiction of debt service cost but the capacity of the economy to absorb such spending in complement with private sector spending without pressuring prices higher.

it seems that elective default could never happen, but clearly they do and there are reasons to elect to do so.

russia, as auerback and harrison discuss while referencing wikipedia, did so out of a desire to maintain foreign exchange holdings dwindling away under an artificially high exchange rate peg which brought ruble holders to the central bank to obtain forex. by 1997 russia had borrowed extensively from foreign vendors in ruble-denominated contracts paying very high interest rates. following the asian financial crisis, commodity demand declines reduced russian forex inflows, precipitating a decline in forex balances, a measure of capital flight and rising interest rates on ruble loans. rate increases choked off economic activity and tax receipts collapsed, aggravating russian government deficits. the IMF orchestrated a july 24 forex loan to fund maturing government bonds, but the peg was maintained and forex continued to bleed away. soon after a run on the ruble began as foreign vendors and asset holders began to realize that the ruble would eventually have to be radically devalued. on august 13 russian markets in stocks, bonds and the ruble collapsed as these foreign participants fled. on august 17 the government simultaneously revalued the official ruble exchange rate to a dirty float and rescheduled both private and public ruble debt -- though it is something of a mystery to this day why public debt was rescheduled. by september the ruble had fallen to about a third of its peg level, and inflation in 1998 exceeded 80% with food items having doubled and import prices quadrupled.

this is a similar story to that which occurred in iceland in 2008, and which the baltic states are currently attempting to forestall. can it happen in the united states?

the US clearly has some of the precursory conditions. a large and durable current account deficit has left it, opposite of japan, with a titanic systemic dependence on borrowed foreign deposits in the form of wholesale funding. there are vast foreign investments in american capital markets assets (though rather less in fixed assets). and the united states does in fact have an artificially-strong fixed or dirty float exchange rate with many of its creditors -- though such are pegged from the other side.

the first phase of the GFC saw export-model current-account-surplus countries take the brunt of economic ramifications of the collapse of trade. germany, japan, china and east asian states are loaded now with massive excess capacity built to fill american, british, spanish and eastern european demand. they continue to struggle with the deflationary consequences of simply not having domestic demand anything like their capacity to supply.

but one can envision a second phase wherein those afflicted systematically withdraw the funding they have been providing to the erstwhile repositories of excess demand. this in fact is being called by socgen economist glenn maguire in the form of large chinese current account deficits going forward; andy xie has said something similar. moreover, rumors of japanese sales of treasury bonds to fund domestic programs have been in the markets recently. should capital flight begin in the united states as it did in russia in 1998 -- and as it did in september 2008 following the collapse of lehman brothers, as evidenced by the titanic run on money markets which ensued and was then stemmed by frantic treasury and federal reserve action -- it is not inconceivable. john hempton has previously compared the position of the united states to that of korea in 1997.

there are some countries -- notably ireland, greece and spain -- which are (at least for now) in a currency union which does not allow them to devalue their currency unilaterally. this is often cited, not least by me, as a weakness -- particularly where the political system does not allow for the kind of fiscal effort which could offset a deflationary collapse through government support of aggregate incomes. but it swings both ways. the euro has also protected these countries from the anticipation of currency collapse which felled russia in 1998 and iceland in 2008. the united states may print the world's reserve currency, but it is a currency and at the whim of its creditors and asset-holders.

on some consideration, there is little doubt in my mind that the fundamental assertions of MMT are valid. there is no need for governments to issue debt instruments which are effectively interchangeable with currency, nor to maintain a balance sheet in the traditional sense. in conditions such as exist now -- with capacity utilization at historic lows, resource gluts, unemployment at generational highs -- there is no traditional inflationary impediment to printing as much spending as may be necessary to offset much-needed (as steve keen illustrates -- see figure 15) private sector saving and deleveraging on a national accounts basis to prevent a deflationary spike of real interest rates and concomitant downward spiral as the financial sector deactivates endogenous money and builds excess reserves, hopefully instead pulling the economy toward something like stability in unemployment if not full employment as it delevers.

moreover, MMT suggests that -- even should a run on the dollar materialize as foreign asset holders dump all things american in anticipation of step-change currency devaluation as a result of either peg-breaking in foreign capitals or radical policy changes in washington -- there is no mechanical barrier to prevent the central bank from buying every single asset dumped, soaking up every last dollar rejected through titanic forex operations. nor need any of the above operations -- sure in the current configuration to balloon the central bank balance sheet stunningly -- result in any loan growth, as the unbelievable reserves which would be created in the banking system can as easily be neutralized by first reinstituting and then raising the erstwhile concept of reserve requirements.

but the central bank cannot subsequently force terms of trade on foreign exporters -- and there's the rub. the dollar in the aftermath of a capital flight would not be very useful in securing traded goods, such as oil. dr. keen:

I think the Chartalists have half a point – a sovereign government with a compliant Central Bank can issue as much fiat money as it wants regardless of its budget position. But that tells us nothing about countries in the EU, for example – which are sovereign but don’t have a national Central Bank; while they acknowledge the international ramifications (currency devaluation), I don’t believe they give them sufficient weight; and I feel that their perception of how the macroeconomy would respond to this injection is somewhat superficial.

in the aftermath, prices might rise fiercely in spite of the further collapse of the FIRE economy as a result not of a wage-price spiral but of old-fashioned domestic scarcity.

though of varying opinion at different points in the education of the last ten years, i have for some time now expected a very serious deflationary resolution to overtake the monster private sector debt bubble, now bust. that remains the near-term prognosis -- particularly during periods when the dollar carry establishment is unwound by changes in risk appetite, driving the dollar north and economic activity south. the primary risk to the american economy remains the lack of political will to engage in the formidable long-term government fiscal deficit spending that would allow the private sector to deleverage over time out of income without engaging a deflationary paradox of thrift.

but i am also gradually coming to the view that americans should take advantage of any such episodes of panic to move cash into low-leverage real goods and commodities as a form of insurance against tail risk.

this is not a call to buy houses, land, equities or hybrid debt -- any asset that was financialized during the boom and whose valuation remains highly dependent on the ability to finance it with debt and/or capital structure is likely to get crushed (particularly in real terms) in coming years. i increasingly expect housing and equities to decline on the order of 80%+ real peak-to-trough. and episodic deflation -- resulting from risk aversion, flagging government stimulus, liquidity withdrawal or any combination thereof -- is indeed likely to make cash the best performer of all.

nor is it a call to the most deflation-proof instrument, government debt. while treasuries may outperform handily in deflationary periods, what they will not suffer well in real terms are the tail risks discussed above.

nor it is a call to run headlong into gold. i agree broadly with the reformed broker, and dubai friday as well as this friday's action confirmed his view. gold is for the time being a risk-on trade, its value being inflated by dollar weakness and speculative fervor in what is really a quite small commodity market. as can be seen when it is denominated in other currencies, gold is not uniquely a dollar story; however, the dollar is a huge part of the story -- and a strong deleveraging dollar rally could as easily as not take a third or more out of the gold price.

but it is a call to opportunistically diversify a significant portion of investable assets out of dollars as insurance against the possibility of a run on the dollar. such an event may never occur, but the anticipation of the tail risk will likely keep the hedge from being a big loser for the duration of the GFC.

keen on the depression

2009-11-18T13:44:00.003-06:00

via rolfe winkler -- at the per capita policy exchange conference, october 2009. abandon all hope ye who enter here.

UPDATE: keen himself links to the same talk.

obama to move away from deficit spending in 2010

2009-11-13T12:12:00.004-06:00

politico scoops the news, which comes in light of jon corzine's loss of the governorship of solid blue state new jersey.

The president's plan, which the officials said was under discussion before this month’s Democratic election setbacks, represents both a practical and a political calculation by this White House.

On the practical side, Obama has spent more money on new programs in nine months than Bill Clinton did in eight years, pushing the annual deficit to $1.4 trillion. This leaves little room for big spending initiatives.

On the political side, Obama can help moderate Democrats avoid some tough votes in an election year and, perhaps more importantly, calm the nerves of independent voters who are voicing big concerns with the big spending and deficits. ...

“Democrats have to reassure voters we are not being reckless,” said a Democratic official involved in the planning. “The White House knows this and that's why we'll be hearing a lot about reducing the deficit early next year. Democrats owned this issue for the past four years and cannot afford to cede it to Republicans now."

... [M]any moderate Democrats are deeply troubled by two recent signs of serious discontent among independent voters. The first was how badly Democrats lost among independent voters in the New Jersey and Virginia gubernatorial races. The second was a Gallup poll released this week that showed Republicans winning the independent vote by 22 points in generic matchups for House and Senate races. That same poll had the parties tied among independents in July.

edward harrison caught the news and interpreted it with typical incisiveness.

I am now moving from multi-year recovery to a double dip baseline.

there's nothing in harrison's post i disagree with. this is the nightmare scenario -- paul krugman must be gasping for air on the floor of his office right now. in my view the question isn't about the directional economic consequences of such a move to reduce deficit spending in 2010. indeed i think the only question will be just how disastrous a collapse awaits.

i would argue from the following premise:

when the united states raised taxes and cut spending in appeasement of deficit hawks following the election of 1936 and roosevelt's politically unpopular aggressive challenges of the supreme court in 1937, after four years of GDP growth on the back of the new deal from the liquidation low in 1933, the balance sheet recession of the 1930s was nearly eight years old -- and four of those years had been spent in a titanic default cycle which washed away an incredible nominal amount of american private sector debt (and with it a third of GDP). as real debt levels (eg, as measured in comparison to GDP and incomes) had returned only to late-1920s levels, however, americans were broadly engaged in continuing balance sheet repair. the extent to which that was true was revealed in the crash of 1937-38.

when japan committed politically to reducing deficits following the election of the hashimoto government in 1996, it was already some seven years distant from its equity market crash and five years past the real estate peak. during that time banks had been, much as here today, turned into quasi-GSEs and loaded with liquidity. the corporate sector at the heart of the debt collapse had been turning income toward debt reduction rather modestly during the intervening period, and began in earnest only following the liquidity crisis and cyclical recession of 1997. but even at that point, japanese GDP had with the aid of fiscal stimulus been slowly expanding with very low inflation for some time, helping to lower real debt levels.

where the united states of 1937 and the japan of 1997 were a number of years removed from their bubble bursts when first their respective governments attempted to reduce deficits, the united states of 2009 remains just over a year into its period of balance sheet repair. virtually nothing has yet been done to lower household debt burdens -- in fact, in relation to incomes and GDP, private sector debt burdens are quite possibly higher now than at the outset. this implies that we are a more highly leveraged society than either of our antecedents -- and will potentially as a result experience any second dip with a more exquisite acuity than either of our antecedents were forced to bear.

that said, there is hope: political duplicity.

The big question for Obama – and the country – is whether the sudden concern about deficits will be more rhetoric than reality once his first State of the Union address concludes.

... The Wall Street Journal reported Thursday the White House is considering applying some money from the $700 billion financial bailout bill to deficit reduction, and that Cabinet agencies have been asked to submit two budget plans for next year, one that freezes spending at existing levels and one that trims spending by 5 percent. Congress has long history of taking those requests and piling on money for programs it favors.

continuing on plus some lard is perhaps a modestly-negative-growth scenario given the effects of slowing stimulus spending. a 5% cut is something altogether more disastrous. but what seems clear from this statement of intent following the gubernatorial races of last week is that the federal government will not be passing a comprehensive stimulus package which replaces the diminishing effect of its first effort. and that means we are approaching the double dip.

stealth depression of small business

2009-11-13T10:24:00.007-06:00

ed harrison highlights david rosenberg's morning note on future revisions to GDP data.

Translation: small businesses are suffering disproportionately because of a credit crunch. Their pain is not adequately reflected in the numbers because of big company bias in real-time data. GDP growth is probably much lower than we realize.

This view is consistent with the dichotomy in the BLS (Bureau of Labor Statistics) household survey used to calculate the unemployment rate and the establishment survey used to calculate non-farm payrolls. ...

That shows employment levels dropping off a cliff over the last three months in the household survey. While I question the magnitude of the fall given the weekly jobless claims data, these numbers are much worse than the job losses seen in Non-farm payrolls. Directionally, this has to be right, meaning the 530,000 weekly claims was probably translating into something more like 300,000 job losses than the 200,000 reported. Again, underreporting of small business distress explains the difference.

this was also a topic addressed by david goldman.

With commercial and industrial lending by American banks down 13% since September 2008, and most banks continuing to “tighten lending standards” in the Fed’s official poll, this is not surprising. Wal-Mart will make it through a recession; not the tea-cozy shop down the mall corridor, much less the real-estate agency in the half-abandoned exurb. The global speculative grade default rate, as Moody’s reported this week, has risen to a post-Great Depression high of 12%. Credit lines for small businesses (including home equity, credit cards, and all the other devices entrepreneurs use to fund themselves) will continue to shrink.

Numerous analysts have made the point that in all previous post-war recoveries, it was small business that led job creation. During the 1980s and 1990s large businesses lost employment and small businesses grew. The fact that job losses at small business are evidently far higher than those at large businesses does not make this look like any recovery at all.

indeed, in spite of third quarter statistics indicating a very light recovery which could as easily be called a stagnation around 2007 levels of economic activity, i suspect that the depression is gathering force in the substrata of the economy which are poorly represented in first-guess economic statistics.

previous recessions have been characterized mostly by large enterprises cutting jobs while small business created them. this time, small business has been cutting jobs even faster than the big boys, making hiring very scarce and short circuiting a lot of the logic behind well-intentioned arguments such as those forwarded by new deal democrat at the bonddad blog, positing a straight correlation between initial claims and non-farm payrolls. initial claims are moderating, but hiring continues to decline. the latest JOLTS report out of the BLS illustrates the trend, though again likely understates the perniciousness of the effects in small business.

what likely doesn't is (via the orange county register) the october survey data out of the national federation of independent businesses.

In the past three months, 8% of respondents increased employment but 19% cut jobs, owners told NFIB.

The future looks a little brighter: 9% plan to create jobs and 16% plan cuts.

More bad news for employees: Owners continued to cut compensation at a record pace, the survey found.

Overall, small-business owners continue to be pessimistic about the economy. In the 1980-82 double recession, NFIB’s Index of Small Business Optimism dipped below 90 for one quarter (100 = owners’ optimism level in 1986). In this recession, the index has been below 90 for six quarters.

hires in small business will have to exceed cuts for any material recovery to take hold. but with these businesses cut off from credit and in many cases actively seeking to downscale and reduce debt, that may not be for some time.

IEA accused of masking peak oil

2009-11-10T12:15:00.005-06:00

the guardian yesterday reported on a whistleblower asserting that the international energy agency has succumbed to pressure from the united states to misrepresent global oil production and recoverable reserves from new discoveries in an effort to cover up a global peak and decline in oil, broadly known as 'peak oil'. the motive was ostensibly to suppress oil prices.

edward harrison:

Conspiracy theorists will love this one! But, we don’t need a conspiracy theory to see that the end of cheap oil is upon us. To find high quality oil deposits (I am not talking about Oil Sands in Alberta here) is becoming more and more expensive. And one oil field after another is hitting peak. We have seen it in Mexico, Russia, the North Sea, the Alaskan North Slope and elsewhere. The only thing keeping us from realizing the peak is Saudi Arabia, the swing producer in OPEC.

british petroleum provides, via seeking alpha, this chart of oil prices back to 1861. in real terms the price of oil clearly has never been so expensive as recently. it's impossible to divorce the effects of financialization from the asset price, but i suspect it is also reflecting a new era of increasing scarcity. and this is not new news. industry opinion has been moving in this direction for years. we at the behest of vice president and halliburton CEO dick cheney invaded iraq and will remain there to secure oil reserves -- the 2003 invasion was very much another in a long-running series of global resource wars over oil. i'm sure it won't be the last as the US and other nations attempt to overcome the ramifications of the net oil export problem and reach for some sort of energy autarky amid the dearth of new discoveries. even the allegedly-optimistic reports of the IEA have been pointing toward slowing production.

but this revelation very definitely demonstrates that peak oil is a deep and growing concern in the front of the collective mind of the oil industry. if assessments are being tinkered with for political reasons, it is because there are real problems entrained with real consequences for oil-dependent societies -- and there is no more oil dependent society on this earth than the united states, whose entire infrastructure was constructed in the age of cheap oil, whose industrial farming model is predicated on cheap petroleum products.

deficits, transfers and spending

2009-11-10T10:31:00.003-06:00

i've come to harp on the need of the federal government to provide the counterbalance in national accounts needed to offset private sector balance sheet repair if a deflationary collapse is to be at least mitigated, if not avoided.

but it's necessary to note that, while the government is going to run a deficit of about (-12%) of GDP in 2009, not all of that deficit is in fact fiscal stimulus. a significant chunk is not spending at all but rather direct transfers to entities such as the GSEs. to the list which includes FNM and FRE we'll soon add the FHA. via alphaville:

As the Washington Post reported on Tuesday, the FHA’s emergency reserve fund has fallen to a 7-year low, below the 2 per cent threshold of its outstanding loans, which it is required by law to maintain:

The Federal Housing Administration, which has played a crucial role supporting American home buyers after the collapse of the mortgage market, has burned through a huge cash reserve in less than a decade and could soon wind up with what amounts to an automatic taxpayer bailout if the agency’s fortunes don’t improve, according to a review of FHA finances.

To be clear, if the losses continue — and all indications are that they will — the FHA will be granted a line of credit with the Treasury, which would put more pressure on the ballooning US deficit and ultimately, taxpayers.

this wasn't unexpected, and they'll be followed by the regional FHLBs (as bruce krasting via zero hedge reminds today). but i think it's important to separate the transfers of obligations to the federal balance sheet (which prevent liquidation of debt pyramids) from spending which supports incomes. those boosted incomes will be used to retire private sector debt in a general deleveraging -- indeed that's what should be hoped for -- but will help to support aggregate price levels as well.

while its true that shifting obligations to the government can free cash flow for the relieved (akin to a default), many of the relieved will be banks or financial companies who will -- in a net negative loan demand environment -- will in aggregate be unable to employ stronger balance sheets in lending. they may instead boost treasuries by expanding their portfolio, but that's about all.

actual spending, on the other hand, is cash flow and will propagate through the economy on its way toward retiring debt.

so when examining the impact of government deficit spending on economic performance -- which i think will be paramount -- one has i think to be careful to factor out such transfers.

AWHI and its irrelevance

2009-11-06T15:08:00.003-06:00

another update with the release of the october jobs report of the aggregate weekly hours index. but i'm frankly not sure why i bother.

the moderation in the decline of AWHI, a traditional precursor of recovery, was noted in june. a month ago, i called into question the nascent recovery implied by AWHI on grounds of diminishing fiscal stimulus.

the employment ratio, or EMRATIO, one of my favorite leading indicators of recession, ticked lower to 58.8% -- a level reminiscent of times before the mass migration of women into the workforce. most disturbingly, in falling over the previous three months from 59.5%, or (-0.7%), the pace of employment contraction is -- almost two years into this contraction -- seen to be accelerating again.

similarly, AWHI has reversed a moderation in its decline and ticked lower to 98.5. total hours (weekly) fell to a new low of 33.0 hours from 33.1. there's quite a bit of noise in the first derivative of AWHI, though there's little doubt that the rate of contraction peaked in march. but this will bear watching over coming months. turns up in AWHI have tended to lead EMRATIO, but if the recent stimulus-aided inventory cycle upswing has run its course further contraction in AWHI is likely.

citing prieur de plessis' reportage on richard koo, ed harrison said:

Get ready because the second dip will occur. It will be nasty: unemployment will be higher and stocks will go lower than in 2009. I am convinced that it is politically unacceptable to have the government propping up the economy as Koo suggests it should. The question now is one of timing: when will the government stop propping up the economy? The more robust the recovery, the quicker the prop ends and the sooner we get a second leg down.

AWHI continues to decline -- ticking a new depression low in october -- but as can be seen here at a much moderated pace. this is consistent with nascent recovery from recession. it is also i think completely irrelevant in a balance sheet recession.

on the basis of the total loans and leases -- updated through the end of september, showing an annualized rate of contraction of (-15%), the worst in a sample dating back to 1947 -- and continuing to gain steam with ever-greater seasonally-adjusted month-over-month contractions -- we can see that private sector credit is being destroyed at an unbelievable rate. i haven't data comparisons to offer from the early 1930s, but would suspect that even then the rate of commercial bank credit contraction rarely if ever grew so formidable. and this is to ignore the annihilation of the commercial paper market and the titanic if ethereal contraction of trade credit, both offset only by the expansion of capital market corporate debt issuance -- much of which has been for financial institution refinancing and facilitated by the TGLP.

and yet we see a positive GDP print in the third quarter. how? the government is running an annualized deficit of 12% of GDP -- that's how. and should it falter from those levels of debt-financed spending while private sector finance remains in full retreat, it will cease to be the necessary counterweight to depression and economic activity will summarily collapse.

in the end, indications like the change in AWHI or the weekly leading economic indicators matter little -- they are about consequence. forecasting big-picture changes in economic activity over the next few years will likely be as easy as monitoring changes in the government deficit in comparison to the rate of private sector balance sheet repair -- that is about cause.

eye of the housing hurricane

2009-11-04T10:28:00.005-06:00

via the daily crux, dan ferris offers the updated mortgage recast chart presented by whitney tilson illustrating all too well the option ARM impulse that looms between today and 2012. though many variable-rate mortgage resets are mitigated by the ultra-low interest rates being bought by the federal reserve, option ARM recasts result in the full amortization of mortgages on which most payers were recapitalizing not only accrued interest but principal.

realtytrac highlights the shift underway.

“Rising unemployment and a new variety of mortgage resets continued to gradually shift the nation’s foreclosure epicenters in the third quarter away from the hot spots of the last two years and toward some metro areas that had avoided the brunt of the first foreclosure wave,” said James J. Saccacio, chief executive officer of RealtyTrac. “While toxic subprime mortgages drove much of that first wave of foreclosures, high unemployment and exotic Alt-A Option ARMs are spreading the foreclosure flood to more metro areas in 2009.”

when do i think buying a house will probably be a good idea? my guess is sometime after that second massive spike in loan recasts -- we're kind of "in the eye" of the housing hurricane at the moment.

the first "subprime" impulse fed created a massive supply-demand imbalance, which manifested as a combination of rapidly declining prices and very long average listing times across many metropolitan areas.

when the second wave of recasts hits, it will fall upon a market already glutted with houses for sale and shadow inventory. it will moreover disproportionately afflict middle- to higher-priced housing, where adjustable rate negative-amortization financing which anticipated little or no refinancing risk and considerable house price appreciation was more prevalent than the classic 'subprime' low-FICO loans which (though certainly present at the higher end) predominated the lower rungs of the housing food chain. given what the reality of negative equity has done to move-up buyers -- that is, virtually eliminating them -- this has the making for gargantuan problems among the suburban 'mcmansion' set. i rather expect that collar-county housing will more or less totally collapse under all the supply and get really, REALLY cheap as we move through 2011 into 2012 or 2013. particularly if there's a strong second leg to the recession -- as i expect there will be, probably starting in 2010, accompanying the decline of fiscal stimulus spending levels from current (-12%) of GDP -- mid-to-high-end house prices might fall shockingly far. there's such a huge supply problem!

many have focused on reversion to the mean in metrics such as price-to-rent, and i agree that the very-long-term forecast has to be exactly that. but what is less commented on is that the mean in price-to-rent becomes the mean only by prices spending as much time and magnitude substantially cheap vis-a-vis rents as they do expensive. given the dynamics of the situation in which we find ourselves today, it is no stretch to forecast an extended period of materially cheap house prices. if that environment is also one of falling rents thanks to very high rental vacancies and declining incomes, house prices could fall stunningly even from today's already-corrected levels.

as with many things in a balance sheet recession, government finances will be a critical determinant. if government deficit spending sustains incomes through a period of private sector balance sheet deflation, rents may correct to account for vacancies but would not be pressured further by declining employment and incomes. if, on the other hand, political pressure builds in favor of deficit hawks and government deficit spending is materially curtailed, it is difficult to provide a rational floor forecast. experience would suggest, on the precedent of 1990s japan and elsewhere, that residential real estate prices could under such conditions ultimately decline peak-to-trough well in excess of (-80%).

japanese LEI and the nikkei

2009-10-30T11:48:00.007-05:00

as albert edwards is drawing parallels to japanese fits of frantic leading indicator expansion followed by disaster selloffs, it seems appropriate to highlight the history of the japanese LEI as maintained by the conference board through the period 1990-2005, which contains virtually the entire japanese private sector balance sheet recession.

i hope you forgive the crude overlay -- i'm sure professional web designers cringe at such things. the overlay of the nikkei has been stretched to fit exactly the same timescale, so comparison is easy.

the first thing to deduce is that the leading indicators will lag the market. this probably isn't news, as the most forward indicator in the LEI itself is the equity market. edwards may be right to the point that, once a downturn in LEI began, it often telegraphed the most severe contractions in price. but in truth it seems on this evidence that, if you wanted to preserve capital most effectively, any significant moderation in the pace of strengthening was a better signal to find the storm cellar.

the second is that the equity market in 1993, again in 1995, and again in 2002-3 was hitting new lows even as the LEI was contracting only mildly or even rising and as the economy stayed out of recession. equity is after all the ass end of the capital structure, and should in a low-growth balance sheet recession be savaged as the systemic balance sheet capacity to warehouse equity contracts severely.

third, as has been noted in reviewing richard koo's data as given in exhibit 13 that accompanied this talk on the balance of financial deleveraging in japan (and which are also reproduced in his book), the character of japan's balance sheet recession changed over time. the 1990 bust saw corporate borrowing slow to nil by 1994 and then stay near the zero line through 1996. this might be characterized as a 'first phase' in which japan's banks with the blessing of the government engaged first in pretend-and-extend lending. the 'second phase' kicked off with the advent of the only true bank liquidity crisis of the entire period, which corresponded closely with the hashimoto fiscal rebalancing of 1997. as the government attempted to withdraw spending support from the economy and improve government finances, the economy dumped into a deflationary tailspin which forced radical deterioration of credit quality. following a series of massive liquidity injections which resolved the banks' liquidity issues, profitability returned as the economy emerged from this second recession in early 1999. as can be seen on exhibit 13, however, profits were directed by the corporate sector directly into debt repayment -- and this did not materially abate until 2005, when (as can be seen in exhibit 11) japanese corporate debt fell to a 32-year low of approximately 40% of GDP.

examining the LEI-nikkei chart, it is possible to discern a change of phase around 1996 as well. (further, i suspect but cannot show one would find similar action following the distressing 1937 fiscal rebalancing attempted by the roosevelt administration.) though economic activity boosted by renewed efforts at government deficit spending thereafter improved, the prices in asset markets diverged from LEI and continued on their downward path throughout the second phase. this is i think the kind of repudiation of the cult of markets and the asset-based economy on which recently bill gross and many others have mused. japan had at long last by 2005 returned to a asset valuation regime dominated by discounted cash flows, and not leverage seeking capital gains. so i expect will the united states in time.

in any case, that change of regime still lies in the future. while material evidence of contracting credit outstanding is plentiful, a lesson of the japanese example may be that credit outstanding may merely stagnate for some time pending future developments for so long as government spending maintains employment and income levels. edward harrison has made tentative suggestions in this direction, and does again today with the PCE release. but it must also be said that the nature of the american credit bubble -- being primarily household and not corporate as was the case in japan -- i think diminishes the capacity of the banks to conspire on the kind of pretend-and-extend schemes that are easier to keep quiet at the corporate level of discussion. particularly considering the potential of household strategic default on mortgage debt, which is an option not open to companies wishing to avoid bankruptcy, individuals can free a significant amount of cash flow by simply walking away and renting for a while without terrific consequences. moreover, household cash flow may be quite a bit less reliable given the potential for growing unemployment and strategic (or simply unavoidable) wage reductions on the part of businesses. such are concerns evidenced in household surveys, as relayed by ft alphaville. should default play a larger role in the resolution of the american credit bubble, one might expect credit outstanding to households to deteriorate quite a bit faster than was the case in japan. and that would advance our transition to the 'second phase' markedly.

ECRI weekly leading index turns down

2009-10-29T14:17:00.009-05:00

via zero hedge, albert edwards outlines a basic investment strategy for the duration of the balance sheet recession.

One of the key conclusions from our late-1996 Ice Age thesis was that once the bubble burst, the close 35-year positive correlation between equity and bond yields would break down. This relationship had persisted for so long that it had become ingrained in investor psychology.

The 35-year period could be divided into two phases. The 1982-2000 equity bull market had largely been driven by PE expansion (not profits), which in turn had been driven by lower bond yields and lower inflation. Conversely, in the dismal years, the Dow went sideways for 17 years between 1965-82 as profits growth was wholly offset by multiple compression - driven this time by higher bond yields and higher inflation. Indeed, throughout this 35-year period, "bad" economic news was generally good for equities as it drove bond yields lower and PEs higher. Equities had only a very loose relationship with the profits cycle.

We knew though from Japan that in a post-bubble world, once bonds and equities had decoupled, that the equity market would mirror the economic and profits cycle. And so, despite Japan's structural equity bear market, one could enjoy numerous 50%+ rallies if one invested as the cyclical lead indicators bottomed out. Conversely one should have ALWAYS sold when these same lead indicators peaked out. After recent massive cyclical gains in equities, that extremely dangerous topping out phase looks as if it has begun.

We have long advocated that in a post-bubble world, investors could participate in explosive upside equity rallies driven by decent economic data and an underlying improvement of profits. We saw many of these rallies in the Nikkei over Japan's lost decade. And even if one believed, correctly as it turned out, that each 50% rally would wither away, it would be simply daft not to participate in these policy-induced cyclical rallies.

UPDATE: pragmatic capitalist picks up the news as well.

obama maintains expanded presidential powers

2009-10-26T09:26:00.006-05:00

though the behavior of the administration has been clear for some time now, glenn greenwald in salon comments on the sharpest attack to date on the obama administration by the new york times.

my question: why did anyone think that a democratic president, any more than a republican president, would be inclined to diminish the power of his (or her) office? was that ever a serious consideration? who here wishfully cast obama as cincinnatus?

the sensible hope one might have had last year around this time for the obama administration and obama himself was that he might have at least slowed the relentless expansion of presidential authority which so thoroughly undermine the principle of divided powers as enshrined in the constitution -- but even this was but a hope, best founded in the notion that it would have been very hard to accelerate that expansion from the pace set by the preceding bush administration. the harder underlying truth, however, is that the era of divided powers is rapidly passing from the american political landscape, and that we are instead continuing a multidecadal transit into a post-constitutional model where the legislative branch, though it may retain the trappings of power, is increasingly a rubber stamp to be manipulated by the executive in order to give the appearance of democratic process to an imperial power structure. barring a successful revolt on the part of a divided, obsequious, self-interested, rent-seeking and typically incompetent legislative branch, this trend figures to propagate indefinitely -- and, should economic conditions deteriorate, perhaps even intensify with frightening speed.

LEI deconstructed, update

2009-10-22T13:15:00.004-05:00

today the conference board released its leading economic indicators, showing a sixth straight month of increase. separately, the ECRI has been pounding the table as a bull on the back of their weekly leading series.

i last took a look at this in july -- pulling apart the various components of the LEI to distinguish between the effects of federal reserve and treasury liquidity provisioning for the financial sector -- money supply, yield curve, asset market prices and the consumer expectations that closely track them -- and the indications being provided by the 'real economy'. this is done on the principle that monetary policy in a balance sheet recession is basically broken and has little if any effect on an economy where debt reduction is now the priority of participants and loan demand is net negative.

the result largely conforms with some of the other evidence of the last few months. though the LEI as reported (blue line) is powering upward, the LEI netted of the most liquidity-sensitive components (yellow line) is decidedly underperforming. perhaps unsurprisingly, the more liquidity-sensitive elements are removed, the worse the performance of the series since march. moreover, the degree of underperformance appears to have widened again since july -- which again finds some confirmation in the talk about town, as it were. indeed the 'real economy' LEI has been barely positive in august and september, which has run the spread between the as-reported and net-of-liquidity cumulative series out to the wide of the (admittedly short) sample.

in fact it's hard to find a lot of encouragement in the slope of the curve even inclusive of liquidity-sensitive factors since april and may. just as the severity of the contraction in LEI softened from december to february, late in the cyclical recession which likely ended in the second quarter, this softening in the expansion of LEI -- along with persistently high initial claims and the continuing contraction in total loans and leases -- may rightly fuel concerns about a double dip.

of course this may simply be noise to be followed in october and november by booming new orders, sharply higher hours and more building permits as precursor to a sharp expansion. but for the time being i read this as a datapoint indicating sluggish and vulnerable economic performance.

too small to fail

2009-10-21T08:50:00.005-05:00

via calculated risk:

From MarketWatch: Treasury to introduce program to help small banks

The ABA and other bank lobby groups for small banks are seeking to have Treasury develop a program to provide TARP funds to small stressed banks -- those with less than $5 billion in assets -- on the cusp of a default that haven't received TARP funds.

And I thought everyone agreed that the FDIC closing small failing banks - albeit slowly - was an example of how bank problems should be resolved. Now we have "Too small to fail"?

at this point it should be no secret to anyone that the bankers own some prime turf in washington. if you need a refresher, this week's frontline is up to the task. there is no systemic reason for small bank creditors and shareholders to be protected by the treasury in this fashion. and yet treasury will apparently be slave again to the special interests of bankers. this is likely a political horse-trade made to satisfy the powerful regional banking lobby kept in washington by the industry as reward for backing FDIC premium increases as the depository insurance fund seeks ways to replenish itself short of drawing on its credit line at treasury following on its actions to support refundings of the money center banks with bond guarantees.

one wonders at what point popular dissent against this manner of utilization of taxpayer funds might take on a more material manifestation. hard times incite radicalism, and there's been a thread of commentary fulminating in financial circles which saw some more light yesterday in the ranting of paul farrell. further, bruce judson -- who has apparently written a book exploiting what he sees as the inevitability of social fracture in the united states -- is making hay out of a telephone call he received on NPR with regards to domestic terrorism. even the op-ed page of the new york times is openly questioning public allegiance to a framework which concentrates capital at the apex of the pareto distribution -- a concentration that has already been seen in some quarters as deeply dangerous. and anyone who has cared to tune in marc faber recently has heard that western capitalist economies are approaching collapse -- the future "will be a total disaster, with a collapse of our capitalistic system as we know it today, wars, massive government debt defaults and the impoverishment of large segments of Western society" as faltering demographics shred government finances and force currency debasement throughout the decade of the 2010s.

now, a blog with the title this one bears cannot be unsympathetic to such views. for what its worth, my timeline of decline has less in common with faber than toynbee or spengler -- the end will come, give or take a century or three. but the views of faber, farrell, judson and many others are an expression of a popular skepticism that has really taken flight in the west only since the first world war (though its intellectual roots are certainly far deeper, dating back as far as the western schism and the fracture of the master institution of western civilization which cumulated in the reformation). that widespread pessimism with respect to the capacity and intention of institutions has worked to undermine social confidence throughout the last century, and provoked in response a steady increase of authoritarianism in western governments.

as such, it is important at least to note the brazenness of recent divergences between the perceived function of government in the service of the elite and the perceived interests of the population as a whole. such displays are frequently the spark of real popular dissent, and the return of hardship will have provided plenty of dry tinder. how, i wonder, would news outlets cast the first episode of political or commercial violence to which the result of public reaction polling was, say, 60% approval?

does this lot of outrage in print amount to a precursor of social collapse? that's great copy but also anyone's guess and in any case highly unlikely (if for no other reason that such collapses are, even if inevitable, quite rare).

what is clearer, however, is that government regulation is the intended counterweight to the protections of limited liability in an efficacious capitalist system -- and further that the level of protection now being offered banks both large and small is more than enough to suspend their private charter entirely in the longer-term interest of the public. protecting depositors with an insurance fund such as the FDIC is itself a tradeoff in this vein, as it diminishes incentives to responsible banking; but now that protection is being further extended not only to bank creditors but even shareholders to some significant extent, the entire system of private credit allocation should have to be brought inside the government firewall. for so long as the entire domestic funding structure of banks is insured, the alternative will be that lenders will have every possible incentive to abuse the underwriting taxpayer with the most extremely reckless and daring lending, knowing full well that no real harm can come to them in the likely event of failure. even if the program is retracted at some point in the future, who would believe that the precedent for the next boom and bust had not been set?

in other words, the establishment of "too small to fail" is inherently incompatible with responsible private credit allocation and indeed any meaningful conception of capitalism itself. it's at the point of "too small to fail" that the responsibility for credit allocation should be legislated to a government office, should it not? and if it is not, then does it behoove a public ultimately responsible for its own future to militate toward such ends -- or, more likely and surely better, toward a convincing repudiation of taxpayer backstops for the entire private sector bank capital structure regardless of systemic importance?

approaching the double dip

2009-10-14T08:49:00.009-05:00

pragmatic capitalist links to this letter by hoisington capital, which kicks off with a view of the most important chart in the world -- made additionally interesting by the inclusion of data reaching back to the long depression of 1873-79. i disagree with much of what hoisington has to say on the multiplier of government spending -- while they view fiscal stimulus as pointless, in truth as stated by richard koo within the concept of the balance sheet recession and highlighted by marshall auerback it is the only realistic means of avoiding an overwhelmingly intense deflationary spiral should the private sector set about debt reduction. koo estimates a multiplier of fiscal stimulus in japan during their balance sheet recession between 1990 and 2005 of close to seven -- which is to say ¥2000tn of private sector ~~debt was retired~~ income was created (see comments) with a stimulus of ¥300tn -- and this appears yet better in light of the alternative, which is a collapse of incomes, deposits and wealth to perhaps half their former level.

absent the political will to massive new fiscal stimulus, however, thomas palley in the financial times via mark thoma lights the pathway of deleveraging from this monster debt precipice.

The future is fundamentally uncertain, which always makes prediction a rash enterprise. That said there is a good chance the new consensus is wrong. Instead, there are solid grounds for believing the US economy will experience a second dip followed by extended stagnation that will qualify as the second Great Depression. Some indications to this effect are already rolling in with unexpectedly large US job losses in September and the crash in US automobile sales following the end of the “cash-for-clunkers” programme.

... The economic crisis represents the implosion of the economic paradigm that has ruled US and global growth for the past thirty years. That paradigm was based on consumption fueled by indebtedness and asset price inflation, and it is done.

palley analogizes a two-step credit crisis outlined by mckinsey earlier this year. with perhaps a thousand american banks set to fail as step two unfolds over the next 24 months, this is about the near future.

mckinsey ... is describing a second-wave credit crisis -- one related not to mark-to-market but to mark-to-maturity, which constitutes 90% of the assets of the american banking system -- which would see banks largely unable to earn their way to solvency over the next few years as loan losses accelerate and net interest margin (NIM) deteriorates even in an environment of stable or increasing loan demand. this dynamic will be particularly effective in killing off smaller banks, as they are both concentrated in commercial/industrial loans with exactly the delayed-fuse features mckinsey describes and suffering already from a deteriorating in NIM.

and this presuming stable loan demand. in an environment of contracting loan demand and insufficient stimulus, this figures to be a lethal banking (and economic) environment, with collapsing incomes driving asset prices lower and losses higher -- notwithstanding this morning's earnings announcement from JPM, which is heavily reliant on asset writeups resulting from remarking risk assets which, though still impaired and now wildly overpriced, have benefited from the liquidity-fueled rally since march. notably, via calculated risk, JPM highlighted continuing increases in loan loss reserving as they see weakness in their prime conforming mortgage portfolio -- a trend mckinsey and others obvious expect to continue.

the $64 question is whether sincere private sector deleveraging gets underway in spite of the efforts of the government. could the government blow another bubble? edward harrison has been playing angel's advocate with regard to this by examining unadjusted figures, and appropriately so. but this interesting takeaway from the JPM call underscores what i think will, with so much damage to the valuations of pledged collateral already having been done and likely to continue as valuations return from ponzi finance models to discounted cash flow, become the dominant dynamic:

Analyst: Loans were down about 5% linked quarter 16% year-over-year. Is that supply or demand, what are some of the ins and outs there?

JPM: Consumer portfolios, you have run off portfolios from Washington mutual and in retail, some tightening of underwriting standards in those businesses generally. So expect that at the origination levels, that for a period of time here, we are going to have downward pressure on those balances. We're in the business of making loans against our underwriting standards today. So it is active supply, meeting demand on that score. On the commercial side, you have seen it a little further down this quarter, and that is you know more, it is a little bit of everything but it is more demand clearly because we see extended credit lines utilized at the lowest levels of all time. You can see a swing in those numbers as soon as confidence returns in our commercial clients and they have some use for that money.

they may be waiting a very long time for that swing. a combination of continuing increased bank prudence (it would after all be hard to be less prudential than banks were in 2006) and more importantly net negative demand for loans as households and businesses retrench into balance sheet repair make, in combination with a populist political impulse to control sovereign debt growth, palley's and hoisington's darker view all too plausible. total loans and leases figure to be the predominant face of deleveraging -- until or unless there's another run on wholesale bank funding. retail sales -- via calculated risk -- will be driven in large part by both how (or if) households attack their balance sheet problems and what the government can muster in terms of deficit spending to accommodate their repairs.

recall that peak stimulus is right now. as CR noted yesterday and albert edwards among others have highlighted, all subsequent quarters will see diminishing effects, within a few months yielding to a tightening effect on GDP.

as this effect takes hold, with no further stimulus now in the pipe, with the prospect of accelerating bank failures, accelerating savings, contracting loan demand and continuing tighter lending standards, palley's prospect of a double dip figures to materialize in 2010 with frightening intensity. as was true in japan, this may suddenly forge the political will for greater fiscal stimulus globally -- but i expect only in a much deeper economic crisis can parliamentary will coalesce.

3q earnings season

2009-10-07T08:45:00.003-05:00

via pragmatic capitalist -- expect upside surprises to dominate.

Unit labor costs have come down at an annualized 5.5% pace in the first half of the year. This is the second largest on record and has allowed corporations to cut costs at a rate that is substantially faster than their revenue deterioration. The math here is simple – profit margins are expanding rapidly. The last time the margin divide was this wide was in 1983. Revenues are likely to be largely in-line or worse than expected, but the market is unlikely to punish firms this early in the earnings recovery.

watch technicals following such a huge equity rally, particularly with liquidity concerns afoot -- but the fundamental backdrop here is very positive in spite of steady credit contraction and revenue slides. i have worried about the margin compression in inputs -- but the biggest input cost is labor, and labor is getting much cheaper.

total loans and leases

2009-10-06T15:04:00.007-05:00

chris whalen:

[W]hile we all do hope for better times ahead, the fact remains that the supply of credit available to the global economy continues to shrink with the balance sheets of banks around the world. ...

[W]hether the deal makes sense or not, there is just no financing to be found. The continuing reduction in bank credit is entirely visible, yet somehow the inhabitants of Washington and Wall Street continue to pretend that it just ain't so.

Lending by the largest banks that received government bailout support declined for the sixth consecutive month in July, the Treasury Department said in its monthly report. Average loan balances at the top 22 recipients of government bailout support dropped by 1 percent in July. Average loan balances had also fallen by 1 percent in June, reports the AP.

But the reduction in available credit is not just reflected in loan balances. More important to many industries and investors is the huge reduction in unused credit lines, what we call Exposure at Default or "EAD" in the IRA Bank Monitor. ...

Now it appears that the entire large bank peer group, roughly the same institutions in the Treasury lending survey, are all trying to reduce EAD as the banking industry heads into the worst part of the credit crunch in 2010. This, by the way, is why Citigroup, Bank America and other happy campers like SunTrust (NYSE:STI) are making all of this noise about repaying the TARP, hoping against hope that they can raise more common equity before those Form 13s starting appearing on EDGAR, showing that the smart money is running away from financials at flank speed. More on this next week.

Bottom line is that deflation is still the chief threat to the US economy, driven by a relentless contraction in bank and nonbank credit. Until we see a restoration of the market for nonbank finance and a sustained turn in the EAD of the large bank peer group, which accounts for almost 70% of the entire US industry balance sheet, we do not believe that any economic recovery will be meaningful in terms of jobs or asset prices. Indeed, we have to wonder whether the FDIC should even try to impose another assessment on the banking industry to fund failed bank resolutions when the effect of this action is to remove capital from the system and thereby accelerate the shrinkage of the collective balance sheet of US banks.

Before Secretary Geithner and the G-20 talk further about raising bank capital levels, we first need to find a way - and fast - to stabilize the existing capital base of the banking industry. Failure to do so, in our view, could be catastrophic for the global economy and could also further radicalize the political situation in the US, where many Americans are starting to realize that the party is well and truly over. As we said on CNBC on Monday, talking about raising bank capital at the present time is the functional equivalent of the imposition of the Smoot-Hawley Tariff Act of 1930. We desperately need a different approach.

i wholly agree with whalen -- traditional inflationary concerns are a non-starter in an environment where private sector credit reduction is overwhelming central bank balance sheet expansion and inexorably overtaking undersized fiscal stimulus. the much-discussed withdrawal of such support will, i suspect, relatively quickly create the political will for its reinstatement. (as an aisde, the reserve bank of australia today became the first to raise its policy rate, from 3% to 3.25%.)

the final arbiter of where we are going, absent a miraculous revival in securitization, will be total loans and leases. albert edwards via zero hedge:

One question I am often asked at the end of a presentation is “how will you know if you are wrong?” Resisting the temptation to totally reject this possibility, I think perhaps I can identify one thing that might indicate this post-bubble world had defied the law of gravity and was reinflating again. Back in the early 1990s minicredit crunch it was not until the middle of 1993 that private sector demand for credit began to grow (supply was not a problem as banks were already healthy). To gauge whether the world economy can surprise and escape this balance sheet recession, keep a very close eye on the bank lending numbers. They may hold the key.

the h.8 is arguably, barring the re-emergence of systemic funding pressure, the most important report being released for the duration of this balance sheet recession.

UPDATE: more from whalen via distressed volatility.

BLS acknowledges birth/death model misstating job creation

2009-10-02T15:00:00.004-05:00

bloomberg:

The U.S. economic slump earlier this year was so severe it short-circuited the government’s model for calculating payrolls, raising the risk that today’s jobs report may be too optimistic.

About 824,000 more jobs may be subtracted from the payroll count for the 12 months through last March when the figures are officially revised early next year, a Labor Department report showed today. The revision would be the biggest since the government started adjusting the numbers in 1991.

The bulk of the miss occurred in the calculations for the first quarter of this year, the Labor Department said. The economy shrank at a 6.4 percent annual pace in the first three months of 2009, the worst performance since 1982.

The figures raise the possibility that the government’s calculations continue to miss the mark.

“We are probably still underestimating job losses,” said John Silvia, chief economist at Wells Fargo Securities LLC in Charlotte, North Carolina. “There could be another 30,000 to 40,000” that the data isn’t picking up.

That would mean the loss of jobs for September could turn out to be as high as 300,000, rather than the 263,000 reported today by the Labor Department. Today’s report also showed the jobless rate climbed to 9.8 percent last month, a 26-year high.

The potential revision for the year through last March would mean that the economy lost 5.6 million jobs for the period instead of the 4.8 million now on the books.

that would be a 16% underestimation of job losses for the period ending march 2009.

From April 2008 through December, the tax records showed the Labor Department’s payrolls figures overestimated payrolls by about 150,000, said Chris Manning, the national benchmark branch chief at the Bureau of Labor Statistics. That implies the estimates missed the mark by about 675,000 in the first quarter of this year, which currently shows a 2.1 million drop in payrolls.

“In this period of steep job losses, the birth/death model didn’t work as well as it usually does,” Manning said in an interview. “To the extent that there was an overstatement in the birth/death model, that is likely to still be there.”

The model added about 184,000 jobs to the payroll total last quarter compared with a 135,000 increase in the same period in 2008, before the financial crisis deepened with the collapse of Lehman Brothers Inc.

“This birth/death model is still assuming that we are getting new jobs from new-business creations,” David Rosenberg, chief economist at Gluskin Sheff & Associates Inc. in Toronto, said in an interview.

“These additions are coming somewhere from ‘Alice in Wonderland,’” he said....

the birth/death adjustment has been a bone of contention for quite a while, with a dash of insight among others advocating the model and barry ritholtz disparaging it. while i joined in criticizing the adjustment, a year ago i believed oldprof to have been proven out. the voiding in his perceived vindication, however, appears to be material as ritholtz's essential criticism -- that the adjustment would fail, as an extrapolation of past conditions, to properly state job creation during turns of trend -- looks spot on.

AWHI recovery in question

2009-10-02T09:41:00.017-05:00

i've previously blogged on the aggregate weekly hours index as a leading indicator of cyclical recovery and revisited that view after last month's jobs report. today's employment situation release from the BLS, though better than those from the depth of the recession some months ago, was nevertheless somewhat disappointing.

the employment ratio, or EMRATIO, one of my favorite leading indicators of recession, ticked lower to 58.8% -- a level reminiscent of times before the mass migration of women into the workforce. most disturbingly, in falling over the previous three months from 59.5%, or (-0.7%), the pace of employment contraction is -- almost two years into this contraction -- seen to be accelerating again.

similarly, AWHI has reversed a moderation in its decline and ticked lower to 98.5. total hours (weekly) fell to a new low of 33.0 hours from 33.1. there's quite a bit of noise in the first derivative of AWHI, though there's little doubt that the rate of contraction peaked in march. but this will bear watching over coming months. turns up in AWHI have tended to lead EMRATIO, but if the recent stimulus-aided inventory cycle upswing has run its course further contraction in AWHI is likely.

and that double-dip scenario is really the primary concern. the excellent edward harrison posted his updated macro framework yesterday.

A lot of the economic cycle is self-reinforcing (the change in inventories is one example). So it is not completely out of the question that we see a multi-year economic boom. Higher asset prices, lower inventories, fewer writedowns all lead to higher lending capacity, higher cyclical output, more employment opportunities and greater business and consumer confidence. If employment turns up appreciably before these cyclical agents lose steam, you have the makings of a multi-year recovery. This is how every economic cycle develops. This one is no different in this regard.

However, longer-term things depend entirely on government because we are in a balance sheet recession. Ray Dalio and David Rosenberg make this case well in the previous quotes I supplied, but it was a recent post about Richard Koo from Prieur du Plessis which got me to write this post. His post, “Koo: Government fulfilling necessary function” reads as follows:

According to Koo, American consumers are suffering from a balance sheet problem and will not increase consumption until their personal finances are back in order. The banks are not lending mainly because nobody wants to borrow and, furthermore, the banks want to build their own balance sheets (raise cash) and get rid of toxic garbage…

Again, when asked what would happen if the government cuts back on its fiscal stimulus, Koo replies: “Until the private sector is finished repairing its balance sheets, if the government tries to cut its spending, we’re going to fall into the same trap Franklin Roosevelt fell into in 1937 (a crushing bear market) and Prime Minister Hashimoto fell into in 1997, exactly 70 years later.

“The economy will collapse again and the second collapse is usually far worse than the first. And the reason is that, after the first collapse, people tend to blame themselves. They say, ‘I shouldn’t have played the bubble. I shouldn’t have borrowed money to invest – to speculate on these things.’

This view of a second, more serious downturn mirrors the one I wrote of when I wrote about high structural unemployment last week. And, again, it is predicated on what government does. I wrote last November that if government stops the support, recession is going to happen. ...

Get ready because the second dip will occur. It will be nasty: unemployment will be higher and stocks will go lower than in 2009. I am convinced that it is politically unacceptable to have the government propping up the economy as Koo suggests it should. The question now is one of timing: when will the government stop propping up the economy? The more robust the recovery, the quicker the prop ends and the sooner we get a second leg down.

this looks a massive problem for the economy going forward. i've already been eyeing fed pressure for liquidity withdrawal, but given the pileup of excess reserves its questionable as to how much an expansionary fed has really aided the economy (beyond, of course, preventing the cascading collapse of bank liabilities that was otherwise inevitable following lehman brothers). but stimulus spending is another thing entirely. there's no question but that government deficits have enabled the economy to tread water since such spending began in earnest, offsetting the collapse of private consumption and increased savings. with pressures on household and business balance sheets as severe now as ever, such spending remains perhaps the only pillar on which the economy is supported. and yet, as eric sprott and others have noted, fiscal stimulus will gradually become a drag on GDP henceforth, as GDP is a first derivative statistic and stimulus was as frontloaded as was practicable. with the passing of one-off programs like cash-for-clunkers and the $8000 housing credit as well, the change in the level of stimulus spending is set to be down without the congressional passage of some further degree of deficit spending.

is there any political will for another, perhaps yet larger fiscal stimulus? i doubt it -- but i also suspect that a consensus in favor will be built out of the desperation of coming quarters, as it becomes apparent that (changes to net exports aside) increased private sector saving and balance sheet repair will be possible only through sustained, planned, large government deficits. failing that, we'll see a depressionary contraction in incomes and tax revenues which will force the necessary deficits at a much lower level of economic activity.

UPDATE: more commentary via mark thoma.

UPDATE: via pragmatic capitalist, david rosenberg picks up on the household survey.

[C]onsider that the Household Survey showed a massive 785,000 plunge in September which again was sequential deterioration because the decline the month before was 392,000. We’ll see if the legions of bulls will add this in their post-payroll write-ups today, but the Household survey actually leads the labour market at true turning points in the business cycle – and employment on this score has now slid by 1.2 million in the past two months.

These numbers far from validate the overwhelming consensus view that the recession has come to an end just because of one positive stimulus-crazed GDP print (didn’t we have that in 2008 too?); not to mention the fact that the last time we came off such a two-month falloff in Household employment was back in March when the stock market was testing fresh 12-year highs. Sustainability is the key and there can be no durable recovery without net job creation and organic wage growth. Both were lacking in today’s report – in fact, the combination of the workweek edging back down to retest the all-time low of 33.0 hours and the near-stagnation in hourly wages dragged the proxy for personal income down 0.2% (reads: in nominal terms) and the year-over-year trend is getting perilously close to deflation terrain at +0.7% from +0.8% in August and +1.2% in July.

UPDATE: and to reiterate rosenberg, spencer of angry bear.

[E]mployment growth in the household survey no longer appears to be bottoming. Usually the household survey leads the payroll survey at bottoms and the latest data does not look encouraging. Even the apparent bottoming in the decline in payroll employment stems more from the point that the employment drop was more severe a years ago, not that the current data is improving.

Finally, average hourly earnings were virtually unchanged as they rose from $18.66 to $18.67. With the drop in the hours worked this means that nominal weekly wages actually fell and the year over year gain fell to 0.7%. Consequently, the growth in nominal personal income is likely to remain negative. Something that has not happened since the depression.

UPDATE: albert edwards via zero hedge makes the point about GDP change all too well.

The lesson from the balance sheet recession in Japan is that the massive private sector headwind to growth has a long, long way to run.

If that is the case, we can expect, just like Japan, frequent relapses back into recession. The market now understands how an end of inventory de-stocking can boost GDP, i.e. it is the change in the change that matters. Similarly as Dylan Grice points out - link, it is the change in the fiscal deficit that is a net stimulus or drag to GDP. A massive 6pp stimulus last year is likely to turn into a 2pp drag on growth next year (see chart below). With continued private sector de-leveraging likely next year and beyond, how can one seriously not expect the global economy to relapse back into recession next year taking nominal GDP deep into an abyss?

'alacrity'

2009-09-29T09:08:00.009-05:00

what fed governor fisher means by 'alacrity' is a bit uncertain -- after all, it would be hard to hold to the promise of tightening liquidity with a vigor "equal in speed and intensity to that with which we pursued monetary accommodation".

and yet, with particular improvement in house prices (however illusory it may prove), the fed might be on the warpath to withdraw easing more rapidly now -- and certainly it seems unlikely that they will extend nearly completed programs to purchase mortgage-backed securities and treasuries under the rubric of quantitative easing.

thinking forward the consequences of a suspension of QE, one has to first understand that up to 50% of recent treasury issuance at the long end of the curve has been soaked up by the central bank. much of the financing of the deficit and debt is being taken up at the shorter maturities, where there is less rate risk, shortening up the funding profile of the government and increasing its roll risk. dealers are highly unlikely to warehouse the kind of issuance in treasury bonds now making its way to market from the treasury, so it is not unreasonable to expect that the treasury curve may steepen. this would be contra the recent trend of lower yields in the long bond, which john jansen attributes to the hedging of more exotic bets in credit, as well as security in the belief that the open markets desk of the fed will not allow rates to rise. there's also been a move out of money market funds into the belly of the curve. but i imagine that a tick up in long rates to quash liquidity and multiplier expansion is exactly what inflation hawks would like to see, provided it doesn't run out of control.

if it does run out of control, we'll see a quick reprise of quantitative easing -- and then the debate over whether the united states is stuck on a hyperinflationary vortex, navigating between the scylla of deflationary collapse of keynesian demand management and charybdis of permanent quantitative easing, would really begin in earnest.

UPDATE: more from edward harrison.

tim duy on liquidity withdrawal

2009-09-25T11:56:00.005-05:00

following on today's earlier post, tim duy provides something of a window on the thinking behind these latest moves to threaten liquidity.

[G]iven the unemployment outlook is sad, wage growth continues to deteriorate, core inflation is falling, and we seem to lack an institutional arrangement to force higher prices, should they even emerge, into higher wages, what is the Fed thinking? Should they really be worried about winding down programs? Are they really confident enough that an inventory correction that will undoubtedly spike GDP numbers will also translate into sustainable growth? Even knowing full while that after the last recession, the US economy languished despite the inventory correction, only to be revived on the back of the housing bubble? In effect, the Fed looks to be putting much weight on the cyclical story playing out, while ignoring the structural story of the necessity of asset bubbles to fuel growth. Pondering this, a little noticed Bloomberg report jumped to mind:

Federal Reserve policy makers are concerned about making “a colossal policy error” leading to higher inflation if they don’t withdraw extraordinary monetary stimulus soon enough, said Laurence Meyer, vice chairman of Macroeconomic Advisers LLC and a former Fed governor.

“When you talk to committee members you see a little bit more angst than you’d expect,” Meyer said in an interview yesterday at the Kansas City Fed’s monetary policy conference in Jackson Hole, Wyoming. “In public they say they’re confident they’ll get it right, they’re confident they have the tools to get it right. But when you talk to them in private there’s some concern there.”

So, added to the Medley rumor, the pieces start to fall together. Internally, perhaps a wide range of FOMC members believe, in their hearts if not in the data, that they have gone so far that the balance of risks have shifted toward inflation. But this is troubling; the basis for the inflation story falls entirely on the Fed's expansion of its balance sheet. Just a meager $1.3 trillion expansion give or take in the wake of an over $11 trillion decline in household wealth? And the bulk of that expansion is sitting in excess bank reserves? Not really much of an inflation story. But why else are they so eager to withdraw? Just to prove to critics they can? With much fanfare, from Bloomberg today:

The Federal Reserve and U.S. Treasury said they’re scaling back emergency programs aimed at combating the financial crisis, reducing support for firms that now have an easier time getting funding.

The central bank today said it will further shrink auctions of cash loans to banks and Treasury securities to bond dealers, reducing the combined initiatives to $100 billion by January from $450 billion. The Treasury has “begun the process of exiting from some emergency programs,” the chief of the government’s $700 billion financial-rescue fund said separately.

Bottom Line. The Fed is moving toward the exit as they look toward the conclusion of their securities purchases programs. But it is not clear that such a move is justified by their own forecasts or the inflation/wage/employment data. There may be an internal fear they have gone too far, a fear that the hawks can exploit. To be sure, I see no reason to expect the Fed will raise rates for a long time. And the Fed maintains it has policy flexibility, claiming to be ready to revive asset purchases should economic or financial conditions justify. But I now suspect the bar for renewed expansion of Fed accommodation may be much higher than I had anticipated. And that the dominant push for expansion would have to come from financial market conditions, while they would be willing to tolerate persistently high unemployment rates so long as U. Michigan inflation expectations say elevated, regardless of the actual inflation data.

not only could we be seeing the popping of liquidity-fueled rallies in equity and credit; duy clearly fears this could be the onset of the second trough in an economic double dip. it should be said that the fed's alphabet soup has been unwinding for some time already, but has also been offset by quantitative easing in the form of mortgage-backed securities and treasury purchasing for the fed's portfolio. there's a strong implication here, however, that QE won't be expanded past the preset limits which the program will likely reach in the next week or two.

UPDATE: zero hedge forwards a bit more from moody's.

all rests on liquidity

2009-09-25T09:26:00.007-05:00

i caught this bit in ft alphaville yesterday, but pragmatic capitalist expanded on it marvelously.

Banks are in the business of lending, but an odd thing has occurred while bank earnings soared – they were doing no lending! Banks have been hoarding record amounts of cash as the government floods their balance sheets via various programs and bailouts. Many assume that the banks are either attempting to loan the money or simply letting it sit on their balance sheets earning nothing. But Moonraker’s analysis raises a more nefarious possibility – the banks are effectively creating a ponzi run stock market in which they use the bailout money to drive various market prices higher and thereby juice their own earnings. It’s quite brilliant when you think about it – until the music stops.

this is more or less exactly what is going on in not only the equity market but credit markets as well. and that makes it absolutely paramount for the individual stock market player to study the liquidity picture for the banks closely. as the spigot shuts, equity will likely be quick to suffer.

there's been a palpable change in the news flow around liquidity provisioning in the last week or two. as examples, bloomberg and the financial times among others have started reporting on federal reserve discussions with primary dealers and money market mutual funds on the use of reverse repos to mop up balance sheet cash.

The Federal Reserve has started talks with bond dealers about withdrawing the unprecedented amount of cash injected into the financial system the last two years, according to people with knowledge of the discussions.

Central bank officials are discussing plans to use so- called reverse repurchase agreements to drain some of the $1 trillion they pumped into the economy, said the people, who declined to be identified because the talks are private. ...

“To be effective, the Fed would have to drain several hundred billion dollars worth of funds through these reverse repos, between about $400 and $600 billion,” said Joseph Abate, a money market strategist in New York at Barclays Plc, a primary dealer. “You may have a dislocation in the repo markets due to the supply effect of the Fed injecting such a large amount of extra collateral into the marketplace.”

Bernanke [has written] that reverse repos could be done with counterparties beyond the Fed’s primary dealers, which serve as counterparties in open market operations and are required to bid on Treasury auctions.

More trading partners may be needed since primary dealers have been shrinking their balance sheets the past two years, and likely can’t absorb an additional $500 billion of securities, according to Abate at Barclays.

those additional counterparties are the money market mutual funds.

The central bank wants to use the deep-pocketed sector to refinance part of the giant portfolio of mortgage-backed securities and Treasuries acquired during the crisis, using a technique called "reverse repos".

This would involve the US central bank borrowing from money funds using some of its assets as collateral, thus draining liquidity from the financial system.

Such actions would neutralise the monetary consequences of the assets re-financed in this way, although the Fed would still hold the credit risk and mark-to-market risk on the portfolio.

The Fed has already talked of conducting reverse repos with primary dealers including the former Wall Street investment banks. But it does not believe that they have the balance sheet capacity to provide more than about $100bn (€68bn, £61bn) of finance.

This is not enough, given how much its balance sheet has swollen. The Fed is buying $1,450bn of MBS alone and has created roughly $800bn in additional bank reserves since the crisis began.

this hasn't happened yet, but other examples of liquidity provisioning are already being retracted. under the rubric of quantitative easing, the fed has gone into the market to buy outright hundreds of billions in treasuries and mortgage-backed securities. chairman bernanke has tried to differentiate what he's doing as "credit easing", but the net effect is to flush primary dealers with newly-minted cash. these programs have virtually reached their planned dollar targets and have not as yet been extended.

banks have also been funding extremely cheaply for nearly a year on the back of FDIC-based guarantees of their newly issued debt. banks utilized the program to issue more than $300bn in refinancing bonds that would otherwise have been extremely expensive if not impossible to float. the program is being allowed to expire, with the already-depleted FDIC on the hook for a pile of credit risk, and banks going forward are likely to be faced with continued significant regulatory pressure to shift their funding profiles away from constantly rolling short-term paper (which fostered so much trouble in 2008) into more stable (and more expensive) bonds. but the situation is far more complex than rolling out a new regulation. from the economist:

Unsurprisingly, regulators think that forcing banks to find more secure funding, along with more capital, will make the system safer. The Basel club of bank supervisors is considering new liquidity rules, as are many national regulators. New Zealand has already drawn up concrete rules. It is not clear how far this can go. There can be no return to an idealised past where only a dollar deposited in a bank would be loaned out. To force banks to rely only on deposits would require a big shrinkage of their balance-sheets, with devastating economic implications. Besides, not all deposits are sticky. The Bank of England reckons that $100 billion of Russian deposits were shipped out of Britain in the last quarter of 2008.

Far from improving, the funding profile of the Western banking system has been getting even sicker this year. Banks have been raising equity and long-term debt and gathering deposits, but in the grand scheme of things their efforts have made little difference. For America’s top eight commercial banks such higher-quality forms of funding have risen only slightly, from 78% to 80% of the total in the past six months. America’s two surviving investment banks, Goldman Sachs and Morgan Stanley, still depend on shorter-term borrowing, usually secured with collateral. This is fairly reliable but, as Bear Stearns showed, in a market meltdown it can dry up without central-bank support. In Britain, Lloyds Banking Group, a leading wholesale-funds junkie, still has half of its total funding maturing in under a year.

If the duration of funding has not changed much, its source has. In America, the euro zone and Britain, central-bank lending and public guarantees of bank bonds have reached about $2.7 trillion. That equates to about 9% of banks’ wholesale funding, using IMF estimates. Support is concentrated on the banks with the worst funding profiles. So Dexia in Belgium has €82 billion ($117 billion) of state funding, and Lloyds could have up to £100 billion ($162 billion).

The original idea was that state support could be withdrawn swiftly as the panic subsided. America’s main debt-guarantee scheme will close to new issuance next month (with those guarantees already issued expiring in 2012). Europe’s schemes are typically due to close by the end of the year, with guarantees expiring between 2012-14. The hope is that banks will not only be able to refinance debt on their own but also extend its maturity, cutting their dependence on fickle short-term funding.

Funding strains have eased. So far this year, Western banks have issued $645 billion of bonds without government guarantees, according to Dealogic, a research firm. But the idea that the banking system can improve its funding profile at the same time as it weans itself off explicit state guarantees looks wildly unrealistic. This partly reflects the sheer volumes of debt involved. As well as turning over existing short-term borrowings of some $18 trillion, Western banks have to refinance longer-term debts that are maturing at the rate of about $1.5 trillion a year. With securitisation markets damaged and confidence in banks battered, that will not be easy.

It is also unclear that the most needy banks can borrow freely yet. Lloyds issued an unguaranteed and unsecured ten-year bond on September 3rd at 193 basis points above government yields, about double what the safest British bank, HSBC, might pay. Not only is this rate “uneconomic”, according to one banker, but Lloyds only raised €1.5 billion, a drop in the ocean. In July Dexia sold a similar five-year bond at 160 basis points above government yields, but the issue size, at €1 billion, is also tiny relative to its needs.

central bankers have really provided two kinds of liquidity support for banks in these difficult times. the use of the federal reserve's balance sheet through repos pushed treasury bonds into the banks and less marketable debt into the fed. these t-bonds could then be used to raise cash on the asset side of the banks' balance sheets. the second form -- and the more important, in my eyes -- was the earnest support of commercial bank (and select other) liabilities through both the fed and the treasury by way of TARP. the alphabet soup of fed special programs in support of money markets, commercial paper, et al were all essentially aspects of this aim, as were FDIC bank debt guarantees. without them, a fast-motion replay of the banking system collapse of the 1930s was a mortal lock. the question, though, is really whether they can even yet be removed.

the economist points out the incredible scale of the funding profile problem that have accrued in the western banking system as a direct result of decades of current account deficits -- "As the Western banking system has expanded over the past two decades its assets have grown to about 2.5 times its deposits" -- "As well as turning over existing short-term borrowings of some $18 trillion, Western banks have to refinance longer-term debts that are maturing at the rate of about $1.5 trillion a year". these are absolutely boggling figures, and put into stark relief the practical limitations of the federal reserve in dealing with systemic funding difficulties in the intermediate term, though that the fed stemmed the tide last year is without question.

stability aside, the difficulty going forward is that wholesale funding, particularly if it is of longer duration, is relatively expensive. many deposit-poor banks may find themselves, without the help of the fed in procuring funding, in a position where the sensible thing will be to divest of assets and contract the balance sheet into something more in line with their deposit base. this means pressure on asset prices -- the opposite of what has been enabled over the last six months.

in summary, it looks very much like the government support of liquidity provisioning for the banking sector is waning in the aftermath of an inventory cycle in the economy and a massive liquidity-fueled rally in the tail end of the systemic capital structure. withdrawal of both liqudity-enhancing asset swaps and direct support of liabilities could have important ramifications for this rally.

UPDATE/ADDENDUM: it's also important to note that this is not exclusively a US story. as alphaville cites today, europe ex-germany is largely in the same position if not worse. the european central bank is there playing exactly the same role as the fed here, and are at a similar juncture.

bid-only credit markets

2009-09-24T15:52:00.002-05:00

david goldman:

[S]ingle-A rated commercial mortgage backed securities ... have more than doubled in price....

These are securities that vaporize if losses on the underlying pools exceed 30% or so, depending on structure. With defaults rising on commercial real estate, the willingness of the market to buy the lower-to-middle part of the capital structure seems foolhardy.

Dealers tell me that markets have been bid only for the last couple of weeks: no-one has anything to sell, and financial institutions have a standing bid for anything with yield. Part of the explanation for the pendulum swing is the available of Public-Private Investment Partnership money to lever up these assets, but that cannot be the only cause. The fact is that the money management industry has no choice but to stampede in whichever direction the market is moving.

High-quality credit was stupid cheap at the beginning of the year. Now it’s stupid rich.

the illiquidity of mid-to-high-end housing

2009-09-24T13:14:00.006-05:00

this factoid from mark hanson:

Let me frame this… in the bubble years existing sales $500k and over were common. In CA alone, from early 2005 to late 2007, the average house price was over $450k. Total sales were huge then too…over 700k nationally in many summer months.

In July 2009 there were only 460k single family (ex-condo) sales – by the way that was down from June’s 465k, but that got lost in the housing bottom headlines. Of the 460k houses sold, only 12k or roughly 2.5% had a purchase price over $500k. I don’t have inventory numbers on houses for sale over $500k but even at 5% of the total inventory that is 1.75 years of supply. Oh, and by the way in CA alone last month there was close to 12k NODs on props over $500k.

This 2.5% sales rate goes to underscore how insignificant (and ruined in many cases) the organic move-up/across buyer has become due to epidemic negative equity and absolute lack of affordability through exotic finance. Unless he can sell and re-buy he will remain gone.

But what really is negative equity? Unlike the bubble years when zero down or a 100% HELOC after the purchase in order to replenish savings was the norm, today’s buyer has to sell for enough to cover the Realtor cost and the 20% down needed to buy most mid-to-high end houses using new vintage loans. Most analysts look at the reported negative-equity figures as the tipping point — it’s not.

If homeowners can’t sell for enough to pay a Realtor 6%, extract the down on the new property, and pay for moving costs they are effectively in a negative equity position. Homeowners know this — a homeowner that has only 15% equity knows they are trapped in their house. We are still learning what this realization does to spending habits, as the focus for many becomes ‘how do I earn or save my way out of this’.

When looking at neg-equity if you move the bar down to 90%, 80%, or even 74% (6% Realtor fee + 20% down) then it changes everything. The vast majority of homeowners in the nation become stuck (see chart below). Without these existing homeowners active in the real estate market, we will never find a true bottom.

hanson is painting a picture of a residential real estate market in a death spiral. with some states seeing a sizable majority of potential homebuyers frozen out of the housing market by negative equity, there will be effectively no (ie, net negative) move-up or organic homebuying. folks with less than 25% equity in a house that can be sold today cannot even move laterally, much less trade up, without adding capital that (for the most part) they don't have to spare. so mid- to high-end homes become completely illiquid assets at anything like current prices -- and illiquidity will drive prices further south as supply overwhelms demand. with prices declining further, banks will tighten lending standards further -- the era of the 30% down payment is already here in the blighted coastal states, and it figures to spread, moving the bar yet further away for the trapped. there is furthermore a demographic trend at work, as savings-light empty-nest baby boomers divest themselves of the grand houses that characterized their materialistic phase and move to downsize in an effort to raise capital and lower expenses in advance of old age. and so the vicious cycle perpetuates itself.

the end result will i think be a massive compression in price differentials between small and large homes. square footage, greatrooms, stainless-and-granite professional kitchens and fourth bedrooms were at a huge premium in the boom; in the bust the functional essence of a home, the roof it provides, will likely become the focal point to the relative devaluation of all extraneous components. it would not surprise me if, in the most afflicted markets, large houses actually exchange more cheaply than mid-size units, reflecting the significant differential in operating costs and taxes.

that may seem like great news if you're waiting out the housing bust from the sidelines and renting your way to, if not prosperity, at least smaller losses. but the effect of further significant declines in house prices on the properties to which the banks are perhaps most exposed has utterly no positive effect for credit quality and therefore the economy.

have expectations for the economy got too high?

2009-09-24T09:20:00.006-05:00

while a positive GDP print for the third quarter seems assured, numerous commentators have explored the nature of the economic rebound. one of the best among them is edward harrison of credit writedowns, who has pegged the uptick as an inventory correction cycle.

I have written about the present business cycle as the mother of all inventory corrections. Erroneously, I suggested we were going to see a re-stocking of inventories. That’s overstating the case. What I meant to say was that inventories were being purged so much in the first half of the year that it would lead to GDP growth even in the absence of re-stocking. This is something I stated correctly in May.

Thinking about production as opposed to sales again, you have to look at inventories. The NBER is not fooled by inventory builds because they look at both industrial production and retail sales. But, since GDP is a pure production statistic, inventory builds distort the picture. For example, say your economy produces $980 worth of stuff one quarter that gets sold. But it also sells a lot of stuff, $20 worth, out of inventory. If next quarter, you need to sell just as much stuff ($1000), guess what, GDP growth goes up automatically (Remember, we are not talking about GDP, but GDP growth). The inventory purge means you are producing less to meet demand than you would otherwise need to. So, when comparing one quarter to the next, unless you purge just as much stuff or unless demand goes down, you need to produce more. Therefore, you get an automatic uptick in GDP growth.

This is what is happening now. The positive impact that inventories is having on GDP growth has to do with the fact that GDP growth is a first derivative statistic where even subtracting a less negative number is positive.

inventory corrections often are an early feature in self-sustaining economic expansions. but in the final analysis, sustainable recovery will come only as a product of end demand pickup -- and that is where i want to focus. new deal democrat, one of the bulls of bonddad, has analyzed in multiple parts his expectations of a reversal in the employment trend. his latest installment integrates his previous analysis of real retail sales, industrial production and initial claims in a nascent model of unemployment, with real retail sales being the ultimate leader of the cycle turn. improving employment, as jobs are added to the economy, provide fuel for further retail sales gains.

this makes real retail sales perhaps the most important economic indicator to watch going forward. the month-ago report for august was really the first positive indication of retail sales growth since the start of the depression in late 2007. the september figure won't be release until mid-october.

does this uptick represent the start of sustainable consumer spending growth? this could be the all-important question.

the depression, as barry eichengreen and kevin o'rourke have made clearer to the world, must (much like its predecessors) be seen in its entirety as a global phenomena to be properly understood. so a look at retail sales trends in other countries might be instructive.

canada:

Canadian retailers unexpectedly posted lower sales in July, led by falling prices at gasoline stations, as consumers brought a two-month shopping spree to an end.

Sales dropped 0.6 percent from the prior month to C$34.2 billion ($32 billion), Statistics Canada said today in Ottawa. Economists expected a 0.7 percent increase in July, based on the median of 20 estimates compiled by Bloomberg. ...

This is a “horrible across-the-board report,” said Derek Holt, an economist at Scotia Capital in Toronto. “It may signal the release of pent-up demand from last fall is over with.”

france:

French consumer spending fell in August when it had been expected to rise, as shoppers cut spending on clothes, shoes and cars, raising questions over the robustness of a nascent economic recovery.

Consumer spending, a key economic driver, fell 1.0 percent month-on-month in August, well below a consensus forecast for a 0.6 percent rise after a fall of 1.2 percent in July, national statistics office Insee said on Wednesday. ...

"In my opinion, it illustrates that difficult times are here for consumption," said Olivier Gasnier, an economist with Societe Generale.

"We are entering a period which is much more difficult for the labour market: prices are beginning to rise and the labour market is not on a good track."

new zealand:

New Zealand’s retail sales unexpectedly fell for a second month in July, adding to signs the economy faces a slow recovery from the worst recession in three decades. Sales dropped 0.5 percent from June when they declined a revised 0.1 percent, seasonally adjusted, Statistics New Zealand said in Wellington today. Core retail sales, which exclude car yards, fuel outlets and workshops, fell 0.5 percent.

britain:

U.K. retail sales unexpectedly stalled in August as shoppers bought less clothing, a sign consumers are cutting back on spending as unemployment rises. Sales were unchanged from July, when they climbed 0.2 percent, the Office for National Statistics said today in London. The median forecast was for a 0.1 percent increase, according to a Bloomberg News survey of 30 economists.

japan:

Japan’s retail sales fell for an 11th month in July, extending the longest losing streak since 2003, as poor weather and a worsening job market kept shoppers at home. Sales slid 2.5 percent from a year earlier, the Trade Ministry said today in Tokyo. The median estimate of 15 economists surveyed by Bloomberg was for a 3.5 percent drop. Consumers cut spending at the fastest pace in five months in July amid falling wages and a record-high jobless rate. The record 25 trillion yen ($266 billion) in stimulus spending that helped Japan’s economy expand for the first time in more than a year has failed to bolster sales at retailers. “Wages have been falling very steeply,” said Masayuki...

germany:

Retail sales in Germany rose for the first time in three months in July as lower prices boosted purchasing power and consumers grew more optimistic about the economic outlook. Sales, adjusted for inflation and seasonal swings, increased 0.7 percent from June, when they fell 1.3 percent, the Federal Statistics Office in Wiesbaden said today. The result was in line with the median estimate in a Bloomberg News survey of 26 economists. From a year earlier, sales decreased 1 percent.

one could also cite china's in-line retail sales, but like most i doubt there's much truth in chinese statistics.

the only unambiguously positive retail sales report in this cycle was the united states', augmented as it was by a huge rush to buy cars under the cash-for-clunkers program and a seasonal uptick in housing activity supported by expiring tax credits that has been powerful enough to overwhelm seasonal adjustments.

but the global picture here is one of disappointment -- retail sales are refusing thusfar to grow as hoped in spite of tremendous global stimulus, and given the relentless contraction of consumer credit that should perhaps not be surprising. western society -- and particularly america, britain and other current account deficit currency unions -- has spent thirty years calling forward future demand by leveraging the household, and with that trend reversed it's hard to expect a big retail sales recovery. this is also why inventory, though it has been cut significantly, is still as a function of sales very high -- and this is the most relevant measure to business profitability, as the modern business model prices for just-in-time delivery and takes losses more quickly on inventory than in times past. though the inventory cycle is pushing activity higher, businesses have the potential to be squeezed both by higher-than-normal inventories and profit margin compression as producer price increases remain difficult to pass on to the consumer. (updated PPI comparison here.)

retail sales measures over the coming weeks may be critical to divining how the inventory cycle plays out -- as a first stage to launching a broader consumer recovery, or as an uptick in a larger depressionary scenario that is simply taking time to play out.

south africa and HSAs

2009-09-17T14:01:00.002-05:00

via physicians for a national health program -- a 2005 reference from the progressive newsmagazine new republic.

improving funding profiles will not be easy

2009-09-17T13:25:00.001-05:00

the economist.

sorry for the lack of recent posting -- busy here and mostly just trying to bookmark things through twitter.

corporate balance sheet repair

2009-09-11T13:07:00.003-05:00

robert peston writing for the BBC -- what is true of the UK in this respect is also true of the united states.

t[T]he Bank of England's fear is that banks are being too averse to risk, that they don't want to lend even to businesses that are fundamentally viable.

And there is evidence that some legitimate requests for credit are being turned down.

But there is something else happening as well: many companies have recognised that their balance sheets are over-stretched, that their debt is too high relative to their devalued assets, and are choosing to repay debt.

Right now it is hard to find a substantial listed or private-equity financed business that actually wants to increase its debt - and many have programmes to reduce their borrowings.

There are, for example, a number of big companies which are technically insolvent: on a realistic valuation of their assets, and including the deficits in pension funds, their liabilities exceed the value of their assets.

They can keep going, because they are generating cash from operations. But although they won't admit it, for fear of panicking shareholders and creditors, they are in what is known as "workout" mode. They are concentrating on shrinking to pay down borrowings.

Paying down debt is rational for each individual business, but it collectively leads to lower investment, lower employment and lower demand in the economy as a whole - and therefore feeds back into worse conditions for business in aggregate and lower economic growth.

This pernicious trend of corporate debt reduction hobbled the Japanese economy for 15 years, according to the compelling analysis of Richard Koo (in his The Holy Grail of Macro Economics).

Corporate debt minimization can't do as much damage here because the debt of British businesses never reached the peaks of Japanese corporate indebtedness - and nor did our asset bubble become quite so egregiously pumped up as theirs.

But if it turns out to be the case that for an extended period, businesses will be choosing to repay debt rather than investing in growth, that will have significant implications for all of us.

It would imply that if households and government also chose simultaneously to cut spending to reduce their excessive debts - and on most analysis, the UK's indebtedness problem is concentrated on the household and public sectors rather than the corporate sector - then the incipient economic recovery could be snuffed out pretty fast.

Which explains why central bankers and finance ministers are only making plans to end their exception stimulus measures, rather than setting a precise date for the withdrawal of the prop.

as peston notes, this is exactly the dynamic of balance sheet recession that has been at work in japan for two decades.

when will unemployment improve?

2009-09-11T11:44:00.006-05:00

bonddad blog with the first of a multipart series -- but the answer might be sooner than you think.

... I believe that the economy will start to add jobs when the initial jobless claims rate drops past 550,000, and stays significantly under that number (about 530,000 or less) for three months, or else quickly drops under 500,000.

But of course, that begs the next question, which is, how can we tell if jobless claims are moving in that direction or not? There are several other data sets that help pinpoint this, and that's what I'll explore next week.

contributor new deal democrat also points to the moderation in inventory-to-sales as evidence that manufacturing might be priming for expansion. the three contributors are split on the viability of a consumer-led recovery.

hiring plans

2009-09-08T14:55:00.001-05:00

via naked capitalism.

august jobs

2009-09-04T12:37:00.003-05:00

via calculated risk.

i would reiterate from two months ago the point of bill gross as conveyed by edward harrison:

His basic point is this: no jobs and no wage growth equals no recovery.

We need to see incomes rise in order to get consumers to spend. If the Obama Administration wants recovery, they need to do more to increase incomes and worry less about bailing out the banks.

the aggregate weekly hours index (AWHI) continues to shrink at ever greater year-over-year rates, but the monthly seasonally adjusted rate of collapse has moderated significantly.

soaring junk bond defaults

2009-09-04T09:13:00.003-05:00

debt resolution is a messy thing sometimes.

The default rate is expected to rise to 13.9 percent by July 2010 and could reach as high as 18 percent if economic conditions are worse than expected, S&P said in a statement.

Default rates have surged from less than 1 percent in 2007 as an economic downturn squeezed corporate revenues and a global credit crunch dried up funding. A 13.9 percent default rate would be the highest since the Great Depression of the 1930s, when it hit 15.9 percent. ...

"Credit metrics in the U.S. show continued deterioration of credit quality and restricted lending conditions," S&P said.

In another sign of corporate distress, the rating agency has downgraded $2.9 trillion of company debt year to date, up from $1.9 trillion in the same period last year.

Just $73.6 billion of debt has been upgraded, though that is up from $35.8 billion in the same period last year.

"The bright spot for credit markets amid the current economic downturn is an increase in new issuance," S&P said. Junk-rated bond sales have grown to $73.6 billion through August from $35.8 billion in the same period last year. Investment-grade issuance has risen to $603 billion from $537 billion, according to S&P.

A reopening of the bond market following last year's credit freeze is allowing companies to refinance debt, keeping defaults lower than they otherwise would be.

so junk defaults have hit 10% on their way to 13-18% in spite of massive refinancing subsidies for troubles issuers fostered by huge liquidity injections by the federal reserve bank into the relevant markets and agents.

if that doesn't underscore just how massive the corporate junk bond problem is, i don't know what could. a lot of these companies are going to default eventually regardless of liquidity provisioning because smaller bank balance sheets are going to force them off the fringe on credit quality concerns, and they'll become a chapter of the history books written on our society's great deleveraging.

FHA lines up for a bailout

2009-09-04T08:53:00.006-05:00

via clusterstock -- this is very much expected and a product of congressional actions to keep bad mortgages afloat.

“FHA is designed to help stabilize the economy, operating within manageable, low-risk loans,” [Federal Housing Administration commissioner Brian] Montgomery said. “It is not designed to become the federal lender of last resort, a mega-agency to subsidize bad loans.

“We don’t want to dramatically enlarge FHA’s portfolio, with a substantial portion of the portfolio problematic, high risk loans that cost homeowners who were careful and bought homes within their means.”

and yet, in the emergent panic over the collapse of the housing bubble in 2007, FHA was asked to become exactly 'a mega-agency to subsidize bad loans' that did dramatically enlarge its portfolio with problematic, high-risk loans.

but the problems of the FHA are small beer compared to the troubles that will come down when FHLB system and GNMA -- the two federal agencies that were forced to stand in for GSEs fannie mae and freddie mac as the financing for each expired -- come a-knocking with the tremendous losses they've been busy booking since china began its great shift away from agency debt. it was long ago apparent that these institutions would have tremendous difficulty standing in for the failing GSE complex. i fear there's plenty more bailing where FHA, FNM and FRE came from -- particularly if, via calculated risk, john burns consulting has it right:

Based on the issues at the FHA, the end of the tax credit, and more supply coming on the market, Burns concluded that "housing could see another leg down later this year or early next year":

[W]atch the growing controversy regarding the FHA very carefully. The decisions made to allow the FHA to continue lending will have a huge impact on the housing market, particularly when so few entry-level buyers have a substantial down payment.

adjusted mutual fund cash

2009-09-03T21:32:00.002-05:00

traders narrative in conjunction with jason goepfert analyze the inflation-adjusted mutual fund cash level.

The mutual fund cash level is no longer neutral. This new adjustment shows that on aggregate, mutual fund managers are holding about 1.5% less cash than the statistical model suggests. While that may seem a trifling difference, historically, it has been a tell for a topping market.

The data fits the market remarkably well. The only caveat is that as timing indicators go it is sloppy. The market may top now, a week from now or a bit longer. With the corollary that the amount of cash may decrease even further. But the message of this indicator is crystal clear: the market is top heavy.

can china really become a consumer society?

2009-09-03T11:48:00.006-05:00

that chinese households are deep repositories of savings has been taken at face value in the macroeconomic community for a long time. many around the world are counting on the chinese government to spur economic growth by utilizing those savings to boost domestic demand, correcting longstanding imbalances in trade that have been the fuel for the great leveraging of the last thirty years.

while china has certainly accumulated massive forex reserves as a result of maintaining its currency peg with the dollar, via paul kedrosky, this BBC radio documentary makes an extremely interesting case that these savings are not what they appear at all -- indeed, that there is essentially no prospect of pushing extant savings into consumer use even if economic conditions improve.

for ... poorer families living in the countryside, the idea that they've got money sitting around in bank accounts that they simply choose not to spend is a misunderstanding of what life is really like. for the Yu family, there are rarely choices about what to spend their money on. ... as Colin's parents explain, they spend almost all of their income on necessities.

expected healthcare expenses play a huge role in forcing savings, even among children expecting to care for their adults in old age, as rural chinese families are essentially self-insuring. young city dwellers have higher incomes and are often insured, but are also committed to saving in advance of caring for parents who in communist china made nothing like the amounts available to them today.

it very much seems to me that, in order for chinese households to transition to a more consumer-oriented society, they will likely need the aid of two things: a stronger currency, and a reliable social safety net. the first would increase purchasing power and domestic demand while decreasing reliance on exports; the second would remove the impetus to self-insure. these are both changes that will take a long while, once enjoined, to shift social expectations in china; as neither has been countenanced thusfar, i can see little prospect of either in the short run.

twenty years of the new normal

2009-09-01T15:00:00.001-05:00

via ed harrison, bill gross' latest missive.

[T]here’s been a significant break in that growth pattern, because of delevering, deglobalization, and reregulation. All of those three in combination, to us at PIMCO, means that if you are a child of the bull market, it’s time to grow up and become a chastened adult; it’s time to recognize that things have changed and that they will continue to change for the next – yes, the next 10 years and maybe even the next 20 years. We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops and begins, as they do in Japan (to be a little ghoulish), starts saving to the grave.

still a depression, but watching industrial production

2009-09-01T12:44:00.005-05:00

barry eichengreen and kevin o'rourke update their charts to note the nascent divergence of industrial production from the early 1930s trend.

This is a sharp divergence from experience in the Great Depression, when the decline in industrial production continued fully for three years. The question now is whether final demand for this increased production will materialise or whether consumer spending, especially in the US, will remain weak, causing the increase in production to go into inventories, leading firms to cut back subsequently, and resulting in a double dip recession.

interestingly, of all the country breakdowns of individual nation industrial production, only the united states is faring better than in the great depression to date. this is very likely due to the reversal of its role in this crisis, as the erstwhile great current account surplus nation (a role now shared by china, japan and germany) to the world's great current account deficit nation and provider of excess demand.

but end demand does not appear to be resuscitating as of yet, except where dramatically subsidized from the public checkbook, nor is retail credit in any expanding as banks continue to reduce balance sheet. as noted by pragmatic capitalist, retail data are still indicating contraction.

Are investors beginning to notice the weekly negative trends in retail? ICSC came in at -0.5% on the week and -0.7% year over year. Redbook came in -4.1%. The strong negative trend in consumer spending cannot be ignored forever. At some point this is going to take a grip on the economy and the stock market. This is a very bad sign for back to school sales….

this bloomberg piece citing the opinions of paul tudor jones and clarium capital's kevin harrington roughly corroborate the view that there's clearly a cyclical inventory restocking afoot, but it may be one limited by the trailing off of fiscal stimulus spending as the year runs out.

cash savings

2009-09-01T11:35:00.003-05:00

via barry ritholtz at big picture, mark warywoda of addenda capital on the state of the consumer.

So far, all we have had is a two-quarter bump up in personal savings rates — that is trivial related to the outstanding debt burden. The debt-to-income ratios have barely budged, given that income had fallen at the same time that spending had fallen.

How is it was possible that debt-to-income ratios hadn’t improved much when the savings rate had gone up to 5%? The short answer is it comes down to the simple equation: Savings = DPI – personal outlays.

A true savings rate should compare personal outlays to only the portion of personal income that’s actually spendable (ex supplemental benefits). A savings rate computed on that basis remains stubbornly very negative. And debt burdens remain atrociously high, at a time when incomes and asset values remain under pressure.

Until about 1970, personal outlays (dominated by Personal Consumption Expenditures (PCE) (96.6%), but also including interest payments and transfer payments) were consistently held under the amount of cash receipts — but not in recent decades.

While the official personal savings rate has always been positive, though trending down over time since 1982 until 2008, the unofficial personal savings rate has trended down since WWII, turning negative in the 1970s, and exceeding -10% for much of the 2000s . . .

Economic growth has increasingly relied on debt growth. The government is trying to preserve economic growth by levering up to fill the void left by private sector deleveraging. But will it be able to do so for as long as house-holds need to continue to delever? Consumers over-consumed for years (because they could — because of housing “wealth”, MEW and excessive leveraging). Leverage allowed consumers to, over the course of the decade, basically get a bonus year’s worth of spending relative to pre-2000 historical spending norms.

note how the cash savings rate went negative more or less exactly as the great leveraging began in the late 1970s. one is of course a function of the other.

this is hardly new news, but i think it gives a better look at the amount of balance sheet repair that stretches out before the american household looking forward. rebuilding the savings base of the country is going to be a difficult and painful job, no matter how it's handled.

baltic dry as a leader

2009-08-31T09:47:00.004-05:00

via kirk report, afraid to trade -- something of an adjunct to seeing shanghai as a leader (off more than 5% today again) may be seeing the baltic dry shipping rate index as a leader. container freight rates are very low in spite of the continuing buildup of mothballed boats in major anchorages like singapore and gibraltar.

UPDATE: more from fund my mutual fund.

renting in chicago

2009-08-31T08:45:00.001-05:00

via calculated risk, a link to the chicago tribune on the difficulties of being a landlord in chicago.

killing off retail short interest

2009-08-28T08:37:00.004-05:00

this is deeply unfortunate, as the entire point from my view of having access within a 401(k) plan to a directed brokerage option is to enable hedging.

Recently, both the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) have cautioned against the use of Leveraged Exchange Traded Funds (ETFs).

Their concerns are that these funds are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Because leveraged and inverse ETFs are reset daily, FINRA and the SEC caution against the use of these funds for investors who plan to hold them for longer than one trading session.

Princor Financial Services Corporation, like several broker-dealers in the industry, has taken the position to no longer allow access to leveraged ETFs, beginning on Friday, August 28, 2009. Princor® will no longer allow purchases in these securities; however, liquidations will continue to be permitted.

i don't doubt that some folks have mauled themselves with ultra proshares -- but that's an argument against defined-contribution retirement planning in its entirety, not any particular instrument. principal and other administrating brokers may not realize that's what they're actually saying, and certainly they don't want to say that, but that is the core of their assertion. if you can't be trusted with a ~~straightforward, well-explained and simple~~ "highly complex" derivative ETF such as these, you really can't be trusted with any aspect of self-planning your financial future. and so 401(k) plans themselves are really quite a bad idea, particularly in comparison to some form of compulsory social insurance.

that is, frankly, an argument i have a great deal of sympathy for -- but i sincerely doubt principal is trying to make it. indeed it isn't hard to imagine other reasons for a forced buy-in of retail short interest, particularly amid the aftermath of one of the great asset price collapses in the history of western civilization, one which has sent any number of insurers and other financial intermediaries whose balance sheets are predicated on, among other things, equity price levels to the brink of destruction.

one might expect that such concerted efforts would drive short interest to very low levels -- and indeed, by the tally of bespoke, it has fallen to the level last seen in february 2007. of note is that bespoke expresses short interest as a ratio to the float; shares short outstanding here. one can see that NYSE shares short are down on the order of 20% from august 2008, but the short interest ratio is down closer to 45%. this is testament to the massive equity offerings that have flooded the market, particularly in the financial sector, as firms have tried to raise capital.

february 2007 was a period when the S&P was marking new post-dotcom highs just prior to the shudder sent through the markets by the reversal of the chinese equity bubble which, for my money, marked the beginning of the global debt collapse even if american shares continued to rally for some months thereafter. margin debt was then at an all-time high, retail mutual fund cash at an all-time low -- balance sheet risk for retail investors was at a maximum, and the suckers were all in. immediately thereafter paul mcculley introduced much of the investment world to hyman minsky, and we've spent much of the last two-and-a-half years living out minsky's hypothesis.

in any case, i suspect the huge short squeeze of recent months, in combination with excess liquidity from banks and other government funding recipients seeking a return, has provided much of the rocket fuel for the markets since march. though the lesson might have been learned in the aftermath of the financial shares short sale ban in the UK and US in september 2008, sucking forward and eliminating all that future demand through covering and forced buy-ins -- and replacing it with a latent pent-up supply -- creates the potential for a terrible air pocket beneath shares, diminishing both liquidity and future demand. i find few market tells more convincing than extremes in short interest.

UPDATE: pragmatic capitalist also adds that reporting hedge funds haven't been so long (31% net) since june 2008. that's still a far cry from the 47% of early-crisis third quarter 2007.

treasury default in the cards?

2009-08-27T23:51:00.004-05:00

via john carney, the speculation of jeffrey rogers hummel on the future of american government obligations.

It is not literally impossible that the Federal Reserve could unleash the Zimbabwe option and repudiate the national debt indirectly through hyperinflation, rather than have the Treasury repudiate it directly. But my guess is that, faced with the alternatives of seeing both the dollar and the debt become worthless or defaulting on the debt while saving the dollar, the U.S. government will choose the latter. Treasury securities are second-order claims to central-bank-issued dollars. Although both may be ultimately backed by the power of taxation, that in no way prevents government from discriminating between the priority of the claims. After the American Revolution, the United States repudiated its paper money and yet successfully honored its debt (in gold). It is true that fiat money, as opposed to a gold standard, makes it harder to separate the fate of a government's money from that of its debt. But Russia in 1998 is just one recent example of a government choosing partial debt repudiation over a complete collapse of its fiat currency.

... [U]nconvinced that the Treasury will default? The Zimbabwe option illustrates that other potential outcomes, however unlikely, are equally unprecedented and dramatic. We cannot utterly rule out, for instance, the possibility that the U.S. Congress might repudiate a major portion of promised benefits rather than its debt. If it simply abolished Medicare outright, the unfunded liability of Social Security would become tractable. Indeed, one of the current arguments for the adoption of nationalized health care is that it can reduce Medicare costs. But this argument is based on looking at other welfare States such as Great Britain, where government-provided health care was rationed from the outset rather than subsidized with Medicare. Rationing can indeed drive down health-care costs, but after more than forty years of subsidized health care in the United States, how likely is it that the public will put up with severe rationing or that the politicians will attempt to impose it? And don't kid yourself; the rationing will have to be quite severe to stave off a future fiscal crisis.

it's thought impossible, but it pays to remember rogoff and reinhart as they observed that better than 50% of world governments typically end up in some manner of default during depressions such as this -- a far more common occurrence than hyperinflation. national defaults also generally are not the death sentence one might infer. particularly in the case of the united states, which is a very large component of global economic activity regardless of its fiscal condition, the idea that the country is going to become an international economic pariah is silly. indeed, willfully engaging in hyperinflation would likely be the more chaotic step by far.

so the option is there, if it is needed. much depends on the extent to which the government is compelled to explicitly backstop the financial system and provide fiscal stimulus -- and particularly to what extent social insurance commitments are retracted.

some measure of devaluation of the dollar at some point seems likely to close the american current account deficit, and any default would likely be accompanied by heady dollar trauma. but i continue to think deleveraging will result in deflation and probable relative strength in the dollar in the intermediate term. i think competitive devaluation is far more likely than a unilateral dollar crash, and privately created money emergent of fractional reserve banking is being destroyed on a scale the fed will find difficult to counteract.

UPDATE: two sides of the debate on federal deficits and debt presented by paul krugman, jim hamilton and krugman again. i tend to agree with krugman.

[I]n 1950, federal debt in the hands of the public was 80 percent of GDP, which is in the ballpark of what we’re looking at for 2019. By 1960 it was down to 46 percent — and I haven’t heard that anyone considered America a debt-crippled nation when JFK took office.

So how was that possible? Was it through drastic cuts in defense spending? On the contrary: we’re talking about the height of the Cold War (with a hot war in Korea along the way), and federal spending actually rose as a share of GDP. So yes, it wasn’t entitlement programs, but it wasn’t exactly discretionary either.

How, then, did America pay down its debt? Actually, it didn’t: federal debt rose from $219 billion in 1950 to $237 billion in 1960. But the economy grew, so the ratio of debt to GDP fell, and everything worked out fiscally.

the trick of course is that it wasn't until 1954 that private, as opposed to public, debt reached a minima. the growth seen from the end of the 1953 recession forward to the 1970s -- a period rightfully associated with the peak of american global economic power -- was made possible by the complete resolution of the private debt bubble which popped in 1929 and more than two subsequent decades of household and corporate balance sheet repair. what economic strength was seen in the intervening time was largely a product of government deficit spending -- again, the refinancing through government-derived income of private debts onto the public balance sheet, particularly between 1941-45. and of course there was the assistance in that resolution of an apocalyptic cycle of defaults and bankruptcies.

if we're to return to the kind of growth track that allowed our society to outgrow its debts following the second world war, we first have to use public policy today to effect private sector balance sheet repair. we have done that only modestly thusfar. krugman is of course correct that government deficits have moderated the default cycle in a way that they didn't in the early 1930s. but a monster debt pile remains to be resolved in the private sector, and government -- particularly through the operations of the federal reserve -- has taken steps to delay or even attempt to prevent this resolution at the possible expense of creating even larger debt resolution problems down the road for an economy that has reached zero hour and experienced a classic bout of what minsky called financial instability, leaving it in a very poor position to grow.

this is a long way of saying that america needs to proceed smartly toward a massive expansion of public spending and debt as a means of refinancing the private sector, transferring obligations to the taxpayer through income so as to provide real relief. of course much debt must simply be liquidated -- not all of the private sector obligations will fit under the treasury umbrella with private debts around 300% of GDP outstanding -- and that means a measure of absolute balance sheet contraction. such contraction can hopefully proceed in lockstep with the closing of the current account deficit and weaning the banking sector off wholesale funding. all this, and an efficiency-minded reconfiguration of social insurance as well.

there's a lot on the american plate, no matter how you look at it. but krugman is i think essentially correct -- this is less a problem of mathematical certitude than political will.

case shiller ticks up

2009-08-27T23:36:00.002-05:00

it's fodder for optimism for those so inclined, but mark hanson anticipated and has been addressing what the uptick in the case shiller index means.

I have been waiving warning flags about this statistical house price appreciation for a few months now — since CA house prices started moving up in April — and finally this month some of the larger research shops have started to point to the same things. These are absolutely unprecedented in nature and are wreaking havoc with reported house prices.

particularly interesting at econbrowser was the comment of jm, here appended.

Except in the low end of the market, stimulated by the $8k credit and "investors" scooping up foreclosures, hardly anything is selling here in the Chicago suburbs. Above $500k, especially above $600k, we have multiple years of inventory on the MLS even though only what absolutely has to be sold is listed -- sales rates are down nearly 80% from bubble peak. Yet the asking prices have still fallen very little, almost certainly because they are set by the amounts of the underlying mortgages, and the only way they can go lower is if the mortgage holder agrees to a short sale or forecloses and takes a loss on the REO. So the prices up in middle and high ranges of the market are not market-clearing prices -- only very few sales are being made, presumably to people who either feel they must buy or who think the market is going to come back soon.

Eventually, those homes are going to be foreclosed upon, and sold at much, much lower prices.

sornette and the china echo bubble

2009-08-27T12:42:00.010-05:00

i added a link to didier sornette's financial crisis observatory in the sidebar last month after jck at alea followed up via twitter on an earlier post referencing the july 10 paper co-authored by sornette calling for a top in chinese equity.

sornette's group modeled a window stretching from july 10 to august 10, with a 20-80 confidence interval from july 16 to july 27.

the peak turned out to be august 4, and all future calls by sornette are now worth watching closely.

if this is in fact the bursting of the chinese echo bubble brought on by massive forced lending by the state-managed banking system, there should be plenty of downside left in china. fund my mututal fund discusses steps being taken in china to rein in such lending. and, as pragmatic capitalist has hammered on recently, china has been the leading indicator par excellence in this crisis.

UPDATE: one can also cross reference this post from pragmatic capitalist on the divergence between hong kong equities and the baltic dry index to derive potential motivation for further disruption in stock prices.

UPDATE: more on sornette's group via new scientist.

davidowitz on retail

2009-08-27T12:17:00.003-05:00

back from a fitful two weeks in southeast alaska....

with thanks to pragmatic capitalist -- howard davidowitz hasn't changed his tune one bit.

"living standards will never be the same." cyclical upticks (such as the current one) will come from time to time on the back of stimulus, but won't last -- "we go right back into the tank," in davidowitz's words. pricing trends in retail indicate pervasive deflationary pressure. his incisive criticism of the obama administration and their projections for growth, revenue and funding capacity for health care expansion among other plans spares nothing.

is it possible to be more dire than davidowitz? "we are in the tank forever. as a country we're out of control. we're in a death spiral. ... we're non-functional." bright spots? extreme value/dollar stores, drugstores (including CVS), major food distributors, rent-to-buy, autozone, kohl's.

"deleveraging the most leveraged economy in history"

2009-08-10T15:51:00.002-05:00

via mish -- this report from comstock partners gives the outlook on a failure to reinflate, with some good charts.

UPDATE: pragmatic capitalist cites as well. i think many underestimate the intensely positive short-run effect that government deficit spending is having right now on an economy that is privately delevering for the longer term. if or when that stimulative spending is phased out by a nervous and divided populist government -- much as the hashimoto government of 1997 did -- the scale of that beneficence will become more tangible.

excess reserves and liquidity

2009-08-07T10:44:00.005-05:00

so as not to lose sight of it, alea observes the declining excess reserves in the banking system, a function of unwinding fed assets (such as currency swaps or term auction credit) outpacing the portfolio accumulation (ie, monetization) of treasuries and MBS. in the comments, i speculated on the association between temporary open market operations (effectively the term auction facility, or TAF) and liquidity available to the financial system as a driver for market prices. the slosh report is an easy place to view the trend in TOMO/TAF (the "slosh"); another is the FRED graph. jck is as always gracious.

hulbert on ned davis, part 2

2009-08-07T08:10:00.003-05:00

following on, more from mark hulbert.

Davis has turned his attention to what would signal that it was time to reduce equity exposure and go to cash. He mentioned four indicators, any one of which would likely cause him to start selling:

Valuation. Davis would look to exit from stocks whenever the P/E ratio on the S&P 500's normalized earnings reaches 20. To be sure, putting this indicator into practice is a bit tricky, since it requires normalizing those earnings -- adjusting them, in other words, for where we are in the economic cycle. Nevertheless, Davis calculates that normalized earnings on the S&P 500 index /quotes/comstock/21z!i1:in\x (SPX 997.08, -5.64, -0.56%) currently stand at "around $60," which suggests that Davis will be looking to start exiting the market at the 1,200 level.
Sentiment. Davis maintains his own sentiment index, which he calls his "Crowd Sentiment Poll." This index currently stands at 62%, according to Davis, which is just above the 61.5% level that he considers to be the lower bound of "extreme optimism." He says that, on past occasions when this index has risen above 61.5%, its eventual peak has averaged 68%. He says that reaching that level this time around would "be a sign for traders to begin selling weak performers."
Internal market divergences. The indicator that Davis relies on here is one that was created three decades ago by Norman Fosback, who currently edits a newsletter called Fosback's Fund Forecaster. The indicator is called the "High Low Logic Index," which represents the lesser of new 52-week highs or new 52-week lows as a percentage of all issues traded. In Fosback's book "Stock Market Logic," he describes this indicator's rationale as follows: "Under normal conditions, either a substantial number of stocks establish new annual highs or a large number set new lows -- but not both. As the [High Low] Logic Index is the lesser of the two percentages, high readings are therefore difficult to achieve. ... When the Index attains a high level, it indicates that the market is undergoing a period of extreme divergence. ... Such divergence is not usually conducive to future rising stock prices." Fortunately for the current market, this index is solidly in bullish territory right now at 0.8%, according to Davis' calculations. He says that it would have to rise to around 2.5% before he would start looking for the exit signs.
Rising interest rates. Davis has found from his research that one of the best market timing indicators in recent years has been the 26-week rate of change for investment-grade bond yields. With that rate of change currently standing at minus 12.6%, a sell signal from this indicator is not imminent.

The bottom line? Only one of these four indicators is even close to flashing a warning signal right now, which is why Davis is bullish right now.

the potential for inventory cycle

2009-08-06T07:55:00.004-05:00

following on yesterday's comments -- john hempton:

Paul Krugman has been predicting a double-dip recession based on an inventory bounce. He figures that middle to latter part of this year will have an inventory bounce which will (briefly) make the economy look good again – but will not (in his Keynsian world view) bring back the fragile flower of true sustainable demand and hence will not result in sustained recovery.

That said – the inventory bounce might be very spectacular indeed. I wish to illustrate with an (admittedly) extreme example – the manufacturing of recreational motor boats (scornfully known in the Australian vernacular as “stink boats”). ...

So what do we have

• End sales down 30 percent

• Dealer sales down 60 percent

• Production down 75 percent

Or – as they put it

We produced 13% of what the dealers actually retailed, in terms of even numbers.

Obviously these numbers are unsustainable and either retail sales have to dramatically fall from current levels (unlikely) or production has to grow dramatically...

How else do you spell inventory bounce?

My guess is that the inventory bounce here will be so big as to restore pricing power to (of all things) luxury recreational motor boats manufacturers.

This looks like a V-shaped recovery – at least for stink boat manufacturers.

Whilst there are inventory shortages in far more important industries (see this story from the WSJ about auto-dealer inventory shortages) they won’t quite be of the scale of Brunswick. But the risks to the inventory driven manufacturing economy are in my view (and quite surprisingly) to the upside.

in the competition between secular private sector deleveraging and inventory dynamics, inventory dynamics can win for a time. the inventory cycle might drive something that looks (for a time) very like a real recovery -- even without any end demand pickup whatsoever.

trimtabs on employment

2009-08-05T14:43:00.004-05:00

via zero hedge, trimtabs CEO charles biderman.

“The personal income report the Bureau of Economic Analysis released Tuesday contained huge downward revisions to wage and salary growth,” said Biderman. “Now that the BEA is using unemployment insurance reports from the first quarter to estimate current wage and salary growth, its data confirms what we have been reporting for months.”

The BEA’s estimates of wages and salary growth changed from year-over-year declines of 0.8% in April and 1.1% in May to year-over-year declines of 4.0% in April and 4.2% in May. Also, the BEA reported that wages and salaries dropped even more sharply in June, falling 4.7% year-over-year.

“Two months ago, we asked BEA economists how they reconciled the huge declines in real-time tax deposits with their report of a modest decline in wages and salaries,” said Biderman. “They could not answer our question. We know now that by ignoring real-time data, the BEA was providing an inaccurate view of the economy’s health.”

this perhaps helps to explain the continuing softening of econometrics, not to mention surprisingly soft deposit growth among commercial banks in spite of increasing savings rates. calculated risk takes on today' comments from proctor & gamble as well as the non-manufacturing ISM.

[T]he ISM non-manufacturing numbers this morning and the P&G numbers matter. Away from auto sales, it is hard to find much evidence of a pick up in consumer demand.

I've seen some argue for a business led recovery. That is the wrong order. Sure, there will probably be some inventory replenishment since some companies probably cut back too far, but most companies already have too much capacity, so after the inventory adjustement what will happen? They will not need to expand until their sales pick up significantly.

So I still think the keys are Residential Investment (RI) and PCE, and therefore I think the recovery will be sluggish. Note that CRE and non-residential investment in structures is a lagging indicator for the economy.

the idea of a business-led recovery amid 65% capacity utilization is something i find hilarious. there's no doubt that the real elements of the leading economic indicators are reviving a bit, giving weakly positive contributions to the LEI over the last quarter. the harder question to answer is, "what does that represent?" -- and i'm of the belief that the pickup in manufacturing activity amounts to channel stuffing following an epic first quarter shutdown. we are continuing to see little to no evidence of a pickup in consumer demand, while -- as inventories decline -- inventory-to-sales remains near cycle highs and very far indeed from the levels which globalized industry honed (and levered) to just-in-time delivery can profitably tolerate.

i admire edward harrison of crdit writedowns immensely, and his analysis of employment trends is valuable. he shows the ISM manufacturing report to be indicating near-recovery.

Given this data and other recent bullish economic reports, don’t be surprised if Q3 GDP change prints a positive number. If it does, it is very likely that the recession is all but over right now. Mind you, I still am talking about a weak Q4 or Q1 2010 recovery and possible double dip. But, I am aware that it is mostly upside economic risk that is apparent in the US. The data cannot be ignored. And right now, it is very bullish.

that double-dip, with a middle "expansion" consisting entirely of channel stuffing and government stimulus, looks fairly probable to me. whether or not third quarter GDP prints positive is immaterial on the longer view, in my opinion. a not-entirely-useless analogy might be the landing one sometimes finds between floors in a long flights of stairs -- less the end of the decline than a pause in it.

declining farmland values

2009-08-05T14:23:00.002-05:00

there's a bit of a vogue among financiers (such as marc faber) for buying farms as a hard asset in lieu of currency. via calculated risk -- maybe they should know that farmland is in a bubble as extraordinary as other forms of real estate, driven by skyrocketing ag commodity prices which have since collapsed.

buying climax?

2009-08-02T10:45:00.003-05:00

there's a lot of lines on this screen cap, but i might isolate out a component of this market screen for attention.

first, buying climaxes -- this is a condition of the underlying components of the index wherein an issue makes a high in the previous five days which is also a 65-day high, but then also reverses to close on this day lower than any of the five previous closes. it is intended to mark big momentum shifts in the underlying which may not be apparent in index price.

some 14.6% of the S&P 500 met that condition on friday, in spite of the index giving the best closing price since november 4. i ran some date-marked red lines through previous spikes in buying climaxes to give some kind of feel for how the condition typically resolves. particularly curious is the divergence with index price -- often, buying climax spikes are part of broader price corrections reflected in the index price. is there any special place for those arising on new five-day high closes?

the previous dates for this infrequent condition: 7/15/2005, 1/6-7/2004, 6/12-13/2003, 1/3/2001, 2/19/1991, 12/12/1990. from five of six of these points there was a possibility of buying lower during a multiweek market stall. just as notably, however, all six saw somewhat higher index prices ahead of trouble -- as though some time was needed to dissipate momentum. small sample size, however, should weigh on the applicability of this particular divergence as a predictor.

GDP for 2q2009

2009-07-31T15:10:00.006-05:00

james hamilton at econbrowser hits the data note that one need know from this report:

In terms of specific factors contributing to the 2009:Q2 growth rate, consumption spending, housing, nonresidential fixed investment, inventory change, and exports each subtracted almost 1%-- had it not been for the positive contribution from falling imports and increasing government spending, the Q2 number would have been -4.3% instead of -1%. Should we be cheering the fact that falling imports were a key factor preventing GDP from declining even more? Falling U.S. imports can create problems for those countries trying to export to us and are a symptom of a very weak U.S. economy. But lower U.S. imports are a necessary element of our longer run adjustment process, and indeed, if the increase in U.S. private saving were just matched by the decrease in U.S. imports, we'd be exactly where we want to be in both the short and the long run.

falling net imports are also gradually denting the capacity of the united states to fund itself with borrowed foreign deposits.

the pace of decline moderated in the second quarter, to be sure. next quarter is likely to see government spending tick up as well, and the decline in residential development flatten out. but i wouldn't put a lot of hope into inventory rebuilding -- without an uptick in end demand, stuffing the channel in third quarter means a deeper contraction in the fourth. and the PCE data in the report gave no indication of a consumer end-demand uptick. as to whether we get a positive print for GDP in 3q2009, i think it's certainly possible and perhaps even probable. but the ongoing debt deleveraging is still slowly gathering momentum -- just one look at the FRED series for total loans and leases tells you so, even distorted as the series is by the reclassification of the assets of washington mutual, as run led to failure and purchase by jpmorgan chase, from the universe of thrifts to that of commercial banks in october 2008, creating the attendant huge spike in the data -- and that will depress consumption perhaps to a degree widely underestimated at this writing.

there's a potentially interesting series to watch here, which is the seasonally-adjusted deposit components of the commercial banking system, released monthly in the h.6. this FRED chart shows the change from the previous period for the h.6 components. perhaps predictably, deposits skyrocketed from september to december 2008. but there's since been what one might think of as a disappointing increase in deposits. deposits are the result of income, which are the result of both the quantity and velocity of money and credit in the system. if the government stimulus is too small to overcome debt deleveraging, it should show up in deposits. and this data is estimated on a weekly basis by the fed.

the change in the total of all five is charted here with an eight-week moving average. there's clearly a massive rush to save in 4q2008 which contributed heavily to the crush in consumption and investment (and perhaps asset prices) in that quarter. but the following two quarters don't show anything like that much saving -- indeed the increase in deposits is frequently less than seen previous to the crash, a period of noted and lamented dissaving. some would-be savings inevitably were fed into the huge surge of securities issuance in the first and second quarters, but this will bear watching in any case. if fiscal stimulus and balance of trade improvements are too small to offset the further contraction of investment and consumption, i would think deposits should show the effect.

galbraith on china

2009-07-31T12:27:00.002-05:00

now this is provocative -- via zero hedge.

University of Texas professor James Galbraith discusses one aspect of China's "booming" economy, specifically the question of China's Trade Surplus, which as he notes has been drastically inflated since 2002 due to Chinese companies over-reporting profits on exports in order to disguise various investments by foreigners into China, so as to beat capital control restrictions.

Galbraith argues the "fake profits" are so large that China may have actually ran a trade deficit in some years, and these figures casts serious doubt on the reported P&L of Chinese companies.

one can only hope for the brad setser response.

specialist short sales

2009-07-31T10:41:00.006-05:00

this is a dataset i've only recently begun to track, so i've no idea what if any predictive value it might contain. the top link group includes this link to NYSE's data page, and i've pulled some figures from it into a spreadsheet figuring to observe the ratios of specialist short sales in comparison to non-specialist and odd-lot short sales. the theory behind the indicator is articulated pretty well elsewhere on the web -- though between the development of supplemental liquidity providers (or SLP) performing a quasi-market-making role and the dying role of floor specialists in general i'm not sure what if any consistency from the data can be expected.

in any case, on yesterday's break and reversal specialist short sales spiked to about 220% of its 20-day moving average. this might be an indication of impending reversal -- or not -- as it arguably was on june 29.

hulbert on ned davis

2009-07-30T09:34:00.004-05:00

mark hulbert offers a synopsis of the typically solid analysis of ned davis.

Now is a particularly good time to check in with Davis, since earlier this week he finished a seven-part series in which he compared the March 9 low with the famous secular lows of decades past. Davis was able to identify seven dimensions that he could use to compare the March 9 low to those past secular lows:

"Monetarily, money should be cheap and amply available:" Neutral. You might think that this factor should be rated as "bullish," given how accommodative the Federal Reserve is currently. But Davis notes that banks are also significantly tightening their lending standards. Given the heavy load of debt under which both consumers as well as corporations suffer (see next criterion), banks are finding it "increasingly hard to find 'credit-worthy' borrowers."

"Economically, the debt structure should be deflated." Bearish. This is the most negative of any of Davis' seven dimensions, since by no means is the debt structure deflated. On the contrary, Davis calculates that the total credit-market debt load right now is nearly four times the size of gross domestic product, and that it takes more than $6 of new debt for our country to produce just $1 of GDP growth. That's almost double the amount of debt required in the 1990s.

"There should be a large pent-up demand for goods and services." Bearish. Davis acknowledges that there has been improvement along this dimension from where things stood at the beginning of the bear market. But he is particularly worried by the ratio of total Personal Consumption Expenditures to Non-Residential Fixed Investment, which currently stands at a record high. At the secular bear market low in 1982, in contrast, this ratio was at a record low.

"Fundamentally, stocks should be clearly cheap based upon time-tested, absolute valuation measures." Neutral. Though the stock market "got undervalued at the March lows," it never became "dirt cheap."

"Psychologically, investors should be deeply pessimistic, both in terms of the stock market and the economy." Bullish. Davis says that past secular market lows were accompanied by an extreme amount of pessimism, and his indicators show a similar extreme existed earlier this year.

"Technically, major investor groups should have below-average stock holdings and large cash reserves." Neutral. While foreign investors have record-low stock holdings, according to Davis, household holdings -- while low -- are not nearly as low as they were at prior secular bear market lows. And institutional investors' stock holdings "are only down to an average weighting historically."

"A fully oversold longer-term market condition in terms of normal trend growth and in terms of time." Neutral. Davis believes that, though many of the excesses of the real-estate bubble have been worked off, some still exist. That's particularly a problem, he says, given that the stock market bubble of the late 1990s never completely deflated either. "As we saw in Japan after 1990, a double-bubble in stocks and real estate leaves it difficult to put 'humpty dumpty' together again."

The bottom line? Only one of the seven foundations of a secular bull market is in place. Three more are neutral, and the remaining three are bearish.

this is not a market-timing call, hulbert makes clear. but even if S&P 666 represented the low point in price of this bear market, it remains likely that equities will trade in sour fashion until most of davis' criteria are met.

revisiting skew and fear

2009-07-29T14:28:00.003-05:00

early in july i cited jason goepfert and his analysis of the CSFB fear index. goepfert:

There have been four other times during a bear market when we've seen a divergence like this, when the VIX is at a multi-month low, but the CSFB Fear Index is at a multi-month high. Over the next three months following those four instances, the S&P averaged -9.2%, and with a risk that averaged more than 6 times greater than the average reward.

today zero hedge updates that reading by running a comparison chart to the VIX.

psychology of the housing market

2009-07-29T09:49:00.005-05:00

calculated risk has put forward a couple of interesting posts on the reportage surrounding the latest case-shiller house price index release.

his view on the fate of prices is much like mine own longstanding -- prices follow peaks in starts and inventory at several quarters of lag.

yesterday:

The reason I bring this up is the Case-Shiller report today really bothered me. To be more accurate, the reporting on the Case-Shiller report bothers me. As I mentioned earlier today, there is a strong seasonal component to house prices, and although the seasonally adjusted Case-Shiller index was down (Case-Shiller was reported as up by the media) - I don't think the seasonal factor accurately captures the recent swings in the NSA data.

I have no crystal ball - and maybe prices have bottomed - but this potentially means a negative surprise for the market later this year - perhaps when the October or November Case-Shiller data is released (October will be released near the end of December). If exuberance builds about house prices, and the market receives a negative surprise, be careful.

and more today:

These are influential writers.

Streitfeld has been writing about the housing bubble and collapse for years. The Atlantic named him "The Bard of the Bubble" in 2006.

Hong has only been covering housing for a couple of years, but he has also done a very good job.

Of course I think house prices will continue to decline in the Fall, and that the May report was distorted by seasonal factors.

please consider that, over the next several months, we are going to witness the closure of hundreds of banks as the collapse of american commercial real estate feeds through the financial system. these banks, especially in the aftermath of the collapse of mortgage securitization, are important originators to the residential mortgage market. over time, surviving american banks in an environment of inadequate fiscal stimulus have great potential to be funding constrained as deposits decline and current account deficits narrow, promoting asset liquidation. further given the massive trauma suffered by household balance sheets and incomes in this depression, with the historical pattern of housing busts cited above as context, housing is very likely to have a long tail of price decline under these circumstances.

and yet, there is actual optimism about a bottom in house prices in press reportage over this first seasonal uptick in three years.

bubble psychology dies hard -- i still remember sitting in the dentist's chair back in late 2001 fielding questions from him as he scraped my teeth about when lucent technologies would "come back". a return to "normal" is part of the human preconception of all stressful times. much harder for most people is to realize that the aberration is not in the crash but in the bubble which preceded it. and it would appear that remnants of bubble psychology is still hanging on, even at this late date.

UPDATE: calculated risk examines the insufficiency of the current seasonal adjustment in the case-shiller series given the volatility of house prices in recent years.

[L]ook at the last couple of years. The SA dashed line is very close to the NSA line, even with the wild NSA swings. This suggests to me that the seasonal adjustment is currently insufficient and I expect that the index will show steeper declines, especially starting in October and November.

Even with the wild NSA swings, most media reports used the NSA data and not the SA data (Streitfeld at the NY Times used both).

this is a similar observation to the one i made in examining the standardization factors for the LEI as related to the explosion in m2. how the data is being adjusted using historical series volatility as a baseline in this new environment of radical volatility is coloring the interpretation of data. it's important to try to see through these statistical effects to get a clearer picture of what's happening.

UPDATE: alphaville with the criticism of free exchange. i comment:

free exchange misses it, i think. CR is basically arguing that the volatility of house prices changes has increased materially beyond that which was witnessed in the historical series section which was used to derive the adjustment. it's not that the seasonal factor has intensified so much as the movement of prices has intensified -- they've become unsticky, as it were, and i don't know too many people who would argue the point.

for so long as this is true -- which i imagine will be the duration of the delevering of the american banking system and household at least -- one should expect SA to not quite do the job.