When the 15-minute and 3-minute charts are harmonious, then I trade only in one direction -- the direction the two time frames are moving. When the two time frames aren't moving in the same direction, then I take smaller positions, but will consider trades in both directions. I use the Exponential Moving Average to determine the direction of the time frames.
Friday, November 6, 2009
the email content from Mish Shedlock:
The Fed prints money by Buying Treasuries from banks. The treasuries go on to the balance sheet of the Fed while banks get the freshly printed money.
To drain money the Fed Sells treasuries to banks and the banks whether they like it or not have to participate.
The Fed can either defend a currency target or an interest rate. It cannot do both. If it wants to lower short term rates it has to supply enough money to do so. If it wants to raise rates to some target it has to drain money.
The Fed has a problem at 0% because if it wants to lower rates it cannot, no matter how much it prints.
U-6 was 17.5%! The household survey will present the most accurate picture of what's really going on! Jobs in the construction and manufacturing sectors contracted "heavily"!
It is significant also that jobs were added in TEMP employment. This is an indicator that job losses will INCREASE in months ahead when those temp jobs go POOF and disappear! They're temporary, after all.
Thursday, November 5, 2009
Wednesday, November 4, 2009
For this reason, I sit out during these news announcements. The risk is too high and the volatility can do devastating damage to a trading account in just a few minutes.
Tuesday, November 3, 2009
"We are rapidly approaching a pivot point," says Doug Kass, a general partner of Seabreeze Partners, "when all the stimulus factors -- such as abnormally low interest rates and government bailouts -- will be withdrawn, and investors will begin to discount that." Kass, who has grown more bearish recently, thinks that a continued weak consumer, an end to the cost-cutting that's fueled corporate-profit growth, and higher taxes, among other things, will mean self-sustaining earnings growth is "far less certain" than the market expects. -- Barron's (Nov. 2, 2009)Over the weekend, I was interviewed in Barron's Streetwise column by Vito Racanelli.
As mentioned in Barron's and last Monday night on CNBC's "Fast Money," we are now approaching the point of maximum fiscal and monetary stimulus.
That means that, statistically, we are moving ever closer to tightening.
Moreover, I have recently argued that not only did much of the fiscal stimulus merely have a temporary affect, less than one multiplier and borrowed from future sales (e.g., "Cash for Clunkers"), but that the underlying strength of the economy was fragile and that the consequences of massive fiscal and monetary stimulation had consequences (e.g., currency debasement and higher marginal taxes) that would serve as a brake on growth and profits in 2010-2011.
So, without further ado, Dave Letterman-style, here are the top 20 signs how bad the economy is!
- 20. The economy is so bad that Barack Obama changed his slogan to "Maybe We Can!"
- 19. The economy is so bad that Sarah Palin is only shooting moose for food, not for fun.
- 18. The economy is so bad that when Bill and Hillary travel together, they now have to share a room.
- 17. The economy is so bad that instead of a coin toss at the beginning of the Super Bowl in February, they will play "Rock, Paper, Scissors."
- 16. The economy is so bad that Angelina Jolie had to adopt a highway.
- 15. The economy is so bad that my niece told me she wants to dress up as a 401(k) for Halloween so that she can turn invisible.
- 14. The economy is so bad that I ordered a burger at McDonald's (MCD Quote) and the kid behind the counter asked, "Can you afford fries with that?"
- 13. The economy is so bad that I saw four CEOs over the weekend playing miniature golf.
- 12. The economy is so bad I saw the CEO of Wal-Mart (WMT Quote) shopping at Wal-Mart.
- 11. The economy is so bad that Bill Gates had to switch to dial up.
- 10. The economy is so bad that rapper 50 Cent had to change his name to 10 Cent.
- 9. The economy is so bad that they Pequot tribe built a reservation on the site of one of their casinos.
- 8. The economy is so bad that the Treasure Island casino in Las Vegas is now managed by Somali pirates.
- 7. The economy is so bad that if the bank returns your check marked "Insufficient Funds," you call them and ask if they meant you or them.
- 6. The economy is so bad that I bought a toaster oven and my free gift with the purchase was a bank.
- 5. The economy is so bad that the only company hiring this week is the one that sends people to scrape bankers off of Wall Street sidewalks.
- 4. The economy is so bad that I went to my bank to get a loan, and they said, "What a coincidence! That's just what we were going to ask you!"
- 3. The economy is so bad that a picture is now only worth 200 words.
- 2. The economy is so bad that Hot Wheels stock is trading higher than GM.(This is literally true!)
1. The economy is so bad that the guy who made $50 billion disappear (Madoff) is being investigated by the people who made over $1 trillion disappear (our policymakers)!
Doug Kass writes daily for RealMoney Silver, a premium bundle service from TheStreet.com. For a free trial to RealMoney Silver and exclusive access to Mr. Kass's daily trading diary, please click here.
from Mish Shedlock:
David asked if I had any comments on his article Debt-deflation: Just the beginning? Here is a partial listing:
The debate rages on.Dave's research is a 70 page Slideshow On Debt-Deflation that is easy enough to read or download from Scribd.
Is inflation or deflation the bigger threat? There are lots of people -- lots of smart people -- on both sides of the debate and they present lots of good arguments. One thing that I have not seen -- and maybe I just missed it -- was an analysis using Irving Fisher's debt-deflation framework. So I decided to put one together myself and to inject my understanding of what Bernanke is try to do to stop deflation from taking hold.
The question I keep coming back to, especially as I read more about the situation Japan faced (I'm reading everything I can by Richard Koo, including his book "The Holy Grail of Macroeconomics."
And just to make sure I am not being one-sided, I am countering my fears of deflation with "Monetary Regimes and Inflation" by Peter Bernholz, which should arrive next week.
Without further ado, below is my research on debt-deflation.
Here is my response ....
You should not be afraid of deflation.
You should be afraid of policies attempting to fight it.
Deflation (rather price deflation) is actually the natural state of affairs. As productivity increases, more goods and services are produced relative to the population and prices would therefore be expected to drop.
It is the Fed, along with misguided Keynesian and Monetarist economists who think falling prices are a bad thing. Who amongst us does not like falling prices (except of course on things we own like houses, but even then who is not sick of higher property taxes that result)?
The reality is inflation benefits those with first access to money. Guess who that is? The answer is easy: banks, government, and the already wealthy. Inflation is actually a tax on the middle class and the poor who get access to money last. During the housing bubble, by the time the poor could get access to to money easily, it was far too late to buy.
Given that inflation benefits those with first access to money, any targeted inflation at all is morally wrong.
Note that Congress has passed 300+ affordable housing measures over the years and all of them failed. The irony now is Congress has simultaneously passed measures hoping to prop up the price of homes while seeking still additional money to create affordable housing.
Home prices need to fall (and will fall) to levels of affordability based on wages and wage growth regardless of what the Fed does. Thus, efforts to prop up prices are triply stupid: They are costly; They they will not work (prices will fall to where they are headed anyway); and they will delay a recovery.
Deflation is only bad in the context of the short-term pain it will involve. Moreover, it is important to remember that the pain of deflation is relative to the inflation party that preceded it. That party must be paid for either in terms of time or price.
Following the Footsteps of Japan
The irony is Greenspan and Bernanke repeatedly criticized the Bank of Japan for not writing off bad bank debts. So what do we do?
We are Following the Footsteps of Japan even though we have proven without a shadow of a doubt it is economic insanity.
Psychology of Deflation Revisited
In January 2007, someone on the Motley Fool told me "Too even compare the citizens of Japan to the US is stupid, stupid, stupid Forest Gump!"
I was also told "Fannie Mae can revive the housing bubble" and that I "ignore an enormous amount of 1990s monetary theory by Bernanke and co about how they would have dealt with Japans deflation."
Inquiring minds can read Q&A on the Psychology of Deflation to see my replies.
It now seems that Things That "Can't" Happen, did happen.
Indeed Economic Madness Is Repeatedly Endless
Bernanke's Deflation Preventing Scorecard
In case no one is keeping track, Bernanke has now fired every bullet from his 2002 “helicopter drop” speech Deflation: Making Sure "It" Doesn't Happen Here.
Misunderstanding Japan's Lost Two Decades
Richard Koo of Nomura Research Institute Ltd. says U.S. Risks Japan-Like ‘Lost Decade’ on Stimulus Exit.
I say U.S. Faces Second Lost Decade "Because" of Misguided Stimulus
Real Lesson of Japan's Lost Decades
The real lesson is no matter how much money you throw around, economies cannot recover until uncollectible debts and malinvestments are written off. That is why you have “zero interest rates and still nothing’s happening.”
The moment fiscal stimulus stops economies are virtually guaranteed to relapse until asset bubbles deflate, and malinvestments and bad debts are written off.
Bailing out the banks did nothing to fix these problems. Consumers are still saddled in debt, in underwater mortgages, with no job. Moreover, there is no driver for jobs given rampant overcapacity in nearly every sector.
Banks do not want to lend in this kind of environment so they don't. Businesses do not want to expand in this kind of environment so they don't. Meanwhile the Obama administration is making matters worse by increasing taxes on small businesses and proposing everyone pay for health insurance, with businesses forced to offer a plan or pony up part of the cost.
This too is giving small businesses an incentive not to hire. Housing prices are too high yet the Administration and Congress are hell bent on propping up prices. The solution is to let prices fall until they are affordable.
Illusion of Stimulus
Recoveries based on stimulus are nothing but an illusion. Here is a snip worth reading from U.S. Faces Second Lost Decade "Because" of Misguided Stimulus written by my friend "HB" about Christina Romer, chair of Obama's Council of Economic Advisers.
I know Christina Romer best for her misinterpretation of what happened in 1937-38. She believes that the fallback into full-scale depression from 'depression light' (as evidenced by unemployment in 1938 almost returning to the highest levels of the depression trough 32/33) is proof that it was a mistake to tighten policy (fiscal and monetary) too early.Understanding Velocity
In other words, according to her, if the Fed had continued pumping as furiously as possible, then everything would have been alright.
In reality, the entire inflationary mini-boomlet-within-the-depression was simply an illusion. 'GDP growth' that is bought with monetary pumping and feckless fiscal spending only misdirects and ultimately consumes even more scarce capital.
Fiscal stimulus may temporarily give the impression of a recovery, but it is not a genuine recovery. It makes things worse. The moment the pumping is abandoned, the true state of affairs is simply unmasked. That is what happened in 37/38 - a slight tightening of monetary policy revealed the fact that the mini-boomlet was as unsound as its predecessor boom in the years prior to the '29 crash.
It would not have been possible to hide this reality forever. There is nothing, absolutely nothing, that government intervention can achieve in terms of 'fixing' the economy. The choice was in either abandoning the unsound policy and the unsound investments it produced, or careen toward a complete destruction of the currency system.
Once again, I stand amazed at how people can look at this, and look at Japan, and look at the housing bubble/bust sequence, and still believe that monetary pumping and deficit spending are viable tools of economic policy when a bust occurs. It really boggles the mind, reminding me of Einstein's definition of insanity, 'doing the same thing over and over again and expecting a different result'.
David had several slides on velocity. The important point he missed is that velocity of money is a result not a cause of anything to come.
Velocity is falling because the Fed is printing hoping to stimulate the economy but banks are not lending because
1) credit risks are high
2) there is rampant overcapacity everywhere, thus businesses have no reason to expand
3) credit worthy consumers do not want to borrow
The attitudes of lenders and potential borrowers have changed. Under these conditions, the more Bernanke prints, the lower velocity will go.
Spending Collapses In All Generation Groups
Please consider Spending Collapses In All Generation Groups
It's no secret that boomers fearing an underfunded retirement have sharply cut spending. However, it's not just boomers cutting back. Consumer attitudes toward debt have changed across all age groups.
Bernanke can flood the world with "reserves" and indeed he has. However, he cannot force banks to lend or consumers to borrow.
Here is a simple analogy that everyone should be able to understand: You can lead a horse to water but you cannot make it drink. And if the horse does not want to drink, it was a waste of time and energy to lead the horse to the water.
In a debt-based economy, it is extremely difficult (by monetary policy) to produce inflation if consumers will not participate. And as noted above, demographics and attitudes strongly suggest consumers have had enough of debt and spending sprees.
Government bodies like Congress can theoretically produce inflation but Japan tried and failed for years.
In the US and globally we are in uncharted territory. Odds are we will see many things we have never seen before as stimulus after stimulus fails to produce desired results.
I ask you to consider Twelve Reasons For A Job Loss Recovery.
Humpty Dumpty On Depression Conditions
The conditions now are very similar to what happened in the great depression, discounting for the moment this reflationary effort by the Fed that is doomed to fail.
For more on the conditions one would expect to see in deflation please consider
Humpty Dumpty On Inflation.
Some of those conditions have changed since December. However, bank failures, total bank credit, and short term treasury yields near 0% have not. Moreover, long term yields have ticked up but they are still at historic lows compared to anything but the lows last December.
It is important not to confuse a recovery in the stock market with an economic recovery.
Don't just take my word for it. Please consider Leading indicators and the shape of the recovery by Paul Krugman?
Michael Shedlock has an awesome takedown of ECRI’s claim that its indicators (a) have successfully predicted turning points in the past (b) point to a sold recovery now. I’d add that this is a really, really bad time to be relying on conventional indicators.
Why? Basically, because in a zero-interest rate world — the three-month rate was .066% last I looked — especially one that’s suffered from a collapse of the shadow banking system, conventional indicators don’t mean what they usually mean. Increases in the monetary base aren’t especially expansionary. The yield curve more or less has to slope up, even if no recovery is expected. And so on.
So historical correlations, to the extent that they exist — and as Shedlock points out, ECRI is claiming a much better record than it really has — can’t be counted on to prevail. There’s really no alternative to making fundamental analyses of the macro situation.
This is a once in several generational event. I bet the ECRIs leading indicators applied in April of 1930 would have looked quite similar.
One thing is for sure, is that Krugman does not hold any grudges. I sure have to give him credit for that. I also happen to agree with Krugman when it come to free trade for which we are both strong proponents.
Unfortunately however, there is a rising tide of protectionism in Congress and this Administration. Note that the Smoot-Hawley Tariff Act is one of the things that made the Great Depression much worse.
States are repeating another mistake by raising property taxes.
Keynesian Model Broken Beyond Repair
The Keynesian and Monetarist models are broken beyond repair.
It is amazing that so much love exists for a man whose ideas have been thoroughly discredited on many occasions. Here is a little blurb from the American Journal of Economics and Sociology.
The crisis policy devised by John Maynard (Lord) Keynes, which seemed to work well during World War II and in postwar reconstruction, met its nadir in 1975. Contrary to Keynesian theory, formalized in the Phillips Curve argument that inflation and mass unemployment are mutual trade offs, double digit inflation and record unemployment made further deficit spending an impossible policy.In case you fail to understand the implications, Keynes is arguing one cannot have a recession and inflation at the same time.
Did The Keynesian Economists Give Up Their Theories Confronted With Japan?
The answer is no. Stagflation in the 70's discredited Keyensian theory as did Japan's building bridges to nowhere.
Keynesian economists now say the problem was Japan simply did not act fast enough.
The amount of global monetary stimulus thrown at curing the deflation problem is staggering. Yet here we are with the same debt overhang, no jobs, and no way to pay off that debt. Deflation looms larger than ever because of Central Bank efforts to fight it.
Let's return to the beginning. It's important to remember that inflation and deflation about not about prices but rather about the expansion of money supply and credit. Concern over prices is putting the cart before the horse.
Fantasizing In Academic Wonderland
Keynesian academic models do not work in a real world, with real people, where attitudes and global forces such as global wage arbitrage are in play. The Fed cannot force consumers to borrow or banks to lend. Nor can the Fed create jobs. Congress can create makeshift jobs but as we have shown above, makeshift jobs cannot possibly create a solid economic foundation.
In response to the above someone is sure to tell me how negative interest rates could be used to force banks to lend. My response is forcing banks to lend cannot and will not work in actual practice.
One reason Bernanke wanted to pay interest on reserves was to slowly recapitalize them over time. One cannot achieve that while forcing them to lend. Moreover forcing banks to lend will do nothing but increase further writeoffs.
Again, it is important to look at how things operate in a real world model, with real consequences, as opposed to fantasizing in academic wonderland about how to force banks to lend.
Fiat World Mathematical Model
Logically speaking, when the problem is debt is to high, it is insane to think a spending spree will fix the problem. Even a 6th grader would be able to understand this, but Keynesian and Monetarist academic wonks just cannot manage the task.
Greenspan stimulated the economy in 2002 and all we have to show for it is a collapsing housing bubble and still more debt.
Instead of following a Keynesian model that does not work, please consider a Fiat World Mathematical Model.
I believe Steve Keen and I have it correct. In a credit-based, fiat-currency model, deflation will always manifest itself as debt-deflation. Price deflation is a meaningless sideshow.
I am not sure how far along we are with debt deflation given that much depends on how far and how long the Fed and Congress attempts to fight it. The preliminary results however, do not look very good. I expect a second lost decade in the US, just as happened in Japan.
Mike "Mish" Shedlock
Historically, both indices have generally tracked Mean Household Income, but as this chart in a new report from St. Louis Fed (.pdf) indicates, as of the middle of this year, there's still no convergence. And based on the upswing in Case-Shiller numbers over the summer, that's still the case.
Remove all of the extraordinary government support from the market, and it's easy to see prices dipping below the lines before they stabilize.
By Martin Hutchinson
Yes, I know we've just had the 80th anniversary of the 1929 crash. So what? We can learn a lot from past crashes and economic disasters, but that particular one is looking less and less relevant to the position we are in today.
For a start, the stock market of 1929 was valued at a level that appears truly moderate by today's standards. The overall price-earnings ratio of the market at its peak of September, 1929, was a mere 13.5 times earnings. Even its hottest tech stock, Radio Corporation of America, never traded in that year above 28 times earnings.
One thing one can learn from those statistics is that valuation standards have changed. The investors of 1929 undoubtedly
thought they were at the top of a bull market. Indeed market trends since 1922 had indeed formed a major bull market, with stock prices rising around 350%, however reasonable the market's valuations at the peak.
It may well be that as the amount of capital gradually increases in the economy, its productivity becomes less, so that real yields on bonds, stocks and presumably real estate in 2009 are far below the level that would have been considered appropriate 80 years ago - and relative prices higher. This possibility would also be suggested by the curious behavior of capital productivity, as reported by the US Bureau of Labor Statistics since 1947. This rose steadily to a peak in 1966 and has been declining ever since, now to a level well below its initial 1947 level.
Naturally, a steady reduction in the productivity of/return on capital over a period of many decades could be one factor explaining the prolonged rise in asset prices and decline in yields coinciding with the loose post-1995 monetary policy. It doesn't explain or justify all of such a change because the period since 1995 is far too short a proportion of the overall 80 years since 1929, but it suggests that some portion of the post-1995 price rise, maybe a quarter, has been caused by a natural secular long-term trend, rather than artificially pumped up by the machinations of the Federal Reserve and Wall Street.
This thesis also suggests that our long-term future may be a grim one in which returns on savings are ever declining, and few people ever manage to accumulate enough resources to retire in comfort, let alone to afford the spiralingly expensive real estate in cities and the pleasanter suburbs. The glorious 1950s suburban dream of home ownership, even at a modest level, may in the end prove to have been sadly temporary.
To return to 1929, if the stock bubble of that year was so much smaller than recent ones - market capitalization at the peak was only about 85% of gross domestic product (GDP), compared with 180% in 2000 or 2007 - then its decline cannot have caused the Great Depression, or anything more than the first downward leg thereof in 1929-30.
Indeed, for the first time this generation has empirical evidence that the '29 crash is unlikely to have caused the depression. The 1987 crash, which was larger than 1929 in its one-day drop, caused no discernable economic depression. And the deep recession of 2007-09, while clearly triggered by a financial crisis, was accompanied only by a steady decline of stock prices with no great economy-sapping crash.
As this column has discussed in the past, the true causes of the Great Depression were the Smoot-Hawley tariff, the fall in US money supply caused by the banking collapses of 1930-33 and president Herbert Hoover's utterly foolish tax increases of 1932. The downturn was then unnecessarily prolonged by a number of president Franklin Roosevelt's New Deal polices, notably his ramping up of the size of government and the power of unionized labor. The crash of 1929 was not quite an innocent bystander, but damn close.
There are much more relevant economic crises than that of 1929 to look at, with more to teach us today. For one example, there is the British secondary banking crisis of 1973-75. In that case, as recently, money supply had been allowed to race ahead of itself in 1971-73 while banking deregulation had caused the appearance of innumerable fringe banks, all attempting to make money by lending to commercial and residential real estate.
The problem was exacerbated by a public expenditure bonanza by the incoming Labor government in March 1974, seeking to consolidate its tenure at a second general election in October of that year and to placate its unruly leftist supporters. Sound familiar? It should.
The real-estate overvaluation problem was solved by a few years of high inflation, touching 25% in 1975, which limited the decline in real estate values, instead causing nominal prices and incomes to rise to meet them. The fringe banks were liquidated through a "lifeboat" sponsored by the Bank of England.
The recession which resulted from the 1973-75 crisis was fairly mild, but the inflation certainly wasn't. What's more, the British economy never got back to decent growth in the next decade. Two years after the crash, a severe government funding crisis occurred, which resulted in the International Monetary Fund being called in, and a second more severe recession struck in 1979-82.
The 1973-75 UK experience strongly suggests that simultaneous fiscal and monetary stimuli are dangerous, and that the recovery from the resultant recession may be something of a false dawn.
The secondary banking crisis of 1973 is fairly well remembered; the British Overend, Gurney & Co crash of 1866 is almost completely forgotten, though it got some mention in the British press when Northern Rock went bust in 2007. This crash is interesting because Overends operated in a manner very similar to modern Wall Street, and very dissimilar to its contemporaries.
Rather than functioning as a private bank or a merchant bank, the two common operations at that time, Overend was London's largest discount house, trading short-term bank obligations and issuing 90-day paper of its own. Instead of being content with the highly satisfactory and consistent returns from this lucrative business, Overend (whose CEO lived in palatial state, more like a modern Wall Streeter than his contemporaries) used its short-term funding to invest in long-term ventures, essentially financing private equity through commercial paper. Naturally, when a liquidity crisis hit, Overend was unable to roll over its obligations, even though it had attempted to rescue itself by an initial public offering the year before.
In today's market, Overend would have been bailed out. Its size and interconnectedness made it the AIG of its day (and its tough and raffish reputation compared to its staid contemporaries increased the resemblance). In 1866, it was allowed to fail. The result was an acute but short-lived market panic, maybe a year of very quiet business in financial services, and then several years of renewed prosperity until the crash of 1873. "Too big to fail" proved to be nothing of the sort.
The third crisis from which we can learn was the simultaneous Mississippi Company (France) and South Sea Company (England) crashes of 1720. Both involved schemes to refinance their country's national debt through exchanging it for shares in growth companies (to be fair, even in the past year, we have yet to see a proposal for a federal debt swap into Google - maybe that is ahead of us.) The French scheme additionally involved issuing paper money, thus making its proponent, John Law, something of a hero to Keynesian economists.
In any case, both schemes collapsed, but the fate of the economies concerned was very different. In France, there were no recriminations (other than against the foreigner Law, who escaped), nor was there any significant effort to reform the financial or political system, or to limit investor losses. Consequently, investor confidence in the French monarchy remained shaky throughout the 18th century, hampering it considerably in that century's wars and eventually causing a budgetary crisis that set off the events of 1789.
In Britain, on the other hand, there was a House of Commons enquiry, several politicians and South Sea directors were imprisoned, and a partial bailout of the company was organized. Consequently, investor confidence in the British government remained strong, to its great future advantage. The one bad British policy was passage of the Bubble Act of 1720, preventing company formation without an Act of Parliament (this was not repealed until 1825). This legislation has been held by some economists to have held back Britain's industrial revolution by half a century or more.
The lessons of 1720 are thus that it is essential to maintain confidence in the financial system, and that misguided corrective legislation can damage the economy for decades. Again, there would appear to be applications for this wisdom today.
Federal Reserve chairman Ben Bernanke believes that today's monetary policy should be primarily governed by the lessons of the Great Depression. However, over the centuries, there have been other financial disasters, whose lessons appear rather more pertinent.
Martin Hutchinson is the author of Great Conservatives (Academica Press, 2005) - details can be found at www.greatconservatives.com.
The governments of every major nation are going to default on their debts. There are two relevant questions: (1) How? (2) When?
Establishments around the world all deny this. They have gained power and wealth by means of the expansion of government. They have justified their success by insisting that the government-business alliance is the only way to establish economic growth and economic security for the masses. This claim rests on a more fundamental claim, namely, that an unhampered free market is destructive of economic stability and will inevitably lead to economic depression.
The Establishments are universally Keynesian. John Maynard Keynes' book, The General Theory of Employment, Interest, and Money, was published in 1936. It defended in theory what all Western governments had been doing in practice for at least five years, namely, running huge deficits. Keynes became as close to an academic high priest as any modern scholar ever has. He was the apostle of national government debt. His ideas today are more influential than they were at his death in 1946. We live in the age of Keynes.
I can think of only one major Establishment figure who has broken with the Establishment on the question of the great default: Peter G. Peterson, who was the chairman of the Council on Foreign Relations until 2007. He now runs the Peter G. Peterson Foundation, which focuses on the looming bankruptcy of the U.S. government. More than any other person of influence, he has warned of the bankruptcy of the Medicare/Social Security programs and their equivalents in the West.
Peterson a decade ago said that he had spoken with the major leaders of the West about the impossibility of funding these social programs. They all told him the same thing: "I will not be around at that time." In short, kick the can.
For older Americans, a single mental image above all others illustrates this perpetual relationship. It is their memory of the annual Sunday cartoon in the cartoon strip, "Peanuts," which was the most widely read cartoon strip – and therefore the most widely read anything – in the United States for at least three decades. The annual cartoon featured two children: the ever-mendacious Lucy, whose hand supported an upright football on the ground, who encouraged the ever-trusting Charlie Brown to run at the ball and kick it. He always believed her. At the last moment, she would pull the ball away, and Charlie would fly into the air, then land on his back. What changed each year was her argument on why she would not pull the ball away, and her final remark to Charlie, as he lay flat on his back. She thought he was stupidly naïve. He was. She always took advantage of him. Her philosophy was clear: "Never give a sucker an even break."
This scene is repeated every other November in the United States, when voters go to the polls. "This time, it will be different," cry the Congressional candidates. Then, for the next two years, they pull the ball away.
The only thing to top this exercise in mendacity in the United States is the testimony to each house of Congress delivered by the Chairman of the Federal Reserve System. Not even the President's annual State of the Union address tops this performance.
The voters never learn. Congress never learns.
The coin of the political realm is the promise. Not money, not power: the promise. Politics sometimes looks like prostitution, with money at the center. This is an illusion. The voters do not come to Congress demanding money. They demand faithfulness. Congress is to the voters what a philanderer is to a mistress. He may shower her with presents, but the presents have meaning to her only because of the promise. "I plan to divorce my wife. It's just a matter of working out the details." She likes the presents, but she believes the promise: "You can trust me. We'll grow old together." She thinks the presents are forever.
He borrows the money to buy her the presents. When interest rates rise, she will find out just how reliable his promises have been.
This is the heart of modern democracy. Politicians promise undying faithfulness. Voters believe them.
The first political campaign I can remember was the 1952 Presidential election. I recall only one event clearly. It was a singing group at the Democrats' national convention. They sang the following:
Then came the chorus:They promise you the sky.
They promise you the earth.
But what's a Republican promise worth?
Eisenhower was elected. Both houses of Congress went Republican. This had not happened since 1928. It would not happen again until 2000. They didn't take it away. They added more.Don't let 'em take it,
Don't let 'em take it,
Don't let 'em take it away!
The great advantage of political promises is that the politicians who make them will not be in office when the bills come due. The benefits are immediate: votes. The costs are deferred. The supply of promises increases.
These promises rest on assurances. "Treasury debt will continue to have a AAA rating." "Treasury debt is backed by the full faith and credit of the United States." "There is no alternative to the U.S. dollar as a world reserve currency." "We owe it to ourselves." "Deficits don't matter." "Inflation is under control."
With the exception of Austrian School economics, every major school of economic thought believes in at least four of these assurances. Keynesians believe all of them.
So, the supply of promises increases. So does the magnitude of these promises. For as long as investors buy the Treasury debt and the GSE debt (Fannie and Freddie), there will be no reversal of this process.
The advent of the day of reckoning is easy to describe: (1) the upward move of Treasury interest rates, or (2) the upward move of prices in response to the Federal Reserve System's expansion of its balance sheet – monetary base – to hold down rates.
Then will come the wail of the aging mistress: "But you promised!" Indeed, he did, but a younger mistress has come along, and she wants the presents that he had promised the first one. When lenders start tightening up, a philanderer has to pick and choose among his mistresses. Old ones lose.
But what of the faithful wife? When will she finally wise up and divorce the lying SOB?
I am writing this report for her.
You know about the size of the on-budget Federal debt. If not, go here.
You presumably know about the size of the officially estimated deficits in the on-budget account: at least $900 billion a year until 2019. If not, go here.
Voters are oblivious. They do not care about anything beyond their next paycheck. Investors are oblivious. They do not care beyond the next quarterly report. Congress is oblivious. They do not care beyond the next election.
Am I saying that Congress has a longer-term perspective than investors? Yes. But why? Because investors believe two things: (1) the existing price of any asset reflects the best judgment of the smartest investors; (2) they will be smarter than all these other investors when it comes time to sell and buy gold.
The average American faces his day of reckoning on the first of every month. Congress faces its day of reckoning in November of even-numbered years. Investors do not believe that they, individually, will ever face a day of reckoning. They think they are smarter than the smartest guys in the room, or else they think Ben Bernanke is, and all those other FED economists are, who will see the crisis coming next time and will take steps to evade it.
Congress also thinks that the FED's economists will find ways to evade the day of reckoning.
Investors and politicians are united. They trust the ability of central banks to evade the costs of political promises. This has been true since 1694, when Parliament granted a monopoly over money to the Bank of England. Parliament wanted a lender of last resort. That was what the head of the Bank of England promised.
The political promises of every nation rest on faith in central banking. The politicians and the investors are united in a confession of faith. This confession of faith rests on an assumption: with fiat money, there can be a free lunch, indefinitely. Every school of economic opinion except the Austrian School also affirms this.
There is a problem with this confession. It is not true. There is no such thing as a free lunch. Fiat money is counterfeit money. It does not create wealth. It destroys wealth.
Congress has promised money. It has also promised wealth. Congress will default on at least one of these promises.
We are back to my original two questions: (1) How? (2) When?
Default has four major forms. We need to consider all of them.
At some point, the government will not be able to find buyers at low interest rates. Rates will rise. The economy will sink into a depression. Revenues will decline. Expenditures will rise. The government will not be able to pay all of its obligations. So, it will raise taxes. The depression will get worse. Revenues will again fall.
Investors will know that the government is likely to default. No credit-rating service will have the courage to downgrade the government's debt, but rates will rise as if they had. The government will reach the day of reckoning. It will default on all of its debts.
Every institution that has government debt in its portfolio will suffer a loss. Its share price will fall. The depression will get worse. Insurance companies will be hit hard. The largest banks, which swapped their toxic debt with the FED at face value in late 2008 will find that they own the most toxic debt of all.
Foreign central banks will refuse to buy any more American Treasury debt. Technically, their portfolios fall to the extent that they held Treasury debt. Then those governments must decide. Should those banks be allowed to inflate to overcome these losses?
The inverted pyramid of debt will topple. The great default will produce the great depression. Unemployment will rise. Depositors will finally go to their ATMs to draw out currency. The banks will default: no withdrawals of currency.
The division of labor will contract. Everyone will get much poorer.
Because a default on all Treasury debt would have such widespread consequences – immediate consequences – economists have argued that this will not be allowed to happen. The central bank will buy the debt. But if it does, at some point it must stop buying or else create hyperinflation. Hyperinflation has the same consequence as default and deflation: a contraction in the division of labor.
I know of only one economist who predicts an outright default: Jeffrey Rogers Hummel. On August 3, 2009, he published an article on the free market site, Library of Economics and Liberty: "Why Default on U.S. Treasuries is likely." His argument is simple: the only alternative is the Zimbabwe option: hyperinflation.
He goes through the numbers. He makes an impressive case. He does not discuss the level of interest rates that would bring on the crisis, but at some point, the Treasury will have to offer high rates unless the FED intervenes.
He says that the welfare state is going to die, all over the world. I think he is correct. I am not convinced that outright default is likely – not before much higher price inflation arrives.
The strategy of the FED is the same as the strategy of Congress: kick the can.
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.The rationing will have to be severe. The promises will not come true.
Mass inflation seems more likely over the next decade. If the world's central banks can coordinate the expansion of money, thereby funding the national welfare states, the public will not be able to escape. They will pay the inflation tax.
The ways around this are limited to investing in real goods: commodities, small farms, used goods stores, small-town real estate. Not many people will see this in time. Of those who do, few will take action. These escape hatches are for people who are hedging against default. The average voter has no financial reserves. Of the 20% who do have reserves, 80% will be stuck in conventional investments. They will believe the Establishment's Keynesian line. "The government can fix it if you just hang on."
Inflation means the erosion of money. It means a hidden default on the political promises. Why hidden? Because the politicians will blame speculators. They will not blame the Federal Reserve for having bankrolled their promises.
I think central banks will at some point refuse to fund governments any longer. They will bail out the largest banks instead. Foreign politicians may force hyperinflation on their central banks, as agents of the government. But as long as the Federal Reserve System maintains its selective independence, it will not adopt hyperinflation as a policy. That would not be in the interest of the largest banks. It would also not be in the interest of central bankers. Their retirement promises would die.
from Wash Post:
THE FINAL White House estimate for the fiscal 2009 budget deficit is in: $1.4 trillion, or 10 percent of gross domestic product. To mark the occasion, Federal Reserve Chairman Ben S. Bernanke called for "a sustainable fiscal trajectory, anchored by a clear commitment to substantially reduce federal deficits over time." President Obama's budget director, Peter Orszag, promised that very thing: "As part of [next year's] budget policy process, we are considering proposals to put our country back on firm fiscal footing," he said.
Recently, pundits who favor additional stimulus spending have been pooh-poohing the whole trillion-dollar deficit thing, arguing that the real worry is double-digit unemployment and citing a historical argument: The last time the United States ran deficits of this magnitude, World War II, the nation coped and prospered.
But today's deficits, though smaller as a percentage of gross domestic product than the post-World War II deficits that the U.S. economy ultimately weathered, may be more difficult to unwind. Defense spending was the sole cause of the World War II deficits; it totaled 90 percent of federal outlays in 1945. At war's end, the United States demobilized, moving from a deficit of 22 percent of GDP in 1945 to a surplus of 1.2 percent of GDP in 1947 -- a swing of nearly one-quarter of GDP in just two years. By contrast, as data compiled by Michael Cembalest of J.P. Morgan show, today's federal spending is driven by mandatory programs: In 2016, entitlements and interest will make up 69 percent of the budget (with defense accounting for 18 percent). These are not only hard to cut quickly; they also have a way of growing unexpectedly. Crushing the Axis powers might seem like a cakewalk next to taking on the lobbies that defend Medicare, Medicaid, farm subsidies, Social Security and the rest.
Here's another difference: The government met its World War II borrowing needs out of U.S. domestic resources, including the sale of $185 billion in low-interest war bonds. The soothing Keynesian adage on deficits -- "we owe it to ourselves" -- applied. In the three years just after World War II, the United States eliminated a lot of its debt through high inflation, which peaked at 14.4 percent in 1947 -- but all the repercussions were domestic. Today, foreigners hold nearly half the $7.5 trillion U.S. public debt. As a result, the politics of deficit reduction are not only extremely difficult, they are extremely difficult and international. Inflation could trigger a global run on the dollar and a nasty interest rate spike. In the deficit debates to come, Mr. Obama should heed the hawks.
Monday, November 2, 2009
This recovery in risky assets is in part driven by better economic fundamentals. We avoided a near depression and financial sector meltdown with a massive monetary, fiscal stimulus and bank bail-outs. Whether the recovery is V-shaped, as consensus believes, or U-shaped and anaemic as I have argued, asset prices should be moving gradually higher.
But while the US and global economy have begun a modest recovery, asset prices have gone through the roof since March in a major and synchronised rally. While asset prices were falling sharply in 2008, when the dollar was rallying, they have recovered sharply since March while the dollar is tanking. Risky asset prices have risen too much, too soon and too fast compared with macroeconomic fundamentals.
So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fuelling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions.
Let us sum up: traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius – even if they are just riding a huge bubble financed by a large negative cost of borrowing – as the total returns have been in the 50-70 per cent range since March.
People’s sense of the value at risk (VAR) of their aggregate portfolios ought, instead, to have been increasing due to a rising correlation of the risks between different asset classes, all of which are driven by this common monetary policy and the carry trade. In effect, it has become one big common trade – you short the dollar to buy any global risky assets.
Yet, at the same time, the perceived riskiness of individual asset classes is declining as volatility is diminished due to the Fed’s policy of buying everything in sight – witness its proposed $1,800bn (£1,000bn, €1,200bn) purchase of Treasuries, mortgage-backed securities (bonds guaranteed by a government-sponsored enterprise such as Fannie Mae) and agency debt. By effectively reducing the volatility of individual asset classes, making them behave the same way, there is now little diversification across markets – the VAR again looks low.
So the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe – for now – for the mother of all carry trades and mother of all highly leveraged global asset bubbles.
While this policy feeds the global asset bubble it is also feeding a new US asset bubble. Easy money, quantitative easing, credit easing and massive inflows of capital into the US via an accumulation of forex reserves by foreign central banks makes US fiscal deficits easier to fund and feeds the US equity and credit bubble. Finally, a weak dollar is good for US equities as it may lead to higher growth and makes the foreign currency profits of US corporations abroad greater in dollar terms.
The reckless US policy that is feeding these carry trades is forcing other countries to follow its easy monetary policy. Near-zero policy rates and quantitative easing were already in place in the UK, eurozone, Japan, Sweden and other advanced economies, but the dollar weakness is making this global monetary easing worse. Central banks in Asia and Latin America are worried about dollar weakness and are aggressively intervening to stop excessive currency appreciation. This is keeping short-term rates lower than is desirable. Central banks may also be forced to lower interest rates through domestic open market operations. Some central banks, concerned about the hot money driving up their currencies, as in Brazil, are imposing controls on capital inflows. Either way, the carry trade bubble will get worse: if there is no forex intervention and foreign currencies appreciate, the negative borrowing cost of the carry trade becomes more negative. If intervention or open market operations control currency appreciation, the ensuing domestic monetary easing feeds an asset bubble in these economies. So the perfectly correlated bubble across all global asset classes gets bigger by the day.
But one day this bubble will burst, leading to the biggest co-ordinated asset bust ever: if factors lead the dollar to reverse and suddenly appreciate – as was seen in previous reversals, such as the yen-funded carry trade – the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments.
Why will these carry trades unravel? First, the dollar cannot fall to zero and at some point it will stabilise; when that happens the cost of borrowing in dollars will suddenly become zero, rather than highly negative, and the riskiness of a reversal of dollar movements would induce many to cover their shorts. Second, the Fed cannot suppress volatility forever – its $1,800bn purchase plan will be over by next spring. Third, if US growth surprises on the upside in the third and fourth quarters, markets may start to expect a Fed tightening to come sooner, not later. Fourth, there could be a flight from risk prompted by fear of a double dip recession or geopolitical risks, such as a military confrontation between the US/Israel and Iran. As in 2008, when such a rise in risk aversion was associated with a sharp appreciation of the dollar, as investors sought the safety of US Treasuries, this renewed risk aversion would trigger a dollar rally at a time when huge short dollar positions will have to be closed.
This unraveling may not occur for a while, as easy money and excessive global liquidity can push asset prices higher for a while. But the longer and bigger the carry trades and the larger the asset bubble, the bigger will be the ensuing asset bubble crash. The Fed and other policymakers seem unaware of the monster bubble they are creating. The longer they remain blind, the harder the markets will fall.
The writer is a professor at New York University’s Stern School of Business and chairman of Roubini Global Economics